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By Gary D. Sprague, Esq.
Baker & McKenzie LLP, Palo Alto, CA
On July 6-7, 2015, the OECD held its last public Consultation on discussion drafts issued under the OECD/G20 BEPS project. The technical subjects of the Consultation were the final two discussion drafts to be issued on transfer pricing topics, namely, a proposed revision of Chapter VIII of the Transfer Pricing Guidelines (TPG) regarding cost contribution arrangements and a proposed addition to Chapter VI of the TPG on "hard-to-value intangibles." The OECD also took the unusual step of presenting at the Consultation a status report on the work relating to the other revisions to the TPG which is progressing under Actions 8-10 of the BEPS project.1
The flow of communications from the OECD is now silent over the summer, as the delegates endeavor to put all of the papers into final form. The final BEPS reports are to be reviewed and approved by the G20 Finance Ministers at their meeting commencing October 8. It is expected that the public will see the final reports shortly before that date.
As is typically the case in OECD consultations with business, the proceedings were opened with remarks from a government and a business representative. In this case, Michelle Levac of Canada, who currently serves as Chair of Working Party No. 6 (which deals with transfer pricing issues) provided comments from the government side, and Will Morris, Chair, BIAC Tax Committee, provided comments on behalf of business. This was the last consultation in a process that has involved an extraordinarily intensive effort on the part of the government delegates to respond to the political pressures that have driven the BEPS project, and an equally intensive engagement by business to provide comments on the proposals as they have been developed. Many exhausted tax policy professionals who have been engaged in the process of developing the new rules, as well as company tax officers who need simply to understand and apply the rules as they ultimately are implemented, have complained of "BEPS fatigue." Accordingly, more than a few ears perked up when Mr. Morris began his remarks with the comment that the BEPS process was not reaching its conclusion, but (using a sports analogy) was only ending its first half, with the second half set to commence in November.
Can it possibly be the case that the international tax community is only halfway done with this project?
I think that Mr. Morris is right, even though the official OECD/G20 work program will come to completion when the final reports are approved in October. The reason for the absence of actual completion at this stage lies in the ambiguities in the documents and the looming uncertainties for taxpayers as the new rules are implemented. In prior OECD projects, the implementation phase has not itself created uncertainty over the actual rules. Take as an example the revisions to the Article 5 Commentary released in 2008 which introduced the "services PE" rule into the Commentary as an alternative permanent establishment (PE) standard which determines tax nexus based on days of presence in the jurisdiction rather than on a "fixed place of business." The technical development process produced fairly detailed and precise guidance, now incorporated in the Article 5 Commentary, which defines when the alternative rule would apply. The implementation process itself didn't create uncertainty; for those governments that amended their treaties, their resident enterprises by and large knew what the rules would be if they sent personnel into the treaty partner State. For those governments that did not choose to amend their treaties, the alternative provision remained just that, an alternative that might be adopted, but in the absence of action had no relevance to the interpretation of existing treaties.
The BEPS process is not like that, for several reasons.
First, some critical technical work remains to be done, even though the two-year mandate of the G20/BEPS project is ending. While the final report under Action 7 on PE revisions will be released with the rest of the final reports in the fall, that report apparently will be silent on the profit attribution consequences to an enterprise that has a PE under the revised standards. That work will proceed during 2016, so that the full consequences of the Action 7 work cannot be known for at least another year. In the status report session, the OECD noted that additional work on profit splits also will be undertaken in 2016-2017, which, from the description, could be substantial work indeed. The expressed goal of the further work is to "unlock the potential of useful guidance within the framework of the most appropriate method rule." One senses that the delegates believe that current Chapter II has embedded within it enchained profit splits that are yearning to be free. Finally, the OECD also reported that further work will be done on the topic of financial transactions, although not much detail was provided as to the focus of that work. Thus, the work to be done in the next few years will not be limited to implementing the BEPS reports as issued in October, but will also include additional substantive technical work.
Outside the transfer pricing area, the Task Force on the Digital Economy will issue its final report in the near future. The current mandate of the Task Force is to monitor the BEPS process and issue a report as to whether any further work specific to the digital economy context is necessary. Business certainly is of the view that the existing BEPS proposals need to be given time to operate and mature before the OECD again considers whether any further policy or technical revisions are needed to address digital business models. After all, Working Party 6 itself has concluded that none of the proposed "special measures" should go forward at this time, except for the "hard-to-value intangible" proposal. It would be disappointing if the Task Force at this late stage were to propose further technical work, rather than concluding that the appropriate course of action is that governments should implement the BEPS final reports, and then monitor how the new rules apply to taxpayers in practice.
Second, the implementation of the BEPS project looks like it will be a long and bumpy process. Unlike the example of the "services PE," many of the critical concepts that are being incorporated into international tax law through the BEPS Actions almost certainly will create uncertainties and exposures for taxpayers due to the ambiguity of the rules.
Some provisions are ambiguous by design, as the purpose is to give tax administrations discretion under anti-abuse principles as to when the rule should be applied to an enterprise. An example here is the proposal under Action 6, which proposes amendments to the OECD Model Treaty article regarding Entitlement to Benefits. The changes would allow a tax administration to disallow a claim of treaty benefit under the following language:Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit… .2
There is not much guidance as to what constitutes "one" principal purpose for an arrangement or transaction that results in a treaty benefit, creating significant risk of different applications of that standard in various jurisdictions.
A further source of implementation uncertainty will be the inherently ambiguous nature of many of the other proposed rules even though they are intended to be prescriptive standards, in contrast to anti-abuse measures. The proposed expansion of the PE standard under Action 7 is one such case. The existing rule is based on a relatively precise legal analysis, i.e., when is a contract of sale concluded. The new rule is expressly intended to describe a greater scope of customer-facing activity, but it is expressed through a standard that leaves much more room for interpretation. The test that presumably will be presented in the final report for adoption in treaties worldwide will create a PE when the dependent person "negotiates the material elements of contracts" for property or services supplied by the nonresident enterprise. What is meant by "negotiation," what elements are "material," and how much authority needs to be held by the dependent person are all issues that will be worked out in tax examinations and Competent Authority discussions, and perhaps litigation, in the future.
From the perspective of the business observer, it also appears that the government delegates have found it difficult to reach consensus on the meaning of some of the core concepts in the project. As noted, the second part of the July 6-7 Consultation included a presentation by various government representatives on the status of the transfer pricing work as the final reports are being prepared. The comments relating to the work on risk, contracts, and intangibles under Actions 8-10 suggested a parallel to the situation with the PE rules; a lot more attention seems to have been focused on the trigger than on the consequences. From the comments, it is clear that the delegates have spent a considerable amount of time refining the statements to be included in the final reports as to when a contractual allocation of risk will or will not be respected, or when the legal owner of an intangible will or will not be entitled to the full residual return from that intangible, but relatively little attention seems to have been paid to articulating what the consequences will be if the taxpayer doesn't fully comply with the stated requirements, and a tax administration asserts that the contractual risk allocation or the claimed intangible ownership should be rejected, in whole or in part. In the absence of concrete guidance on the allowed adjustment, the consequences of an audit determination that the taxpayer has failed to establish that its risk allocation or intangible ownership should be entirely respected are likely to vary considerably among jurisdictions and across taxpayers.
Finally, there is a danger that this project has created some unwarranted license in the views of some tax administrations as to what interpretations of the law may be appropriate in a case in which "BEPS behavior" is alleged. For example, one tax administration has suggested that it could interpret that country's existing tax treaties to apply the principles of the "significant digital presence" PE as described in the September 2014 report of the Task Force on the Digital Economy, even though that report merely identified options that had been discussed by the Task Force, and noted that all of the nexus proposals in that report would require further development. I suspect that, absent the larger political environment of the BEPS process, it never would have occurred to a tax administration to interpret an existing treaty based on a policy paper's proposal of a rule that would require a treaty change to adopt that rule.
The BEPS project certainly will change some core international tax rules, but it looks like we won't know the full consequences of those changes for many years. I expect that tax administrations and taxpayers will quickly identify needs for further guidance, such as on the question of the consequences when an entity in the group is regarded as not fully bearing the commercial risk it purports to bear. Despite the "BEPS fatigue" which many now feel, there certainly will be a second half to this project which may well be just as important as the first.
This commentary also will appear in the September 2015 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Isenbergh, 900 T.M., Foundations of U.S. International Taxation, Chip, Culbertson, and Maruca, 6936 T.M., Transfer Pricing: OECD Transfer Pricing Guidelines, and in Tax Practice Series, see ¶3600, Section 482 — Allocations of Income and Deductions Between Related Taxpayers; ¶7160, U.S. Income Tax Treaties.
Copyright©2015 by The Bureau of National Affairs, Inc.
1 The full proceedings are available to review by video playback at: http://video.oecd.org/?action=video&id=1903 (July 6 morning session); http://video.oecd.org/?action=video&id=1904 (July 6 afternoon session); and
http://video.oecd.org/?action=video&id=1905 (July 7 session).
2 OECD (2014), Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing. http://dx.doi.org/10.1787/9789264219120-en, p. 66.
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