Finance Ministers from G20 Nations Endorse OECD Final Recommendations on BEPS Provisions
In anticipation of a meeting of the G20 ministers of finance, on October 5, 2015, the Organisation for Economic Co-operation and Development (“OECD”) released its final report on the Base Erosion and Profit Shifting (“BEPS”) project. The report and actions were endorsed by the G20 on October 9, 2015. There are 15 proposed anti-abuse actions. The OECD has in essence backed off some of the original provisions for further considerations.
The Actions in the report center around 3 pillars: coherence of international tax rates; reinforcement of economic substance and income in transparency. Actions 1 and 15 are outside the 3 pillars. Action 1 deals with the digital economy and Action 15 deals with the development of a multilateral instrument that countries can adopt to amend their existing tax treaties to implement any relevant BEPS reforms.
A summary of the provisions and what recommendations have been made is as follows.
Action (1) Address the Tax Challenges of the Digital Economy
Action 1 in essence does not contain any recommendation but rather refers to other Actions that will impact the digital economy.
Action (2) Neutralize the Effects of Hybrid Mismatch Arrangements
The Action contains recommendations on how to end mismatches of income and expense through the use of hybrid arrangements.
The 2015 Report also includes further guidance and comments on (i) the treatment of stock lending and repos; (ii) how to treat a payment that is included under a controlled foreign corporation (“CFC”) regime, (iii) the operation of the mismatch rule; and (iv) the treatment of hybrid regulatory capital under the hybrid financial instrument rule.
Examples of such practices include the use of preferred equity certificates in Luxembourg and participating notes in Ireland.
Action (3) Strengthen CFC Rules
The Report offers no specific recommendations for CFC’s. However, it provides for 6 “building blocks” for the design of a CFC regime:
- definition of a CFC,
- CFC exceptions and threshold requirements,
- definition of income,
- computation of income,
- attribution of income and
- prevention and elimination of double taxation.
Any implementation of the CFC rules will require legislation by jurisdictions.
Action (4) Limit Base Erosion via Interest Deductions and Other Financial Payments
The Report recommends a common approach to present base erosion through the use of interest expense.
The Report recommends 2 main approaches to limiting deductions: a “fixed ratio rule” which allows an entity to deduct net interest expense up to a benchmark net interest/EBITDA ratio within a corridor of 10%-30% and an optional “group ratio rule” that allows interest deduction up to the net interest/EBITDA ratio of worldwide group.
The Report further allows countries to apply a different group ratio rule to the worldwide group ratio (e.g., an “equity escape” rule, which compares an entity’s level of equity and assets to those held by its group), or not adopt a group ratio rule at all. It also protects the fixed ratio rule and the group ratio rule from planning and includes additional optional elements, including: (i) a de minimis threshold for entities with low levels of net interest expense, (ii) carryforward/back provisions and (iii) an exclusion for third party interests.
These recommendations on interest expense would require jurisdictions to adopt legislation.
A number of EU jurisdictions already have interest deduction limitations that operate similar to the recommendation.
Action (5) Counter Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance
The Report identifies 2 issues: the development of a substantial activity requirement for preferential tax regimes and the implementation compulsory exchange of rulings.
In the context of the substantial activity requirement, the only way intellectual property (“IP”) regimes will work is if there are qualifying expenses giving rise to the IP income.
With respect to the compulsory exchange of rulings the Report identifies 6 types of rulings that will be subject to compulsory exchanges between jurisdictions.
The six categories of rulings are:
- rulings related to “preferential regimes” (broadly, those concerning geographically mobile income such as IP and financing);
- unilateral advance pricing agreements (APAs) or other unilateral cross-border rulings in respect of transfer pricing;
- cross-border rulings providing for a downward adjustment of taxable profits;
- permanent establishment(“PE”) rulings (including whether or not a PE exists and the amount of profits attributable to the PE);
- related party conduit rulings (which include rulings on income that flows through a country, including where two domestic entities are subject to different tax treatments); and
- a catch-all category for any other type of ruling agreed by the Forum on Harmful Tax Practices in the future as giving rise to BEPS concerns in the absence of spontaneous information exchange.
For most rulings, the information will be automatically exchanged with (1) the countries of residence of all related parties with which a company enters into a transaction for which a ruling is granted, or which gives rise to income from related parties benefiting from “preferential treatment” (broadly, more beneficial than the country’s normal tax regime) and for PE cases, this includes the residence country of the head office and/or the country of the PE; and (2) the residence country of the ultimate parent company and the immediate parent company. Conduit rulings will be exchanged more widely. The related party threshold for this purpose is 25% (to be kept under review) based on direct or indirect voting rights or equity interests.
Just a day after the OECD released its package on BEPS, the European Commission announced, on October 6, an agreement on further measures that target companies trying to avoid paying what is considered their fair share of taxes.
EU member states unanimously agreed to the automatic exchange of information on cross-border tax rulings at a meeting of the Economic and Financial Affairs Council in Luxembourg, according to an October 6 release from the commission. Proposed rules on automatic information exchange formed the centerpiece of an ambitious tax transparency package to combat harmful tax competition that was unveiled by the commission in March.
Action (6) Prevent Treaty Abuse
The Report recommends that countries adopt, in their bilateral treaties or either a general treaty anti-abuse rule based on the principal purposes of the transaction (the “PPT” rule) or a limitation on benefits rule (the LOB rule) supplemented by a mechanism that would deal with conduit arrangements not already dealt with in tax treaties, or both.
The U.S. has a limitation on benefits (“LOB) provision in all recently adopted tax treaties, however, with the exception of the Canadian-U.S. Tax Treaty, the U.S. is the only signatory to the tax treaties that enforces the LOB provision.
With the exception of U.S. tax treaties the adoption of the PPT or LOB provisions will require modification of tax treaties.
Action (7) Prevent the Artificial Avoidance of (“PE”) Status
The Report on Action 7 contains agreed amendments to the OECD definition of permanent establishment. These changes address techniques used to inappropriately avoid the existence of a permanent establishment (for example through commissionaire arrangements).
By including commissionaire agreements in the definition of a PE, the threshold for having a PE in a jurisdiction will be substantially lower. Commissionaire and other arrangements will be determined by a new test of which party “habitually plays the principal role” in generating sales or making purchases where the contracts are “routinely concluded without material modification” by the contracting entity. The commentary to the model tax treaty (but not the treaty wording itself) contains a clear statement of the policy intention that buy-sell distributors, including limited risk distributors, should not create a PE of their principals (although the simultaneous holding of stock locally by a principal is likely to create a PE due to an anti-abuse rule).
The implementation of the expansion of the PE concept will require modification of all tax treaties.
Action (8-10) Assure that Transfer Pricing Outcomes Are in Line with Value Creation
- Action 8 deals with transfer pricing issues relating to transactions involving intangibles.
- Action 9 considers contractual allocation of risks, and profit allocation to those risks.
- Action 10 focuses on other high-risk areas, including transactions which are not deemed commercially rational (re-characterization) and the use of transfer pricing in a way which results in diverting profits from the most economically important activities of the multinational enterprise (“MNE”) group.
Action (11) Measuring and Monitoring BEPS
The Report on Action 11 recommends that the OECD works with governments to report and analyze more corporate tax statistics (such as statistical analyses based upon country-by-country reporting [“CBCR”]) and to present them in an intentionally consistent way.
Action (12) Require Taxpayers to Disclose their Aggressive Tax Planning Arrangements
The Report on Action 12 provides a series of options that enables countries to design a regime that fits their needs to obtain early information on aggressive or abusive planning schemes and their users.
Action (13) Re-Examine Transfer Pricing Documentation
The 2015 Report on Action 13 incudes revised guidelines on transfer pricing documentation and CBCR. In particular, the Report proposes a 3-tiered documentation structure: (i) a master file containing high-level information regarding global business operations; (ii) a local file specific to each country disclosing details of material related party transactions and (iii) a CBCR.
The report requires the master and local files to be delivered by multinational businesses to local tax authorities, whilst the CBCR is to be filed in the ultimate parent’s jurisdiction and shared via exchange of information protocols.
The U.S. appears to be moving towards adoption of CBCR reporting despite a letter from Orrin Hatch and Paul Ryan to Treasury Secretary Jacob Lew questioning whether Treasury has the authority to draft regulations dealing with CBCR.
Action (14) Make Dispute Resolution Mechanisms More Effective
The Report on Action 14 notes that countries have agreed on a minimum standard and a number of best practices in relation to dispute resolution.
A group of 20 states, including Australia, France, Germany, Italy, Luxembourg, Spain, the United Kingdom and the U.S., have also committed to provide for mandatory binding arbitration in their bilateral tax treaties.
Action (15) Develop a Multilateral Instrument
The report notes that it is desirable to develop a multilateral instrument to streamline the implementation of tax treaty-related BEPS measures.