OECD Delivers Final BEPS Recommendations to the G20 Finance Ministers (article)
On October 5, 2015, the OECD presented final recommendations1 relating to the Base Erosion and Profit Shifting (BEPS) project to the G20 Finance Ministers. The recommendations represent a multi-year focus on international tax policy aimed at curbing tax avoidance by multinational enterprises (MNEs) and include more than 1,600 pages covering 15 action points.
The project was motivated by the global need to address perceived weaknesses in the international tax framework that create opportunities for MNEs to reduce the tax base of countries through profit shifting and other aggressive tax planning strategies. The fundamental objective of the project is to lay the foundation of an international tax framework under which profits are ultimately taxed where economic activity and value creation occurs. The BEPS policy measures offer minimum standards, best practices and recommendations to:
- Appropriately align taxation with the substantive and value creating activities,
- Remove gaps or “loop holes” stemming from lack of uniform international tax laws, and
- Increase disclosure and transparency allowing governments to assess the risk of potential BEPS involving taxpayers within their taxing jurisdiction.
A number of countries have already proposed (or actually implemented) local tax reform during 2015 to address some of the perceived BEPS concerns. Many countries will continue the tax reform process of adopting BEPS policy measures (or adaptations of the measures). The United States is expected to be among the countries adopting some form of these policy measures during 2016. Governments operating in their own interests will likely create uncertainty around BEPS measures in the near future as the timing of the adoption of the changes will vary from country to country, and many countries will propose unilateral tax reform variations that may or may not maintain consistency with the recommended consensus-based framework of BEPS policy measures.
At the same time, increased audit activity is anticipated around international tax and transfer pricing structures and transactions. It is also expected that there will be an increase in disputes that must be settled on through the mutual agreement procedure (MAP) in tax treaties. Audit activity and disputes will inevitably increase the cost and risk involved with international tax and transfer pricing compliance for MNEs. Of note, 20 countries have committed to providing a framework for mandatory binding arbitration in their bilateral tax treaties to help ensure more efficient and timely dispute resolution.
The OECD will continue to work in 2016 on certain types of financial transactions, attribution of profits, profit split methods, intangibles, and further guidance on implementation of the existing consensus framework.
The 15-point action plan that was presented to the G20 Finance Ministers on October 5, 2015 is briefly summarized below.
Action 1: Addressing the Tax Challenges of the Digital Economy
Action 1 identifies difficulties caused by digital business within the current international tax framework. The measures propose a number of potential direct taxation and indirect taxation mechanisms such as digital nexus, modifications of permanent establishment (PE) exemptions, withholding on digital transactions, VAT based on the jurisdiction of the customer and others mechanisms that will provide taxing authorities options to address the challenges of taxing digital business.
Action 2: Neutralising the Effects of Hybrid Mismatch Arrangements
Action 2 recommends measures to neutralize arrangements where companies, through various tax structuring involving the use of hybrid instruments or hybrid entities, may benefit from:
- Deductions in the paying jurisdiction without corresponding income inclusion in the receiving jurisdiction or
- Deductions in both the receiving and paying jurisdiction on payments such as royalties, interest, or other intercompany payments.
The measure seeks to appropriately view both sides of any transaction to avoid double non-taxation of income.
Action 3: Designing Effective Controlled Foreign Company (CFC) Rules
Action 3 provides guidance on effectively preventing taxpayers’ ability to shift income to CFCs. Because of differences in the tax systems of many countries, the action provides various options for the implementation of effective CFC regimes based on “building block” rules that address the definition of a CFC, exemptions and thresholds, income computation and attribution of income, and the prevention of double taxation.
Action 4: Limiting Base Erosion Involving Interest Deductions and Other Financial Payments
In an effort to limit MNEs from artificially inflating interest deductions through the use of intra-group debt as a mechanism for tax minimization, Action 4 provides two primary approaches to limit interest deductions:
- A fixed ratio rule where specific interest expense to EBITDA ratio caps are used to establish deductibility levels for the local taxpayer, for example 10 - 30 percent, or
- A group ratio rule where the interest to EBITDA ratio of the consolidated controlled group of companies is used to determine the local taxpayer’s cap for deductibility of interest expense.
Action 5: Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance
Action 5 addresses concerns around rulings or other preferential tax regimes offered by taxing authorities. The measure provides for an agreed upon “nexus approach” for assessing whether or not substantial activity is being undertaken in a jurisdiction where a taxpayer is receiving preferential tax status from, for example, a patent box type regime. The action also provides a framework for compulsory exchange of information relating to rulings so that the potentially harmful practice can be transparently monitored.
Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances
Action 6 provides a minimum standard to prevent treaty shopping and includes changes to the OECD Model Tax Convention to avoid potential conflicts with domestic anti-abuse rules. The agreed standards include:
- A clear statement expressing intention to avoid creating opportunities for low or no taxation,
- Inclusion of a specific anti-abuse rule based on Limitation on Benefit (LOB) provisions,
- Inclusion of general anti-abuse rules based on a principal purposes test in order to deal with situations not covered by the LOB rule, including transactions involving dividend transfers, dual residence, transfers of shares deriving value from immovable property and shares transferred to PE in countries which do not tax such income, and
- Ensuring treaties do not inadvertently prevent application of domestic anti-abuse rules.
Action 7: Preventing Artificial Avoidance of Permanent Establishment Status
Action 7 proposes alternative formulation of paragraphs 5 & 6 of Article 5 to prevent artificial avoidance of PE status. The changes include a recommendation of a broader definition and test for what constitutes a dependent agent, a more limited independent agent test, and a limitation of specific activity exemptions.
The initially proposed, and fairly open ended, language for contract negotiation activities such as “negotiating material elements of a contract” creating a PE was modified in the final deliverable where agency activities involved with concluding contracts or performing “the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the principal” would create PE.
Actions 8/9/10: Guidance on Transfer Pricing Aspects of Intangibles
The measures provide guidance on how “to align pricing outcomes with value creation.” The primary purpose of these measures is to strengthen transfer pricing rules to ensure that the location of profits for tax purposes aligns appropriately with the substance or value creation in transfer pricing arrangements. The measures primarily focus on transactions involving capital, risk, and intangibles because these types of transactions have significant profitability implications while also being considered easy to transfer contractually and difficult to properly value because of limited comparable transactions. The focus of evaluations for these types of transactions will move beyond the legal or contractual arrangements to more appropriately evaluate the real conduct of the parties as a basis for allocating capital, risk, and returns amongst entities involved in a transaction.
Taxing authorities are actively looking to mitigate artificial arrangements. Taxpayers involved in these types of transactions will need to carefully develop their factual basis regarding the functions, assets, risks and, more specifically, clearly evidence the real location from which strategic decision making regarding risk taking, capital allocation, and intangibles development is executed. A taxpayer’s factual basis for which entity in reality has the ability to exert control and real economic capacity to bear risk will be important with properly aligning “pricing outcomes with value creation”.
Action 11: Measuring and Monitoring BEPS
Action 11 discusses collection of data and the development of indicators to facilitate the performance of BEPS analysis. The OECD envisions assisting governments with more effectively using data that has already been gathered and evaluating new data that is proposed to be gathered through Actions 5, 12, and 13.
Action 12: Mandatory Disclosure Rules
In Action 12, the OECD provides an overview on existing mandatory disclosure regimes and offers guidance on a framework for taxing authorities to implement disclosure regimes relating to aggressive planning schemes used by taxpayers within their jurisdiction. The guidance recommends rules for targeting abusive planning and developing effective information exchange procedures to assist in this process.
Action 13: Guidance on Transfer Pricing Documentation and Country-by-Country Reporting
Action 13 presents a 3-step approach to transfer pricing compliance:
- A masterfile containing information for the whole MNE group,
- A local file that provides specifics and transactions of the local taxpayer, and
- Country-by-country reporting (CBCR) which provides details on taxes, financials, employees, and related party transactions on an entity-by-entity basis for the MNE to be used by taxing authorities for risk assessment.
See MNE Need to Reevaluate Transfer Pricing Documentation for more detail on the recommended transfer pricing compliance approach.
An added implementation package clarified recommendations for thresholds related to CBCR reporting, for preserving taxpayer confidentiality, for appropriate use of CBCR by taxing authorities, and for implementing appropriate CBCR filing and information sharing processes.
Action 14: Making Dispute Resolution Mechanisms More Effective
Action 14 provides a minimum standard relating to dispute resolution which includes minimum commitments by governments to implement best practices for MAP. The final report also indicates commitment from 20 countries to providing a framework for mandatory binding arbitration in their bilateral tax treaties to help ensure more efficient and timely dispute resolution.
Action 15: Developing a Multilateral Instrument to Modify Bilateral Tax Treaties
Action 15 explores the potential for a multilateral instrument to amend existing bilateral tax treaties and facilitate implementation of BEPS-related measures. Based on the initial analysis, a working group has been developed to develop this instrument for approval in 2016.
Please contact Don Reiser, Josh Finfrock or your local CBIZ MHM tax professional with any questions on how these measures may apply to your company in the near future.
1. BEPS 2015 Final Reports, http://www.oecd.org/tax/beps-2015-final-reports.htm ↩
Copyright © 2015, CBIZ, Inc. All rights reserved. Contents of this publication may not be reproduced without the express written consent of CBIZ. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.
CBIZ MHM is the brand name for CBIZ MHM, LLC, a national professional services company providing tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies. CBIZ MHM, LLC is a fully owned subsidiary of CBIZ, Inc. (NYSE: CBZ).