This article was written by Jerome Tse & Frances Leitch
Heads of Government Summit in Brisbane. One of the key priorities of the G20 in 2014 is to combat global tax avoidance by improving “international cooperation to protect the integrity of national tax systems”, and addressing “base erosion or profit shifting” or “BEPS”.
The Organisation for Economic Co-Operation and Development (“OECD”) is leading the global charge on BEPS and is now just under midway through an ambitious Action Plan that was released in July 2013 and has been fully endorsed by the G20 Finance Ministers.
“BEPS” refers to the erosion of the corporate tax base in a particular jurisdiction by aggressive tax planning, including profit shifting of multinational enterprises. Specifically, BEPS is regarded as the consequence of multinational enterprises manipulating the interaction of domestic tax rules and international tax standards to achieve double non‑taxation or less than single taxation.
The crux of the issue stems from the OECD’s view that international tax policy and standards, developed in the 1920s and designed to preserve tax sovereignty and prevent double taxation, were not designed to deal with current global business practices. As a consequence, how these rules operate to tax the profits of multinational enterprises does not reflect the economic substance of what they are able to achieve with regard to increased levels of cross-border trade and/or the use of global value chains.
OECD Action Plan
The July 2013 OECD Action Plan seeks to address BEPS by providing countries with international and national tools and instruments to better align the limits of tax sovereignty with global economic realities. The Action Plan covers three overarching areas of focus, namely, increasing “coherence”, “substance” and “transparency” of international tax regulation. Of the 15 Actions, only Actions 1 and 15 sit outside of these three main themes.
Actions 1 and 15
Action 1 seeks to counteract the challenges posed by the digital economy to current taxation principles. The main concern from the “digitalisation of the economy” is that it allows enterprises to operate in a jurisdiction without being liable to tax under the traditional concepts of residence and source. KWM’s Paris office responded to the OECD request to send comments on the Discussion Draft released 24 March 2014. In our response, we suggested that tax rules relating to digital economy should be general and should be able adapt to existing situations and to the evolution and emergence of any new business models in the future.
The OECD received 62 other submissions on the Discussion Draft. The submissions generally acknowledged that:
- The digital economy is enmeshed across all businesses in various sectors and cannot be separated from the broader economy
- Tax leakage due to the digital economy should be addressed through the overall Action Plan rather than a specific measure directed at the digital economy
Action 15 is an ambitious final step in the BEPS project and seeks to develop a multilateral instrument that countries may adopt to amend their existing bilateral treaties to implement any relevant BEPS reforms that achieve consensus. Work on a framework for the multilateral instrument will commence in early 2015. Concerns still remain as to whether all countries are attracted to such an option. Action 15 will only achieve success if all (key) OECD countries ultimately agree to ratify the multilateral instrument.
The Actions under “coherence”, seek to establish international coherence in corporate taxation regimes. Although the OECD acknowledges that each country can design its own tax policies as it sees fit, a level of coherence is still required to avoid double non-taxation or less than single taxation.
||Neutralise the effects of hybrid mismatch arrangements.
||Strengthen CFC rules.
||Limit base erosion via interest deductions and other financial payments.
||Counter harmful tax practices more effectively, taking into account transparency and substance.
The “substance” themed reforms seek to ensure that taxation is aligned with the economic substance of the transaction.
||Prevent treaty abuse (see the contribution of the Paris office here).
||Prevent the artificial avoidance of PE status.
|Actions 8, 9 and 10
||Assure that transfer pricing outcomes are in line with value creation (with specific regard to intangible, risks and capital, and other high risk transactions).
The reforms in the area of “transparency” seek to promote tax certainty and predictability.
||Establish methodologies to collect and analyse data of BEPS and the actions to address it.
||Require taxpayers to disclose their aggressive tax planning Arrangements.
||Re‑examine transfer pricing documentation.
||Make dispute resolution mechanisms more effective.
What can we expect following the G20 Summit in Brisbane and the G20 Finance Ministers meeting in Cairns, Australia in late 2014?
It is easy to take a less than optimistic view of the OECD’s ambitious task to address the BEPS problem. Indeed, the OECD has itself previously acknowledged (in its February 2013 report) that it is not sure “about how much BEPS actually occurs.”
There will be difficulties in achieving consensus on whether to deal with certain Actions in the first place. For example, Action 3 will require significant changes from some entrenched positions (one example being the US “check the box” regime), which is unlikely to take place. Given most OECD member countries have adopted different CFC regimes, achieving consensus on this Action may be difficult and poses serious threat to the ‘coherence’ that Actions 2 to 5 are designed to bring.
Consensus as to how to address certain Actions may also pose difficulties. Currently, in relation to Action 2, the OECD is considering both a primary rule (for example, a denial of a deduction where it is not taxable in the other country) and a secondary defensive rule (continuing the example, where, for whatever reason, the primary rule is not applicable, the other country is required to include an amount in a taxpayer’s ordinary taxable income). A key issue here would be how the primary and secondary rules interact to ensure that a taxpayer is not ultimately subjected to double taxation. Further clarity is still required.
In our view, the area that is most likely to achieve consensus is around transfer pricing (Actions 8 to 10, and 13). There is significant global pressure on transfer pricing, which is likely to incentivise OECD member countries and the G20 to complete work on these Actions. These actions are also designed to bring transparency to the international tax system (particularly Action 13), which is in line with the G20 supported OECD work on Common Reporting Standard for the automatic exchange of information. The Australian Treasurer, Joe Hockey, has again highlighted that ‘tax transparency and information exchange’ is ‘an important theme’ for the G20,with further agreement from the G20 Finance Ministers and Central Bank Governors on the use of the Common Reporting Standard following their recent meeting in Cairns.
Overall, when the theme of these Actions is premised on, and has as its aim, a level of global consensus and coherence being reached, it is unlikely that the OECD will achieve all of what it set out to in July 2013. Taxpayers, especially those in highly regulated industries (financial institutions, pension funds etc) that require taxation certainty, will need to keep an eye on these reforms and, where necessary, provide input into their development, in order to obtain a satisfactory solution going forward.
The expectation, or perhaps hope, is that the G20 Summit in Brisbane will evidence a continuing commitment by the G20 countries to, in the words of the Australian Government, “an inclusive, multilateral approach to reform that minimises the risks of unilateral action and the re-emergence of double taxation which would damage international trade.” This will only be achievable if the G20 Summit is able to show real tangible progress in 2014, like that which it achieved in St Petersburg in 2013.
KWM are monitoring developments and would be happy to keep you directly informed. Please contact one of the contacts listed below to either discuss this topic further or stay directly informed.