The OECD Action Plan on Base Erosion and Profit Shifting
08 August 2013
Posted by: Author: PwC
Author: PWC (Tax Synopsis)
We reported in earlier editions of Synopsis on the reaction of the OECD to press articles alleging irregularity on the part of multinational companies in arranging their tax affairs and the views of finance ministers of the G20 nations on tax avoidance. The OECD Action Group has completed Phase I of its proposed response and has produced an action plan for tackling base erosion and profit shifting.
The action plan:
- identifies actions that are need to address the concerns,
- sets deadlines for implementation, and
- establishes the resource requirements and methodologies to be applied.
The background summary recognises that the chief influence has been the rapid expansion of the global economy. This has benefitted the economies of the nations of the world. It has also resulted in enterprises that are organised globally rather than nationally or regionally. As a result, multinational enterprises have been able to "greatly minimise their tax burden”, which has harmed governments, shifted the tax burden to individuals and has affected fair competition.
Taxation is a sovereign right and, globally, nations have recognised that there may be excessive taxation unless double taxation is mitigated. This has in the main been achieved through international agreements, but, despite these agreements "gaps and frictions” have arisen, because they relate to circumstances which were not taken into account when the international standards were originally designed. In addition the growth of the digital economy has introduced new ways of doing business, as well as difficulty in identifying how value is added and where profits are made. The main risk that emerges from the current climate is that countries might decide to tackle the issues unilaterally rather than co-operatively. The effect of unilateral action is well summarised:
"Inaction in this area would likely result in some governments losing corporate tax revenue, the emergence of competing sets of international standards, and the replacement of the current consensus-based framework by unilateral measures, which could lead to global tax chaos marked by the massive re-emergence of double taxation.”
The report therefore suggests that untimely unilateral action to protect tax base may prove damaging to the global economy. It endorses the statement of the G20 Leaders who said:
"Despite the challenges we all face domestically, we have agreed that multilateralism is of even greater importance in the current climate, and remains our best asset to resolve the global economy’s difficulties.”
The action plan
The action plan envisages actions in these basic areas:
- the development of new international standards for domestic legislation;
- realignment of taxation with substance in relation to both operations and transfer pricing; and
- improved early detection mechanisms to inform policy and provide greater certainty and predictability for business.
At the top of the list is the determination of the taxable income of digital business to identify where and how profit is derived, and to develop ways of levying indirect taxes (GST or VAT) on digitally delivered products.
A number of actions are aimed at ensuring that there is greater international coherence in tax legislation around financing arrangements. Hybrid debt instruments are seen as a significant means of creating mismatches in tax treatment, and the neutralisation of the negative effects of these instruments will be the subject of specific focus. The use of controlled foreign companies in low tax jurisdictions, particularly for investment financing, requires the design of rules that will counter abuse. Methods to limit the erosion of the tax base through interest deduction will be evaluated and considered. In this respect preferential tax jurisdictions are a key pressure area and greater co-operation is necessary to ensure that the activities in these jurisdictions have sufficient substance to justify the income that is derived through them.
Conduit structures involving the interposition of entities in third countries to benefit from treaty concessions are identified for special consideration. Substance requirements will partially address the concerns, but the measures contemplated include the development of counters to treaty-shopping and other forms of treaty abuse. Permanent establishment issues are a critical feature of the action plan, which recognises that permanent establishment status may easily be avoided through commissionaire arrangements or the fragmentation of activities between numerous entities.
Transfer pricing is seen as a significant element in the base erosion and profit shifting environment, where contractual arrangements may enable the separation of the income from the economic activities through which it is derived, and the action plan will seek to develop measures to ensure alignment of tax outcomes with value creation. Particular attention will be given to the valuation and exploitation of intangibles, capital allocation and unusual transactions.
The report emphasises the need to improve the information gathering process so that timely information is available on structures that shift profit or erode the tax base. Attention will be placed on obtaining disclosure of tax planning strategies, which should relieve the need for transfer pricing documentation. It recognises that the data that is collected will need to be co-ordinated and analysed. Thus it is recommended that mandatory disclosure rules should be developed for aggressive or abusive transactions, arrangements or structures. At the same time, a more harmonious approach to transfer pricing would be expected to reduce the cost of preparing transfer pricing documentation and provide greater clarity and certainty.
It is recognised that mutual agreement procedures under international treaties are unsatisfactory in many cases, as there is no provision for arbitration to resolve differences of opinion between jurisdictions in most treaties. Thus, solutions are necessary to address these to enhance clarity and certainty in international commerce.
The final recommendation recognises that there must be an over-arching instrument developed so that the actions move from policy to action swiftly and effectively. It is proposed that there should be an international instrument to which countries may become signatories that will amend existing international treaties and commit to measures It also suggests that an innovative approach needs to be developed to foster the implementation of measures to curb base erosion and profit shifting on an ongoing basis in response to the developing commercial environment.
Ambitious time frames are mentioned. It is estimated that the majority of the actions can be completed within a period of two years, with the final international instrument for implementation likely to take longer, as the final element of the plan.
The proposed methodology involves conducting the project in the member countries of the OECD and the extension of invitations to associates and other countries, where appropriate. It is recognised that developing countries face problems in this area and should be included. Global bodies and forums will be engaged to promote discussion.
The success of the project will be judged on its ability to meet the expectations of the various nations, and the process will require the development of mechanisms to obtain consensus on a speedy and defensible basis. The consultative process must be inclusive and the views of civil society, non-governmental agencies and business will be taken into account in developing the proposals that will emerge.
In certain respects, South Africa is ahead of the international game, particularly with regard to reportable arrangements and general anti-abuse rules. We note that some of the issues raised in the report are being addressed domestically. The recently released draft of the proposed tax amendments for 2013 contains significant proposals on hybrid debt and base erosion through interest deduction. These are creating considerable uncertainty for international and domestic taxpayers. It is impossible to predict what proposals might be developed by the OECD task team; but it might be opportune for SARS and Treasury to defer unilateral action so that the measures that are eventually introduced will reflect international practice, norms and standards consistent with the OECD determinations.