The OECD ‘Action Plan on Base Erosion and Profit Shifting’ (‘BEPS’) was issued on 19 July 2013. This identifies 15 key actions along with timelines, with most actions being addressed within two years. The scale of the plan is ambitious, and will result in a dramatic change in the landscape of tax planning in the international arena. An underlying theme is tackling the artificial separation of taxable income from the activities that generate it. Going forwards, the focus will be much more on the underlying substance and where value is really created within an international business.
The action plan highlights the huge changes in the way multinational enterprises (MNEs) operate in the 21st century – particularly the impact of the digital economy, and the impact this can play in tax avoidance. Other changes over the years which have also had an impact include the removal of trade barriers, the free movement of capital, exploitation of intellectual property and the way risk is managed. As international standards and bilateral tax treaties have not kept pace with these changing business models, they have been unable to tackle aggressive tax planning.
Sweeping changes are proposed in many areas, and these will require cooperation at international level. The current mood in the G20 suggests that the political will to see this through will be forthcoming.
What actions have been proposed?
As noted above, there are 15 actions identified altogether, and these have been split into the timeframe set out below. The action plan anticipates that some of the actions could take faster, and there is a real sense of urgency that rapid action must be taken.
Actions in the next 12 – 18 months
The first tranche of actions will focus on the following areas:
- Report on the implications of the digital economy and possible actions – this will cover both direct and indirect taxes. A key issue identified is the ability of a company to have a significant digital presence in another country but without being liable to tax on the resulting profits. This is certainly one of the areas of international tax planning which has come under close scrutiny by the Public Accounts Committee and the media in the UK;
- Putting a stop to hybrid mismatch arrangements and arbitrage opportunities – these are structures that exploit the different tax regimes of countries. Whilst the OECD action plan acknowledges it is hard to see which country is actually losing tax, it is clear this practice will no longer be tolerated. For example, this includes ‘double dip’ arrangements where the same interest expense is relieved in two different countries, or where an asymmetry of treatment between countries is exploited, so that one county grants a tax deduction for a payment which is not then taxed in the hands of the recipient;
- Prevention of treaty abuse - by developing model treaty provisions and the provision of guidance on domestic provisions to deny treaty benefits in inappropriate circumstances (such as the double non-taxation of profits);
- Updating transfer pricing on intangibles - to prevent the siphoning off of profits by moving IP in such a way that the profits are divorced from where the real value has been created. There will be a greater emphasis on underlying substance. This is another area which has attracted attention in the UK recently ;
- Re-examining transfer pricing documentation requirements with a common template to allow Governments to see the big picture regarding the global allocation of profits, economic activity and taxes paid;
- Starting work looking at harmful tax practices i.e. preferential tax regimes. This is particularly an issue for income such as profits from financial activities and IP, as the underlying assets can easily be moved anywhere. More account is to be taken of the underlying substance. The OECD will also engage with non-OECD members – it remains to be seen whether they will cooperate or if the ‘problem’ of base erosion will simply shift to new territories;
Actions in the next two years
The next tranche of actions identified are:
- Strengthening controlled foreign companies (‘CFC’) rules – the UK is ahead of the curve here, having only just overhauled the UK’s CFC rules to focus on profits which are in reality generated in the UK but which are reported as arising in overseas subsidiaries. The OECD wishes to remove or reduce the incentives for multinational enterprises to shift profits into low taxed jurisdictions;
- Limit base erosion by using related party and third party debt to achieve excessive interest deductions, or to finance the production of income which is either tax exempt or deferred;
- Change the trigger for creating a taxable presence in another country, known as a permanent establishment (‘PE’) – at present, companies can avoid tax in another country by ensuing their business there is limited to preparatory or auxiliary activities, such as marketing activity and the storage of goods, and by making sure that sales are actually concluded in a different (low tax) territory. Another arrangement under attack is the use of commissionaire arrangements. These are sales agency arrangements which allow a third party agent in a country to make sales by acting as an undisclosed agent for the principal, and where the bulk of profits remain with the principal (which can therefore be located in a low tax territory). The only profits the ‘host’ country (i.e. where the sales agent is based) can tax are the commissions received by the sales agent, which are relatively low. Commissionaire arrangements are only possible in civil law jurisdictions, such as those in continental Europe – not the UK, which operates common law;
- Transfer pricing work on the allocation of risks and capital within a multinational enterprise. There will be a greater focus on where value is actually created and underlying substance;
- Further work will continue reading transfer pricing of intangibles and harmful tax practices;
- The development of a mandatory requirement for the disclosure of aggressive or abusive transactions. This will draw on the rules some countries already have in place in a domestic context. For example, the UK has had the Disclosure of Tax Avoidance Rules for a number of years, and since 17 July 2013, the new General Anti-Abuse Rule (‘GAAR’);
- On the positive side, there will also be work done to improve dispute resolution between countries as regards taxing rights.
Actions beyond 2 years
Work will continue on tackling BEPS beyond the first two waves of action. Longer term work will focus on:
- Transfer pricing aspects of financial transactions;
- Further work on harmful tax practices; and
- Development of a multilateral instrument to change bilateral tax treaties.
The changes proposed in the OECD’s action plan are far-reaching. Multi-national enterprises have been put on notice that planning of the types highlighted above will be countered in the future. It is now a good time for such businesses to re-evaluate their tax policies and start the process of identifying where new tax risks lie and how these should be dealt with. Inevitably this will mean changes to underlying business practices and structures, which will take time. The OECD’s timeframe is remarkably short, so there is little time for multinationals to lose.
For more information, please contact Jean-François Plourde