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BEPS: Shaking Up The International Tax Framework

Global Incorporation Guide [GIG] Editorial

October 13, 2016

Those with business interests in more than one jurisdictions will be all too painfully aware of the tax pitfalls of operating internationally. But as if coping with the existing international tax framework wasn't bad enough, the OECD, supported by most major economies, has come along to shake things up further in the form if its base erosion and profit shifting project, more commonly known as BEPS, which aims to address the problem of tax avoidance by multinational companies.

Background

On February 12, 2013, the OECD released its preliminary report on the problem of BEPS, which contained a series of observations about current shortcomings in the international tax system, and reaffirmed its view that current international tax standards have been left behind by changes in global business practices, especially with regards to companies which have a large presence on the internet, but a small "physical" presence on the ground. The fact that it is possible to be heavily involved in the economic life of another country, for example by doing business with customers located in that country via the internet, without having a taxable presence there or in another country that levies tax on profits, was noted repeatedly throughout report.

Although the "Addressing BEPS" report acknowledged that cross-border businesses may suffer as a result of badly constructed international tax rules which can result in the double taxation of income, the BEPS Action Plan produced by the OECD in July 2013 for the G20 dealt more with the question of how to stop the double non-taxation of multinationals' income occurring in the future.

The Action Plan contained 15 specific actions designed to give governments the domestic and international mechanisms to prevent corporations from paying little or no taxes, as follows:

  • Action 1: Address the challenges of the digital economy

  • Action 2: Neutralize the effects of hybrid mismatch arrangements

  • Action 3: Strengthen controlled foreign company rules

  • Action 4: Limit base erosion via interest deductions and other financial payments

  • Action 5: Counter harmful tax practices more effectively, taking into account transparency and substance

  • Action 6: Prevent treaty abuse

  • Action 7: Prevent the artificial avoidance of Permanent Establishment status

  • Action 8: Assure that transfer pricing outcomes are in line with value creation/intangibles

  • Action 9: Assure that transfer pricing outcomes are in line with value creation/risks and capital

  • Action 10: Assure that transfer pricing outcomes are in line with value creation/risks and capital

  • Action 11: Establish methodologies to collect and analyze data on BEPS and the actions to address it

  • Action 12: Require taxpayers to disclose their aggressive tax planning arrangements

  • Action 13: Re-examine transfer pricing documentation

  • Action 14: Make dispute resolution mechanisms more effective

  • Action 15: Develop a multilateral instrument

OECD Secretary-General Angel Gurría said that the Action Plan "marks a turning point in the history of international tax co-operation. It will allow countries to draw up the coordinated, comprehensive and transparent standards they need to prevent BEPS. International tax rules, many of them dating from the 1920s, ensure that businesses don't pay taxes in two countries - double taxation. This is laudable, but unfortunately these rules are now being abused to permit double non-taxation. The Action Plan aims to remedy this, so multinationals also pay their fair share of taxes."

The Final BEPS Package

Between the OECD publishing the initial Action Plan, and releasing its final recommendations, extensive consultations took place involving governments, regional tax organizations, NGOs and business associations. Indeed, all told, the consultative phase saw 60 countries directly involved in the technical groups and others participating through regional structured dialogues, while businesses and NGOs contributed more than 12,000 pages of comments on the 23 discussion drafts published and discussed at 11 public consultations.

This work culminated in the final BEPS package, announced by the OECD with much fanfare on October 5, 2015, which includes new minimum standards on: 

  • country-by-country reporting, to provide tax administrations with a global picture of the operations of multinationals;

  • treaty shopping, to put an end to the use of conduit companies to channel investments;

  • curbing harmful tax practices, in particular in the area of intellectual property and through the automatic exchange of information on tax rulings;

  • and effective mutual agreement procedures, to ensure that the fight against double non-taxation does not result in double taxation.

In addition, the final recommendations have led to the approval of new OECD Guidance on the application of transfer pricing rules.

The OECD is also encouraging governments to adopt stronger rules covering Controlled Foreign Corporations, interest deductibility, and hybrid mismatch arrangements (which enable double non-taxation).

An important element of the BEPS project is the development of a multilateral instrument capable of incorporating the tax treaty-related BEPS measures into the existing network of bilateral treaties, which is ongoing (see below).

In summary, the package is intended to repaint the tax landscape globally and, according to Saint-Amans, Director of the OECD Centre for Tax Policy, such fundamental changes would have not been possible before the financial crisis and the advent of tax information exchange. He said recent international cooperation on tax matters has opened the door to extensive reforms previously thought impossible, such as during the work it attempted ten years ago to close the door on aggressive tax planning.

The final package was endorsed by G-20 finance ministers at their summit on October 8, 2015, in Lima, Peru, where they stressed their commitment to the rapid, widespread, and consistent implementation of the BEPS recommendations.

BEPS – A Progress Report

In a report released at the G-20 Finance Ministers and Central Bank Governors' meeting on July 23-24, 2016, in Chengdu, China, the OECD said that a total of 85 countries had joined the inclusive framework on BEPS, and that a further 19 countries are likely to have joined the framework by the end of 2016. The report also noted that over 50 countries have now taken concrete steps to implement the country-by-country reporting framework proposed under BEPS Action 13.

The report stated that tax treaty-related BEPS measures are being incorporated into the multilateral instrument to amend double tax agreements, which 96 countries are currently negotiating. 

"The MLI will allow countries to meet the BEPS minimum standard aiming to put an end to treaty shopping (Action 6)," the report said. "It will also provide the possibility for countries to address the issue of hybrid mismatches, the updated definition of the ‘permanent establishment' concept, other forms of treaty abuses with specific treaty rules, as well as improving dispute resolution processes. On that last issue, an optional provision that provides for mandatory binding arbitration will be incorporated in the text of the Convention."

"Major progress has been made and we expect the text of the instrument to be initialed by November [2016]," the OECD added.

The report notes that more than 2,000 bilateral tax treaties could be amended if the participating countries agree to the multilateral instrument. A signing ceremony for countries, including all G-20 members, will be organized in the first half of 2017, the OECD said.

BEPS – The Business Verdict

The world of business is generally supportive of the broad thrust of the BEPS project hoping that it delivers a more consistent set of international tax rules that are easier to follow. However, many business groups have repeatedly warned that the devil could be in the detail, and that the project could ultimately fail if countries implement the OECD's recommendations in an inconsistent way. Indeed, some say that there is a danger that the international tax framework could become more unpredictable.

However, opinions seem to be split as to whether the ongoing implementation of BEPS measures around the world are disrupting business operations.

One of the most recent surveys on the matter concluded that BEPS has had little impact on the way businesses plan their tax affairs. This global survey of 2,600 business across 36 jurisdictions by financial advisory firm Grant Thornton reveals that 78 percent of businesses have not changed their business's approach to taxation in response to BEPS.

The lack of impact is even greater in the G7 countries (83 percent), with 89 percent of US businesses and 86 percent of UK businesses saying that BEPS has had little impact on their tax planning. According to the businesses surveyed, BEPS has had the greatest impact on business tax planning in the countries of Indonesia (35 percent), Nigeria (38 percent), and India (36 percent).

Francesca Lagerberg, Global Leader of Tax Services at Grant Thornton International, said: "It is fascinating that after the initial excitement around BEPS, and its potentially game-changing elements, so few in the survey have taken active steps to change what they are doing. The reasons for this are likely to be many. A number of companies will be reluctant to be the first mover in this area and may be looking to see what others are doing in their industry or region. Governments have not yet explained how or even if they will implement BEPS in some countries, so that leads to business caution."

Lagerberg added: "Equally, business leaders prefer the black and white to the grey on tax issues, so businesses would undoubtedly benefit from more guidance on what they should do next. Many will have been bitten by retrospective legislation or rule changes on tax in recent years and will be nervous about action before the ground rules are clear. The recent EU action against Apple and its agreements with Ireland does not help make these tax issues any clearer for businesses."

However, it is probably fair to say that the majority of surveys carried out with regards to this issue have concluded that most businesses are at the very least concerned about the future international tax framework, and the increased risks of operating in a more uncertain tax environment.

For example, middle-market businesses expect to be significantly impacted by BEPS Action Plan, according to a survey of 494 international business leaders conducted by audit, tax, and consulting services provider RSM US LLP, the results of which were published in June 2016.

According to the survey, middle-market businesses (defined as having revenues from USD5m to USD1bn) anticipate that compliance costs will increase, along with tax burdens and business uncertainty. 72 percent anticipate a 5-10 percent increase in their effective tax rate as a result of BEPS, and 92 percent also expect increased compliance costs.

"Addressing the BEPS Action Plan will have a significant impact on US-based middle-market companies that have international sales and operations," said Ramon Camacho, International Technical Tax Lead at Washington National Tax, RSM US. "While BEPS should level the playing field and perhaps curtail corporate 'tax inversions,' companies of all sizes with international business need to begin to prepare for the tax, compliance, and business issues coming their way."

As mentioned, despite the increased costs and likely business challenges, companies broadly support the BEPS initiative, and 69 percent opined that a global taxation standard is necessary. But most businesses surveyed see BEPS as a work in progress rather than a final solution, recommending that more work is needed from governments globally to ensure the original objectives of the proposals are met. 61 percent were skeptical that the BEPS Action Plan will ensure that tax is paid where profits are created, and just one third of respondents said that implementation of the recommendations will level the international tax playing field.

What's more, the findings of another survey, released in October 2016, show that tax authorities around the world are ramping up their audit campaigns as a result of BEPs. This survey of 250 senior tax executives by tax and audit firm Ernst and Young found that 49 percent of all respondents are currently seeing tax authorities raise audit issues that reflect the BEPS focus areas, a jump of 16 percent year-on-year. 60 percent selected transfer pricing as the top focus area being raised as an audit issue, with 54 percent saying it is also the top BEPS area affecting them in terms of changes in law and reporting requirements.

Nearly a quarter (23 percent) of tax directors said that they are currently under audit in more than 15 countries, an increase of 6 percent from 2015 and 10 percent from 2014. In line with this, 56 percent say the number of countries subject to an active audit has increased, up from 49 percent a year ago. 72 percent say the enforcement posture and tactics of foreign tax authorities has become more aggressive, up from 66 percent in 2015.

The International Chamber of Commerce has been particularly vocal about the dangers of a fractured response to BEPS by individual nations, warning that a disparate approach to the OECDs recommendations threatens to stymie international trade and investment.

"Some of the measures being implemented at national level do not impact local business in isolation, but have broader consequences internationally," the ICC said in May 2016. "ICC encourages national governments to consider the inter-connected dynamics that help facilitate global trade when developing their local policies. Deviations from internationally agreed guidelines create tax barriers and ultimately undermine global efforts to establish a consistent international tax landscape."

Christian Kaeser, Chair of the ICC Commission on Taxation and Global Head of Tax at Siemens AG, added: "For the business community, the integrity of the international tax system is of critical importance. In order to establish a level playing field, implementation of the BEPS recommendations would need to be consistent across global markets. Unilateral disparate tax rules will introduce double or multiple standards that not only create compliance challenges for business but essentially undermine the consistency of the international tax system."

Even the OECD has stressed the need for policy makers to provide a certain tax environment for businesses, to maintain trade and investment. Discussing the tax challenges facing EU countries at the informal meeting of EU finance ministers, held in Bratislava, Slovakia, on September 10, 2016, OECD Secretary General Angel Gurría said:  "Of course there will always be some degree of policy uncertainty due to economic change – such as new business models arising from developments in the digital economy – but governments can design tax policies to minimize tax uncertainty.

Conclusion

However, despite Gurria's reassurances, all the indications are that the BEPS project is driving tax uncertainty for internationally-facing businesses, and will continue to do so until such time as the project nears some sort of conclusion. In the meantime, businesses will have little choice but to keep abreast of international tax developments, and plan accordingly to minimize any tax risks.

 

Tags: Slovakia | Peru | Nigeria | environment | agreements | internet | Ireland | multinationals | investment | trade | G20 | interest | compliance | tax planning | standards | transfer pricing | audit | Tax | BEPS | business | tax

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