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OECD releases first proposals for fight against tax avoidance by multinationals

Monday, 10 November 2014   (0 Comments)
Posted by: Authors: Chris Smith and Rozelle van Wyk
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Authors: Chris Smith and Rozelle van Wyk (BDO)

The Base Erosion and Profit Shifting (‘BEPS’) Action Plan originated from a need to address aggressive tax planning. The release by the OECD of the first 7 proposals of the 15-point action plan on 16 September 2014 is considered to be a milestone in the attempts to prevent the artificial shifting of profits through inter-company charges, the transfer of patent licencing rights and similar practises. This article considers these proposals.

BEPS refers to tax planning strategies to artificially exploit gaps and mismatches in tax rules to shift profits to tax jurisdictions where there is little or no real business activity. Typically the tax rates in these tax jurisdictions are either much reduced or no corporate tax is payable. BEPS strategies are often not illegal but rather an exploitation of gaps and mismatches in the tax rules of different tax jurisdictions. BEPS distorts competition since it creates tax opportunities for multinational enterprises which are not available to domestic enterprises.

The OECD in collaboration with the G20 published a 15-point action plan to address BEPS in July 2013. The recent proposals released by the OECD followed extensive consultation with OECD members, OECD accession countries, G20 countries, developing countries, business, NGOs and other stakeholders and address 7 of the 15 points of the BEPS Action Plan. These proposals will remain in draft form until the finalisation of the remaining 8 action points in 2015. The purpose of the BEPS Action Plan is to avoid base erosion and profit shifting in order to ensure that profits are taxed where the economic activities generating the profits are performed and where value is created. 

The 7 action points which were released on 16 September 2014 with an official explanatory statement to address BEPS are as follow:

Action 1: The Tax Challenges of the Digital Economy

Action 2: Hybrid Mismatch Arrangements

Action 5: Harmful Tax Practices

Action 6: Tax Treaty Abuse

Action 8: Transfer Pricing & Intangibles

Action 13: Transfer Pricing Documentation and Country-by-Country Reporting

Action 15: The Feasibility of Developing a Multilateral Instrument on BEPS

Action 1 of the BEPS Action Plan deals with the tax challenges of the digital economy. Consensus has been reached that the digital economy cannot be ring-fenced for tax purposes. The proposal includes a detailed analysis of the digital economy, business models, key features and resultant tax challenges of the digital economy. It was concluded that the collection of VAT in business-to-consumer transactions needs to be addressed to protect tax revenue and to level the playing field between foreign and domestic suppliers. The potential development of a reasonable administrative rule to distinguish between activities of preparatory or auxiliary nature and core components of the business will be considered when addressing action 7 of the BEPS Action Plan on artificial avoidance of a permanent establishment status. Furthermore it was concluded that the characterisation of certain cloud computing payments under tax treaty rules needs to be clarified. It was found that that the digital economy does not generate unique BEPS issues, but that some of the key features of the digital economy exacerbate BEPS risks. Accordingly, it was agreed that care will be taken to ensure that work carried out in the other areas of the BEPS Action Plan will address the BEPS risks of the digital economy.

The OECD defines hybrid mismatches as ‘cross-border arrangements that take advantage of differences in the tax treatment of financial instruments, asset transfers and entities to achieve ‘double non-taxation’ or long term deferral outcomes which may not have been intended by either country’. Action 2 of the BEPS Action Plan deals with hybrid mismatches by providing recommendations for domestic rules to neutralise the effect of hybrid mismatch arrangements and recommending changes to the OECD Model Tax convention to deal with transparent and hybrid entities. The proposal includes the introduction of a defensive rule which a tax jurisdiction can apply if the counterparty tax jurisdiction does not have its own domestic hybrid mismatch rules. A commentary to the proposed domestic rules will be prepared in order to explain how the rules should operate in practise.

Action 5 of the BEPS Action Plan attempts to counter harmful tax practices by considering transparency and substance. The proposal builds on the OECD’s 1998 report Harmful Tax Competition: An Emerging Global Issue. The proposed improved transparency will enable tax jurisdictions to take defensive measures. The framework on transparency includes an obligation on tax jurisdictions to spontaneously exchange taxpayer-specific and general rulings related to preferential regimes. A substantial activity factor to ensure that profits are taxed where substantial activities take place, has been explored in the proposal and will be subject to further discussions. 

Action 6 of the BEPS Action Plan aims to limit tax treaty abuse and in particular prevent treaty shopping. The OECD defines treaty shopping as the arrangements through which a person who is not a resident of one of the two States that concluded a treaty may attempt to obtain benefits that the treaty grants to residents of these States. The first section of the proposal proposes anti-abuse rules to be included in treaties in order to prevent the granting of treaty benefits in cases where a person tries to circumvent limitations provided by the treaty.  Thereafter the required domestic anti-abuse rules are discussed when a person tries to circumvent the provisions of domestic tax law using treaty benefits. In terms of the second section of the proposal the title and preamble of the Model Tax Convention will be reformulated to clarify that tax treaties are intended to eliminate double tax without creating opportunities for tax evasion and avoidance. The final section of the proposal deals with tax policy considerations which tax jurisdictions should consider before entering into a tax treaty.

Action 8 of the BEPS Action Plan deals with the transfer pricing aspects of intangibles and aims to ensure that transfer pricing outcomes relating to intangibles are in line with value creation. In the process, the OECD publication Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations has been reviewed to, amongst others, clarify the definition of intangibles, provide guidance on the identification of transactions involving intangibles and provide guidance on the determination of arm’s length conditions for transactions involving intangibles. The proposal addresses the first phase of the work required under the BEPS Action Plan. The second phase of the work is to be completed during 2015. The arm’s length principle and other special measures to address transfer pricing concerns related to BEPS will be considered.

Action 13 of the BEPS Action Plan deals with transfer pricing documentation and country-by-country reporting which will provide tax administrators with useful information to assess transfer pricing risk, allocate audit resources and, if required, commence audit enquiries. The proposal includes revised standards for transfer pricing documentation. Multinationals will be required to produce three documents: a country-by-country report, a master file and a local file. In terms of the country-by-country reporting, multinationals will be required to report on income, earnings, taxes paid and economic activity in the various tax jurisdictions in which it operates. Multinationals will also have to report on their total employment, capital, retained earnings and tangible assets in each tax jurisdiction. The business activity of each entity in the group will also have to be disclosed. The master file will contain high-level global information regarding the global business operations and transfer pricing policies of the multinational. The master file will be available to all relevant country tax administrations. The local file will include more transactional transfer pricing documentation with information on related party transactions, the amounts involved in related party transactions and the company’s analysis of the transfer pricing determinations with regards to the related party transactions. Further work is required to identify the most appropriate method for the filing of the information by multinationals and the subsequent dissemination thereof to tax administrations.

Action 15 of the BEPS Action Plan deals with the feasibility of developing a multilateral instrument to modify existing tax treaties. The purpose would be to expedite and streamline the implementation of the measures developed to address BEPS. The proposal identifies the issues arising from the development of a multilateral instrument and provides an analysis of the related international tax, public international law and political issues. The proposal concludes that the development of a multilateral instrument is desirable and feasible.

BDO has warned that the scope and speed of the implementation of the proposals by individual countries could create more inconsistencies in how different countries deal with tax matters. These inconsistencies could cause even more turbulence in the tax environment in the years going forward which means that multinational companies will need increasing support and guidance to navigate the changes.

South Africa is likely to be impacted by the proposals which are expected to be widely implemented by various national governments. The impact of the proposals will be felt in South Africa particularly because many multinational enterprises operate here and also since South Africa has an extensive network of tax treaties which will be affected. The proposals and the information which will become available subsequent to the implementation thereof will assist the South African Government to develop the necessary domestic legislation and amend tax treaties in order to successfully address BEPS in South Africa.

In addition to potentially creating additional tax revenue, the BEPS Action Plan will restore the credibility of tax systems by preventing the avoidance of tax liabilities by high-profile taxpayers and by levelling the playing field between multinational and domestic enterprises.

This article first appeared on the November/December edition on Tax Talk.



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