Companies Need to Refocus on Tax Planning Amidst Government’s Plans to Clamp Down on Base Erosion
28 August 2013
Posted by: Author: PwC
The Government has drawn the line for companies that seek to use debt and other means to decrease their tax base. Multinational companies need to keep abreast of legislative developments and position themselves to best cope with what can be a fresh and increasingly global approach to dealing with tax planning for cross-border transactions, says PwC Tax Services.
In order to curb excessive interest deductions, National Treasury recently issued proposals contained in the draft Taxation Laws Amendment Bill, 2013. Deductions that are perceived to be excessive are typically channeled as interest, royalties, services fees and insurance premiums. "Although financing in the form of debt is commonly used for legitimate commercial reasons, it can also be used as a means to erode the tax base, a concern for tax authorities the world over,” says David Lermer, South Africa and Southern Africa Region Leader for PwC Global Tax Services.
One of the typical ways in which base erosion takes place is by shifting income to a no tax or low tax jurisdiction according to National Treasury. The protection of the tax base from artificial debt and excessive debt has been on the policy agenda for more than two years. Finance Minister Pravin Gordhan announced in his February Budget speech that excess debt would be addressed. The Government initially raised concerns around tax schemes that lead to base erosion in 2011 and introduced legislation to counter such schemes that used the intra-group rollover relief rules to introduce debt providing for interest deductions into companies.
Over the last several years tax schemes used by multinationals have become an increasing area of focus and concern for tax authorities globally. The recent paper issued by the Organisation for Economic Co-operation and Development (OECD) on Base Erosion and Profit Shifting (BEPS) states: "[w]hile there are many ways in which domestic bases can be eroded, a significant source of base erosion is profit shifting.” The project, which has received significant attention, has been supported by the G20 and various individual governments.
"The fallout from the global financial crisis, changing trends in cross border investment and trade flows, have caused national governments to question the acceptability of traditional tax structures and reconsider whether the long established principles governing cross-border taxation need to be revisited,” says Lermer.
The release of the OECD’s action plan on base erosion and profit shifting comes at a time when there is increased scrutiny from tax authorities on tax avoidance and corporate tax practices. Globally, organisations are feeling the heat and are increasingly concerned about their corporate tax and reputational risks.
"Added to these difficulties is the fact that we live in a digital environment where many products and services tend to not fall within the tax system of one country or another,” says Lermer. As a result a large number of corporate profits go untaxed. "Furthermore, many of the international tax rules have become outdated, with some of the principles governing the taxation of cross-border trade between 40 and 100 years old. Double taxation agreements were entered into between countries to support cross border trade and assist businesses by preventing double taxation. These DTAs (based, in the main on the OECD Model Convention and to a lesser extent on the UN Model) do not create a tax liability where one does not exist in terms of domestic law, but simply relieve taxation in terms of the way the countries to the agreement have determined how they wish to split their respective taxing rights. The result is that DTAs can and have been used to achieve double non-taxation. This is a key focus of the OECD Action Plan.”
Of key concern to South Africa is excessive deductible interest, including in relation to hybrid debt instruments where the debt instrument has both debt and equity features, being debt in form, but carrying many of the defining features of equity. Worldwide taxpayers have used hybrid instruments in cross-border transactions to obtain tax benefits, including double non-taxation or interest relief with no income pick-up. The revised rules propose to reclassify the interest returns on these hybrid instruments as dividends, so that there is no South African tax relief for the interest return.
Another area of concern regarding excessive deductible interest is that of debt between connected persons. The relationship between creditor and debtor can become blurred when both parties form part of the same economic unit and the choice of funding instrument may not be driven by purely commercial factors. This situation typically arises when a parent company lends money to a wholly-owned subsidiary. The proposal dealing with connected person debt typically limits the interest deduction to 40 percent of the debtor’s taxable income if the creditor holds more than 70 percent of the equity shares or voting rights in the creditor company.
Kyle Mandy, Head of National Tax Technical at PwC, says: "The OECD’s plan is largely dependent upon various governments implementing any recommended measures. For this to have significant success there would need to be widespread adoption of some common rules.” However, it is likely that some countries may elect not to do so because of the benefits that actually flow from providing incentives and tax breaks to multinational corporations. Furthermore, some stakeholders may be wary of the OECD and similar institutions in shaping national tax policy on the grounds that it is each country’s sovereign right to impose tax on whatever basis it sees fit, he says.
"It is important to note that no or low taxation is not necessarily a bad thing, if it is based on specific targeted incentives granted by governments to develop their economies, create jobs, support specific industries, capital investment etc. In other words, the incentives are key to the country’s growth potential and are based on substance so that the tax relief is aligned to the underlying business operations.”
To quote from the OECD Action Plan:
"No or low taxation is not per se a cause of concern, but it becomes so when it is associated with practices that artificially segregate taxable income from the activities that generate it.”
"In certain respects, South Africa is ahead of the international game, particularly with regard to reportable arrangements, general anti-avoidance rules (GAAR) and the proposals contained in the 2013 draft tax amendments,” he adds.
Mandy concludes: "The world of tax planning is potentially facing the most significant period of change for many years. There is a growing recognition of the need for global coordination of responses to the issues, even where the solutions are ultimately to be incorporated into national tax systems and legislation.
"It should be accepted that countries retain the ultimate right to impose tax, but that a global initiative and response will help align key aspects of many national tax systems to assist in maintaining the integrity of those systems and ultimately avoiding onerous outcomes for taxpayers. Unilateral actions, such as those proposed by South Africa, run the risk of leading to double taxation and reducing the country’s attractiveness as an investment destination. However, the challenges to resolve many of the issues are significant and real progress cannot be expected to be speedy. The OECD has set itself a two year deadline to address the action points, but this may well be ambitious given the need for consensus between a wide range of countries.”