Multinational groups, large and small, are now overhauling their international tax planning from top to bottom, due to BEPS, hopefully without getting into the Panama Papers.
What is BEPS?
On October 5, 2015 the OECD published a final comprehensive package of measures aimed at BEPS – Base Erosion Profit Shifting. Countries around the world are starting to legislate and/or apply the BEPS principles.
The BEPS package consists of a number of detailed “Actions” that governments are free adopt.
Which Actions Matter the Most?
Nearly all the OECD Actions may be potentially relevant to a multinational group. But we believe it appropriate at this stage to focus on especially on the following.
Action 2 deals with neutralizing the effects of hybrid mismatch arrangements. caused by different tax treatment in different countries regarding hybrid companies (e.g. US LLCs) and hybrid instruments (e.g. subordinated loans). The OECD recommends amending domestic laws and/or tax treaties to prevent an expense deduction if the item is not taxed in the recipient country. Failing that, the recipient country may tax the item after all.
Action 4 deals with interest payments on regular loans (not hybrids) within a group which create a large expense for an onshore borrower company and little or no tax for the lender company in a sunnier climate. The OECD recommends limiting the expense deduction to 10%-30% of EBITDA (earnings before interest, taxes, depreciation and amortization). This limit might be increased if the group’s worldwide borrowings are higher.
Action 7 tightens up permanent establishment (PE) rules in tax treaties. A PE is a fixed place of business or a dependent agent. The OECD now recommends treating as dependent agents anyone that concludes contracts or plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the foreign company they represent.
This will not apply to independent agents acting in the ordinary course of their business. But it will apply to any agent acting exclusively or almost exclusively for a closely related foreign company, where one controls the other, or both are under common control.
Actions 8 – 10 deal with aligning transfer pricing outcomes with value creation. Transfer pricing refers to the pricing of transactions between related parties – tax planning is possible. The OECD now recommends “careful delineation of the actual transaction” based not only on any contract between the related parties but also their conduct. If an offshore company is allocated risks and profits, it should control those risks and have the financial capacity to assume those risks. If that company merely contributes cash (a “cash box” company), it should only be entitled to a risk-free return. There are detailed recommendations relating to hard-to-value intangibles which prevent tax authorities taxing their transfer within a group with hindsight if certain conditions are met.
Action 13 supplements the transfer pricing recommendations by requiring groups to file transfer pricing studies that contain a high-level group “master file” and a more detailed “local file”.
Furthermore, the OECD recommends that groups with consolidated annual revenues of EUR 750 million file “Country-by-Country” Country (CbC) reports.
What it means:
Although the word “offshore” scarcely appears, the OECD is targeting offshore tax planning techniques and various other loopholes. For example, having no taxable presence onshore, or having royalty and interest expenses onshore but no tax anywhere on corresponding income.
Tax authorities will now get far more information about the global activities of multinationals and greater authority to tax them. Also, it will be harder for multinational corporations to transfer promising intellectual property offshore at a conservative valuation and then attribute substantial profits to that offshore location in subsequent years.
How will this be implemented?
It is expected that most governments will sign up to a “multilateral instrument” (Action 15) to implement BEPS changes in one go.
In addition, some countries are passing their own laws to implement selected parts of BEPS, for example, the EU, the UK, Australia, Canada and South Africa. Other countries’ tax authorities are expected to apply BEPS as an interpretation or clarification of their existing legislation.
What should multinational corporations do?
Multinational corporations should now conduct a detailed review of their international tax planning.
Those with annual global revenues over EUR 750 million will generally be most concerned with the Country-by-Country (CbC) reports (Action 13). Therefore, multinationals must modify their systems and processes in order to capture the required data.
All multinational corporations, large and small, should review their business models and supply chains. Are there agency arrangements that will trigger a permanent establishment for a corporation from one country in other countries?
New transfer pricing studies will generally be advisable. A profit split study should be added to see if profit is allocated to where value is generated. New proposals issued June 29, 2016, provide clarification on profit split studies.
As for intellectual property, are there past latent capital gains tax exposures and/or future income tax exposures?
Governments will be looking for royalties perceived to be excessive. The R&D function should be checked, especially if a “patent box” preferential tax regime has been used in countries like the UK or Cyprus. The rules for them will soon be changing to make sure that tax is reduced where R&D expenditure is mainly incurred.
Group treasury and financing arrangements should be reviewed. New limits may soon apply to interest expense deductions perceived to be excessive, if corresponding interest income is not taxed or if a group loads higher-than-average borrowing costs onto a particular group member.
The above is just the tip of the iceberg. Doing business in other countries and with other countries just got more taxing. Multinationals everywhere must now do some tax homework.
As always, consult experienced tax advisors in each country at an early stage in specific cases.
The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.