International tax: What you need to know about the BEPS project

Donald Drysdale By Donald Drysdale for ICAS

20 October 2015

Donald Drysdale comments on what the OECD’s BEPS project is all about, and where it has got to so far.

BEPS Final Reports 2015

Tax strategists in organisations operating internationally will have studied the Final Reports 2015 that emanated from the OECD’s ‘base erosion and profit shifting’ (BEPS) project on 5 October. All 2,000 pages of them.

Those with less pressing need, but wishing to maintain awareness of international tax developments, should take a look at the more manageable 48-page compilation of the executive summaries.

The project was born out of an OECD study which concluded in 2013 that BEPS activity by multinationals arose from interplay among tax rules – e.g. domestic laws not co-ordinated across borders, international tax standards not keeping pace with the changing global business environment, and a lack of relevant information at the fingertips of tax administrators and policymakers. Global remedies were needed.

The OECD describes its latest reports as the culmination of two years of unprecedented worldwide effort, with more than 60 countries directly involved in the technical groups and many more participating in shaping the outcomes through regional structured dialogues. They have reached agreement on a comprehensive package of measures, designed to be implemented domestically and through treaty provisions in a coordinated way, supported by targeted monitoring and strengthened transparency.

On 8 October the G20 finance ministers endorsed the final package of measures and renewed their commitment to rapid, widespread and consistent implementation.  The G20 heads of state are expected to endorse this at their summit in Turkey in November. Action to counter BEPS is not simply an aspiration – it’s actually happening.

Key elements of the project

The BEPS project has focused on a wide range of issues.

The global digital economy has come in for particular attention, with discussions around technical issues such as nexus and data, and measures intended to level the playing field between domestic and foreign suppliers.

A common approach has been agreed to eliminate the tax benefits of mismatches and put an end to costly multiple deductions for a single expense, deductions in one country without corresponding tax in another, and multiple foreign tax credits arising from one amount of foreign tax paid.

Controlled foreign company (CFC) rules have been examined closely.  Although policy objectives vary among jurisdictions, recommendations have been agreed which seek to discourage taxpayers from shifting income into foreign subsidiaries.

On interest deductibility, measures have been agreed aimed at ensuring that an entity’s net interest deductions are directly linked to the taxable income generated by its economic activities.

In moves to counter harmful tax practices, preferential regimes that aid profit shifting have been scrutinised.  For intellectual property (IP) regimes such as patent boxes, consensus has been reached on an approach allowing taxpayers to benefit only to the extent that they have incurred qualifying research and development expenditure giving rise to the IP income.  In the UK, consultations on amending the patent box are expected soon.

New minimum standards seek to prevent treaty abuse, including ‘treaty shopping’ – where a non-resident of a territory benefits from a tax treaty concluded by that territory.  Changes to the OECD Model Tax Convention have been agreed; these include steps to ensure that treaties are not used to generate ‘double non-taxation’, and that they do not inadvertently prevent the application of domestic anti-abuse rules.

The definition of ‘permanent establishment’ (PE) is being changed, making it more difficult for a non-resident entity to use artificial steps to avoid paying tax on income earned in a territory.  The UK has already legislated against ‘avoided PEs’ through its Diverted Profits Tax, and Australia’s impending multinational anti-avoidance law will do likewise.

Transfer pricing rules, which determine the conditions and price of related party transactions on the arm’s length principle, have been clarified and strengthened to ensure that they result in better alignment of operational profits with the economic activities which generate them.  More work is being done on some issues considered of critical importance to developing countries.

There is also to be a stringent new standardised approach to transfer pricing documentation, including a minimum standard and common template for country-by-country reporting. Multinationals will have to report annually, for each tax jurisdiction where they do business, the amounts of revenue, profit before tax and tax paid and accrued, and other data including number of employees, stated capital, retained earnings and tangible assets in each tax jurisdiction.  In the UK the Finance Act 2015 already gives HM Treasury power to impose such requirements.

Recommendations have been agreed on steps countries should take to obtain timely information on aggressive tax planning strategies, and help them respond swiftly to tax risks. Unlike the UK, where the DOTAS disclosure requirements are well established, some countries have no such mandatory disclosure rules.

Negotiations are to be convened quickly to develop a multilateral instrument to implement the BEPS treaty-related measures and facilitate the modification of bilateral tax treaties in a synchronised and efficient manner.  Recognising the importance of removing double taxation as an obstacle to cross-border trade and investment, countries have committed to a minimum standard for resolving treaty-related disputes – although this may raise significant resourcing issues for tax authorities.

BEPS activity by multinationals is believed to be increasing and may account for global corporate income tax losses as high as £150 billion annually.  To measure the tax effects of BEPS and monitor the effectiveness of the BEPS countermeasures, countries will have to improve their collection and analysis of relevant data.

Ongoing work planned

The reports of 5 October mark an important stage in the development of international fiscal co-operation.  Huge progress has been made but not all the planned actions of the BEPS project have been completed.  While countries begin implementing some of the measures, an ongoing programme of collaborative work will continue through 2016 and beyond, including work on:

  • Negotiating the multilateral instrument to support the amendment of bilateral tax treaties.
  • Providing additional guidance on profit attribution to PEs.
  • Addressing a number of technical issues before updated OECD transfer pricing guidelines can be published, perhaps not until 2017.
  • Designing an inclusive framework to support and monitor the implementation of the BEPS package more widely, with countries and jurisdictions participating on an equal footing.

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