What is it?
BEPS is an acronym for base erosion and profit shifting and “refers to tax planning strategies that exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to locations where there is little or no real activity but the taxes are low, resulting in little or no overall corporate tax being paid”.1
To take a simple example, a foreign multinational looking to establish an Australian subsidiary can determine whether to capitalise the subsidiary with equity (non-deductible, but frankable) or debt (deductible), subject to our thin capitalisation regime which generally restricts the quantum of deductible debt to 60% of total assets (or a 1.5:1 debt to equity ratio). The foreign multinational can set an appropriate interest rate for any such debt, albeit subject to the transfer pricing rules that require the rate to be “arm’s-length”. And the foreign multinational can determine whether to provide the loan from its head office (which may be subject to a high corporate tax rate) or via another subsidiary located in a low or no tax country. This might reduce the tax on a portion of the Australian sourced profits from 30% (the Australian corporate tax rate) to as little as 10% (the Australian withholding tax rate for interest).
More complex examples might involve an oil company setting up a “marketing hub” in a place like Singapore or a technology company entering into a “double Irish Dutch sandwich”.2
What is being done about it?
There have already been inquiries into BEPS and related issues by the US Congress, UK House of Commons and the Australian Senate which have put a number of multinational companies under the microscope.
In September 2013, the G20 endorsed the 15 point BEPS Action Plan developed by the Organisation for Economic Co-operation and Development (OECD) to be considered and implemented in 2014 and 2015.3
At their meeting in Brisbane in September 2014, the leaders of the G20 committed to taking action to address BEPS and implement the recommendations of the OECD including endorsement of the first seven deliverables.4
The current status of the BEPS Action Plan is outlined in the table here.
Some key areas of focus are:
- mismatches in treatment of certain hybrid finance instruments, which may be treated as equity in one jurisdiction and debt in another (Action item 2);
- the current limitations of the controlled foreign company rules, which operate to tax residents of a country on the accruing profits of foreign companies they control (Action item 3);
- the level of interest deductions available to multinational groups and whether they should be restricted further, eg. by reference to the global gearing of the group rather than some fixed ratio (Action item 4);
- the control of “abuse” of tax treaties, eg. by imposing limitation of benefit provisions (Action item 6);
- modernising the definition of “permanent establishment” to address issues arising from the digital economy (Action item 7);
- ensuring that the transfer pricing rules operate appropriately for intangible assets, take account of risk and capital and address other high risk transactions (Action items 8 – 10); and
- increasing the level of disclosure of aggressive tax planning arrangements (Action item 12).
Recognising that many of these issues arise from bilateral tax treaties between countries that are not easily modified, one of the more ambitious aims of the OECD is to develop a multilateral instrument that can be applied – and to that extent modify or supersede – a country’s bilateral treaty network (Action item 15).
Despite the G20’s support for the OECD approach, some governments have “jumped the gun” and sought to address aspects of BEPS on a unilateral basis. For instance, the United Kingdom has proposed a 25% “diverted profits tax” applicable to multinationals with UK business activities that enter into “contrived” arrangements to divert profits away from the UK by avoiding the creation of a permanent establishment (taxable presence) in the UK or other contrived arrangements that produce an “effective tax mismatch outcome” and which have “insufficient economic substance”. Australia has recently announced that it has formed a joint working group with the UK to develop measures to address the diversion of profits by multinational enterprises away from their host countries.
Why should I care?
The danger is that, unless the OECD can garner international consensus for its proposed reforms – including among developing countries outside the OECD – any changes made by individual countries may actually result in double taxation.
To take a simple example, if Australia was to treat loans provided by a foreign parent to its Australian subsidiary as equity (and so non-deductible), this would increase the tax paid on the Australian subsidiary’s profits in Australia. If the foreign jurisdiction was to continue to respect the form of the transaction and impose tax on the “interest” received by the foreign parent, then double taxation would be an inevitable result.
Corporate counsel working for multinational groups may need to prepare for an increase in tax related litigation arising from the focus on BEPS. For instance, the recent Chevron case before the Federal Court, concerning the appropriate pricing – under Australia’s transfer pricing regime – of intercompany debt ran for some 21 days and involved some 18 independent experts and myriad counsel. The Australian Taxation Office (ATO) is currently examining some 86 multinationals (reportedly including 25 technology companies) with concerns focussed on:
- migration of intangibles offshore;
- creation of offshore hubs for marketing or procurement;
- debt push down/excessive interest arrangements;
- tax arbitrage via hybrid entities/instruments;
- transfer pricing outcomes that are inconsistent with arm’s length outcomes; and
- e-commerce structures.5
Such disputes can be time consuming and costly, particularly where they require an examination of the factual business practices within a multinational group, as may be the case where the ATO is seeking to argue that the business has a permanent establishment in Australia. As with any litigation, the better prepared you are in advance, the greater the probability of a successful resolution. Indeed, by the time you hear from the ATO, they will already have been examining and developing an understanding of your business for some time. This understanding will be enhanced from 2017/2018 when the “common reporting standard” for sharing of taxpayer financial information between countries starts to take effect.
Beyond the immediate challenges of dealing with any inquiry or ATO audit, there may also be longer term implications of any changes to the structure of the “international tax system”. For Australian multinationals, any reforms may increase the level of compliance and cost in doing business offshore and may make some foreign activities sub-optimal. For local management of a foreign multinational, any focus on the “economic substance” of entities may lead to increasing pressure to relocate management from Australia to some foreign location.
Although much of the day to day tax planning and compliance may be handled through your finance function, and possibly co-ordinated from offshore, it represents a broader issue – and legal exposure – that corporate counsel needs to be across and involved with. The current focus on BEPs by the Australian and international press, coupled with the parliamentary inquiries mentioned above, highlight the reputational issues which may arise if these matters are not addressed appropriately.
Where to get help?
Our taxation team has considerable experience in all areas of international taxation, including transfer pricing, and is available to assist clients with proactive risk reviews, restructuring of cross-border arrangements and ATO audits and enquiries.