Richard Collier and Philip Greenfield examine the effect the OECD and G20 BEPS project has had on the international tax environment.
In the business world, it is hard not to be aware of the ongoing and very high-profile OECD and G20 project on Base Erosion and Profit Shifting (BEPS).
The aim of the project is, primarily, to put a stop to the ability of multi-national corporations (MNCs) to structure their business so as to ensure material profits are subject either to no tax or tax at a low rate. There are also other objectives behind the BEPS project. These include addressing the perceived problems of 'digital business' – ie, whether and how tax systems need to change to deal with business that may be done in one state by a tax payer in another state who has no presence in the first state and transacts business over the internet. The BEPS project also aims to revamp some earlier work of the OECD on harmful tax practices – meaning it will aim to identify which tax regimes created by states are to be viewed as 'harmful' and therefore should be phased out.
All these objectives are reflected in the OECD's Action Plan of July 2013, which sets out an ambitious programme of work to be completed over a two year time-frame and by reference to 15 work streams dealing with specific issues or areas.
As indicated, the bulk of the BEPS project is directed at constraining the tax planning activities of MNCs. However, one of the work streams of BEPS is aimed at improving dispute resolution procedures between states where disputes arise from the allocation of taxing rights between states. Given the concerns that the BEPS project could lead to an increase in double taxation, together with the prospect for increased disputes, MNCs will welcome this work. However, it is recognised that it might prove difficult to secure material progress given the reluctance of some states to consider the development of new arbitration processes.
It is now just over a year since the OECD's BEPS project started in earnest following the publication by the OECD of its Action Plan. We have over the last few months seen a broad range of detailed proposals from the OECD dealing with such topics as tax treaty abuse (aimed at preventing the inappropriate use of tax treaties to secure reduced withholding tax and other benefits); hybrid mis-matches (targeted at situations where tax deductions are given twice or where tax deductible payments are not taxed in the hands of the recipient); and country by country tax reporting and transfer pricing documentation. In all these areas, significant tax reforms are being proposed. We have also seen a wider discussion of the tax issues presented by digital business, although the immediate work in that area relates to transfer pricing and permanent establishment issues.
Taken together, there seems little doubt that, directly or indirectly, the BEPS project is having, and will continue to have, a material effect on the international tax environment. This point is important as there was some scepticism initially on whether the OECD would secure sufficient consensus to deliver tangible proposals for change. With the package of the initial work streams released on 16 September 2014, there seems materially less doubt that the OECD will achieve consensus to deliver most or all of their planned changes. Not surprisingly, this has led to some shift in thinking on the part of multi-nationals as to the likely effect in practice of the ongoing OECD work.
That effect of BEPS is likely to be seen in any one of three different ways. First, via the OECD changes themselves - and here such changes could be effected ultimately through changes to double tax treaties (via the OECD Model double tax treaty) or the OECD’s Transfer Pricing Guidelines. OECD change may also come through the enactment of OECD proposals for changes to the domestic tax system of individual states.
Second, changes are also emerging from the mechanism that the OECD does not want to see, namely from the unilateral actions of individual states - as seen recently, for example, in France, Mexico and China.
Third, and perhaps most immediately, there is the change effected by a behavioural shift on the part of the tax authorities, as they tighten their approach to dealing with the cross-border tax affairs of MNCs.
Given that we have now seen the output representing broadly the first half of the BEPS project, what conclusions may be drawn? There are three immediate points. First, the scale and scope of the work in progress is clearly more far-reaching than many had anticipated at the outset of the project. For example, the comprehensive treaty abuse proposals have caught many off guard as the scale and comprehensiveness of the package was largely unexpected.
Second, unlike virtually all previous OECD tax projects, the ambitious package as a whole is broadly on schedule, notwithstanding the incredibly tight deadlines that have been set. This does not mean that there are no different views being expressed by states on the BEPS package. A variety of different views and perspectives amongst states clearly does exist. However, so far at least, the OECD has managed to confine the level of outright disagreement and kept its package broadly on schedule.
Third, it is clear that the OECD package is very likely to have a significant impact on taxpayers, whether that is a constraining effect on tax planning (as in the case of the impact of the hybrids proposals and the treaty abuse proposals) or whether it forces new compliance obligations (as in the case of the country-by-country reporting proposals and the revised approach to transfer pricing documentation).
The focus of the OECD work on BEPS has now shifted on to a second wave of work streams with a view to completing the package of BEPS proposals by the end of next year.
The list of work in progress includes: control foreign company ('CFC') or anti-tax haven measures, the treatment of interest payments (designed to prevent excessive interest payments by taxpayers); work on the permanent establishment threshold test (intended to ensure the rules dealing with the circumstances in which a taxable presence is created are able to accommodate modern business practices and structures); work on risk shifting and ‘excess’ capital; high risk transactions including profit splits and recharacterisation; disclosure obligations; dispute resolution; data on BEPS; and the multi-lateral treaty that would amongst other things facilitate the updating of a swathe of existing tax treaties in one go.
Most of the work streams for 'Season 2' of BEPS contain some major challenges, which may well prove controversial – not just amongst multinationals but also amongst the tax authorities participating in the process. States may have very different views on what measures are acceptable (for example on how far it is acceptable to have broad-based and subjective anti-avoidance rules and how far their own domestically headquartered multinationals are to be shielded from the changes proposed).
The issues can be illustrated by reference to a couple of the upcoming work streams. In relation to the work on permanent establishments (ie, the rules which determine whether or not a taxable presence is created) it is not yet clear how far reaching will be the changes to these rules, although the OECD is known to be working on a wide range of different issues affecting most of the existing rules.
One of the obvious candidates for change is the 'dependent agent' rule (which applies to create a taxable presence of an overseas principal in a state where an agent in that state recurrently concludes contracts on behalf of that principal).
The operation of the rule is widely regarded as problematic and this might suggest it would be easy to secure agreement for its change. However, changing this rule could have far-reaching effects on the taxation of international business and push wide taxing rights to countries which have so far not had them. Accordingly, whether as a political matter significant change will be made remains unclear.
Similarly, in the case of the OECD's proposed work on 'excess capital' and risk shifting, the OECD is targeting what it perceives as instances of the abusive location of capital in tax havens or low tax states (excess capital), together with what it sees as abusive instances of the shifting of risks (and therefore reward) from high tax to low tax states.
There are two obvious issues that will need to be addressed in this work stream. First, how far should the tax authorities go in ignoring the effect of legal contracts and documentation that has been entered into by separate (if associated) companies? Second, if the approach is to turn on criteria of what is, and what is not, acceptable, where is the line drawn and by what operative tests? These are clearly difficult issues but, judged on its output to date, it seems unlikely that the BEPS project will pull its punches in delivering substantive proposals for change.
The above discussion indicates that there is a real prospect of significant reform and that the project as a whole will likely have a bigger impact than was initially considered by some commentators. This obviously raises the question of what taxpayers should do now.
We would suggest there are four important matters to address. First, given the potential impact of the BEPS package, MNCs would be well advised to monitor the developments and ongoing work within the BEPS project so they have a good (and timely) idea of what is coming.
Second, there are some areas within the BEPS project where the views of business are sought, such as on the way in which any new rules may be applied. It is therefore important that business fully participates in this process, highlighting matters of particular concern.
Third, given the significance of these tax developments and their potential impact on business and arrangements adopted by business, it is important that their effect is known within business, which indicates the need for communication internally within a MNC on the changes that are in progress. Fourth, it will already be clear in some cases that there are within a MNC areas of vulnerability to impending changes as a result of the BEPS project. It would therefore be sensible for each MNC to identify any such vulnerabilities and remediate them where possible ahead of any tax authority action.
Centre for Business Tax at the University of Oxford. He specialises in cross-border allocation of income.
Philip Greenfield has been in the tax profession for over thirty years. He is a member of PwC's global teams that work on tax policy and tax reputation, and has been closely involved in PwC's response to the BEPS project.
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