The OECD Sept. 16 released its first set of deliverables under its Action Plan on Base Erosion and Profit Shifting, a project to rewrite the global tax system in order to curb the kind of tax planning that has allowed large multinational companies to pay low effective tax rates through practices such as the shifting of intangible assets across borders. The organization issued more than 1,800 pages of documents comprising its work on seven action items:
• Action 1—a report on tax challenges of the digital economy;
• Action 2—model domestic legislation and a model treaty provision for addressing so-called hybrid mismatch arrangements;
• Action 5—a report to the G-20 on countering harmful tax practices more effectively, taking into account transparency and substance, updating earlier OECD work;
• Action 6—guidance on measures for preventing tax treaty abuse;
• Action 8—guidance on transfer pricing aspects of intangibles;
• Action 13—guidance on transfer pricing documentation, including a country-by-country reporting template; and
• Action 15—a report on the legal feasibility of a using a multilateral instrument to update some 3,000 bilateral double-tax treaties around the world based on the OECD Model Tax Convention on Income and Capital in order to quickly implement the BEPS actions.
The report on the digital economy reflects agreement by the 44 countries involved in the BEPS project—the 34 OECD countries plus Argentina, Brazil, China, Colombia, India, Indonesia, Latvia, Russia, Saudi Arabia and South Africa—that “you can’t have special rules for the digital economy. You can’t ‘ring fence’ it,” said Raffaele Russo, head of the BEPS project.
The work done on the digital economy will have an impact on Action 3, which aims to strengthen rules for controlled foreign corporations, and Action 7, which aims to prevent the artificial avoidance of permanent establishment status. Russo said Action 7 will attempt to clear up “a pretty confused debate” on whether it is possible to do business without a physical presence—an element that the OECD task force on the digital economy has concluded is sometimes overstated and sometimes understated.
In the model legislation and model treaty language released under Action 2, Achim Pross, head of the organization's division on international cooperation and tax administration, pointed to three important concepts: linking rules, rule order and scope. The basic operation of linking rules means that where double non-taxation otherwise would occur, the domestic law of one country links to the other country's law to eliminate it. The linking rules are divided into a “primary rule” that applies whenever a hybrid mismatch arises and a “defensive rule” that “makes sure that the rule works whether or not every single country in the world adopts it. The new guidance also narrowed the scope of the rules, upping the originally proposed 10 percent common ownership threshold for meeting the definition of “related party” to 25 percent.
The OECD's progress report to the G-20 on harmful tax practices, the subject of Action 5, vows to continue work on preventing such practices with a specific focus on preferential intellectual property regimes. Russo said the BEPS project has established criteria to determine that a preferential regime is not harmful. First, the regime has to require the presence of a substantial activity.
Pascal Saint-Amans, head of the OECD’s Center for Tax Policy and Administration, said the guidance on treaty abuse under Action 6 “goes beyond what was expected” in containing a minimum standard that requires countries to include a main purpose test or a limitation on benefits test in their treaties. The fact that the Netherlands, which is used as a hub by companies for treaty shopping, has agreed to the minimum standard is “a game changer,” Saint-Amans said.
A significant development under Action 8 is countries’ agreement to eliminate “cash boxes,” Saint-Amans said. He cited the classic example of a Bermuda company owning and funding a “magic” brand, formula, or algorithm that generates significant cash. The company is entitled to the cash under a cost sharing arrangement with its headquarters company, and under the current interpretation of the arm's-length principle is entitled to the excess return. Some language is bracketed in the report on that action to reflect that it may change pending work on two other related actions. The bracketed language contains two options for dealing with cash boxes: recharacterizing the transaction as one that would not occur between unrelated parties, and applying a transfer pricing analysis that strips income out of the cash box.
A third option Saint-Amans described would be to adopt special measures outside the arm's-length standard under BEPS Action 9, to be developed in 2015, given that the arm's-length standard would operate to remunerate the cash box. Under a special measure, countries will be allowed to assert that they do not like the outcome of an excess return and will be able to "kill" the excess return through their tax treaties and domestic legislation.
The OECD’s work on Action 13 reflects changes described by an OECD official in March to a version of a template for country-by-country reporting that was released in January. The new template is six columns and asks multinationals to disclose to tax authorities their turnover, profits, accrued taxes, paid taxes, employees, and assets in all the countries where they operate. An implementation package for the template is still to come.
The report on Action 15 concludes that it is legally feasible for countries to develop a multilateral instrument in order to modify the network of bilateral tax treaties and thus swiftly implement BEPS measures. The more countries that sign the multilateral treaty, the more effective it will be, “but there is no need for all the countries to sign the convention,” Saint-Amans said. Some countries can implement BEPS through bilateral negotiation.
He said the BEPS project will draft a mandate to start negotiations of a multilateral treaty by January, and countries will then decide whether to start negotiations.
Molly Moses, Managing Editor, Transfer Pricing Report
To sign up for a free trial of Transfer Pricing Report, which has extensive coverage of the OECD’s BEPS plan, visit http://www.bna.com/Transfer-Pricing-Report-p7899/.
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