On 5 October 2015, the OECD published the final reports of the OECD/G20 Base Erosion and Profit Shifting (“BEPS”) project, which consist of a package of measures for a co-ordinated international approach to reform the international tax system. This package will be discussed by the G20 ministers of finance on 8 October 2015. The combination of proposed anti-abuse rules and increased transparency will have significant implications for (groups of) companies operating in multiple jurisdictions. Contents General comments 2 EU implementation of BEPS Package 2 Action 1: Address the tax challenges of the digital economy 2 Action 2: Neutralise the effects of hybrid mismatch arrangements 2 Action 3: Strengthen CFC rules 3 Action 4: Limit base erosion via interest deductions and other financial payments 4 Action 5: Counter harmful tax practices more effectively, taking into account transparency and substance 4 Action 6: Prevent treaty abuse 5 Action 7: Prevent the artificial avoidance of PE status 5 Actions 8-10: Aligning transfer pricing outcomes with value creation 6 Action 11: measuring and monitoring BEPS 7 Action 12: Require taxpayers to disclose their aggressive tax planning arrangements 7 Action 13: Re-examine transfer pricing documentation 7 Action 14: Make dispute resolution mechanisms more effective 8 Action 15: Develop a multilateral instrument 9 6 October 2015 OECD releases final BEPS package Tax Flash 2 General comments The final BEPS package includes and consolidates the final 2014 deliverables of the OECD BEPS Action Plan that identified 15 action points (the “Actions”). Although the final BEPS package is intended to be comprehensive, the level of proposed commitment varies per proposed measure. The OECD/G20 member states commit to consistent implementation in the areas of preventing tax treaty shopping, Country-by-Country Reporting, combatting harmful tax practices and improving dispute resolution, whereas in other areas, such as hybrid mismatch arrangements, CFC and interest deductibility, they have agreed on a “softer” general tax policy direction. The OECD identifies various next steps, including implementation of the proposed measures, monitoring this implementation and the involvement of developing countries. The OECD emphasizes the importance of a consistent and coherent implementation of BEPS measures that require changes to domestic laws. Furthermore, technical work on certain Actions will only be completed in 2016 and 2017. Moreover, the OECD/G20 countries intend to develop a framework for extending the implementation of BEPS measures to non-OECD and non-G20 countries. It is still difficult to predict whether and to what extent countries will accept harmonisation of international tax standards, in particular with regard to the Actions that have not resulted in minimum standards. Fear for loss of sovereignty and the competition for capital between countries will certainly play a role in the further development of the proposed measures. EU implementation of BEPS Package In connection with the need for a consistent implementation of the BEPS package, the OECD refers to the corporate tax action plan of the European Commission of June 2015. The European Commission calls upon the 28 EU member states to reach a political agreement before the end of the second semester of 2016 on the EU implementation of BEPS Actions 2, 3, 4 and 7. The European Commission clearly points at a so-called “anti-BEPS Directive”. The current state of play shows that the implementation of the relevant BEPS measures may also be put in the hands of the EU Code of Conduct Group on Business Taxation, which only provides non-binding guidance. Action 1: Address the tax challenges of the digital economy Reference to other Actions Following the 2014 deliverable on Action 1, the final report reaffirms that the digital economy cannot be segregated nor ring-fenced from the rest of the economy. Because the digital economy has no unique BEPS issues, but certain key features that intensify BEPS concerns, these issues were identified and influenced the work on other Actions. In particular the work on CFC rules (Action 3), the artificial avoidance of permanent establishment (“PE”) status (Action 7) and transfer pricing (Actions 8-10) are expected to substantially address the BEPS concerns posed by digital economy. Action 2: Neutralise the effects of hybrid mismatch arrangements Common approach, recommendations for domestic law and tax treaty rules The final report on Action 2 sets out recommendations regarding the design of national rules and the development of model treaty provisions to neutralize the effects of hybrid mismatch arrangements that can result in double-non taxation due to the differences in the tax treatment of an entity or a financial instrument under the law of two or more countries. 3 The recommendations for the design of national rules have the form of so-called “linking rules” that connect the tax treatment of a financial instrument or an entity to the tax treatment in the other country. There is a hierarchy in the form of primary rules and rules of a secondary nature (also referred to as “defensive rules”). The aim of this hierarchy is to prevent more than one country applying linking rules to the same arrangement. The recommended primary and secondary rules are still essentially the same as in the interim report on Action 2 which was published in 2014. In short, under the primary rule, the deduction of a payment will be denied to the extent it is either not included in the taxable income of the recipient, or if the recipient is also able to claim a deduction. Under the defensive rule, a payment must be included in taxable income to the extent such payment is deductible with the payer (or the double deduction with the recipient should be denied). Compared to the previous report, the recommendations have been supplemented with further guidance and a total of 80 practical examples have been added to explain the linking rules in further detail. With respect to the tax treaty aspects of hybrid mismatch arrangements the final report proposes, among other things, to include a new provision in the OECD Model Tax Convention that will ensure that the benefits of tax treaties are granted in appropriate cases with regard to the income concerned. The new provision will also ensure that these benefits are not granted where neither country taxes this income. It is anticipated that the revisions of the OECD Model Tax Convention will be completed and released by 2017. Finally, it is emphasized that implementation of these rules now becomes key. To that extent, OECD/G20 will conceive an inclusive framework for monitoring whether countries implement these rules, on equal footing with all interested countries that are participating. Action 3: Strengthen CFC rules Recommendations for domestic law rules The final report on Action 3 gives recommendations on the design of controlled foreign company (“CFC”) rules to respond to BEPS risks. CFC rules tax income of controlled foreign subsidiaries in the hands of resident shareholders, if certain conditions are met. CFC rules test, among other things, if the subsidiary is based in a low-tax jurisdiction and if it earns passive income. The final report considers all constituent elements of CFC rules and breaks them down into six “building blocks”: (i) the definition of a CFC, (ii) CFC exemptions and threshold requirements, (iii) the definition of CFC income, (iv) the computation of CFC income (v) the attribution of CFC income and (vi) the prevention and elimination of double taxation. The recommendations provide flexibility to implement CFC rules in a manner consistent with the policy objectives and international legal obligations of the country involved. Therefore, the impact of these recommendations is still uncertain. The recommendations could result in the implementation of OECD recommended CFC rules in countries that do not have CFC rules and the amendment of existing CFC rules, in order to tackle BEPS risks more effectively. 4 Action 4: Limit base erosion via interest deductions and other financial payments Common approach, recommendations for domestic law rules The final report on Action 4 recommends a common approach to prevent base erosion through the use of interest expenses, and to facilitate the convergence of national rules in the area of interest deductibility. This approach is based on a fixed ratio rule which limits an entity’s net interest deduction to a percentage of its earnings before interest, taxes, depreciation and amortisation (“EBITDA”). As a minimum, this rule should apply to entities in multinational groups. The recommended approach proposes a range of possible EBITDA ratios between 10% and 30%. Countries can supplement this approach with a worldwide group ratio rule, which allows an entity to exceed this limit in certain circumstances. In addition, countries are allowed to supplement the fixed ratio rule and group ratio rule with other provisions that reduce the impact of the rules on certain entities or situations which pose reduced BEPS risks. Further technical work on this Action is expected to be completed in 2016. The recommended approach is expected to impact entities with a high level of net interest expenses in combination with a high net interest/EBITDA ratio, in particular where the entity’s ratio is higher than that of its worldwide group. Action 5: Counter harmful tax practices more effectively, taking into account transparency and substance Minimum standard The final report on Action 5 focusses on two identified priority issues: (i) the development of a substantial activity requirement for preferential tax regimes and (ii) the implementation of compulsory spontaneous exchange on certain rulings. In the context of IP regimes, the report endorses the “nexus approach” as a requirement for substantial activity. Under this approach, taxpayers may only benefit from an IP regime to the extent that they incurred qualifying expenses giving rise to the IP income. The report also provides for some further guidance (e.g. for qualifying IP assets). Although the report states that the nexus approach has been primarily developed in the context of IP activities, it mentions that this approach can also be extended to other (non-IP) preferential regimes (in the Netherlands this may apply, for instance, to copyrighted software). With respect to the exchange of information on rulings, the report identifies six categories of rulings. It confirms that the spontaneous exchange applies both to future rulings (issued after 1 April 2016) and to past rulings (issued after 1 January 2010 and in effect as from 1 January 2014). The information must be exchanged with all countries involved in the transaction covered by the ruling, as well as the residence country of the immediate parent company and the group’s ultimate parent company. Exchange of information under this framework may take place in 2016. 5 Action 6: Prevent treaty abuse Minimum standard The final report on Action 6 closely follows the direction taken in the previous reports on Action 6. To counter treaty shopping, it is proposed that countries include in their tax treaties either (i) a (simplified) limitation-on-benefits (“LOB”) provision in combination with a principal purposes test (“PPT”), (ii) a PPT alone or (iii) a LOB provision supplemented by provisions that would deny treaty benefits to conduit financing arrangements. The report contains detailed proposals for treaty provisions as well as elaborate explanatory guidance. At the same time, it is now explicitly recognized that countries will have to tailor these provisions to cater for their specific situation. Most of the proposals were included in the previous reports. The OECD Model Tax Convention and its Commentary will be amended accordingly. The multilateral instrument that is currently being developed by an ad hoc group comprised of OECD member states and other interested states, and which is scheduled to be ready for signature by the end of 2016, will provide tools for implementation of these concepts in tax treaties (see Action 15). It is, however, recognized in the report that further work still needs to be done. In particular, the report notes that the outcome of the pending consultation process in the United States on changes to the LOB provision in the US Model Income Tax Convention, as proposed in May 2015, will have to be reviewed. It is anticipated that this review is completed in the first quarter of 2016, after which the relevant parts of the report can be finalized. This would be in time to take it into account in discussions on the multilateral instrument. Also, further work will be done on the tax treaty position of noncollective investment vehicles (non-CIVs) and pension funds. Apart from the main focus of the report on broad anti-abuse provisions, the report contains proposals for a number of specific anti-abuse provisions to target specific forms of treaty abuse. These proposals include an alternative tie-breaker rule disallowing dual resident companies tax treaty benefits, unless the competent authorities settle the residency by mutual agreement, and alternative higher withholding tax rates for income attributable to a low taxed PE in a third state. These proposals follow similar proposals in the previous reports. The application of tax treaties to cross border transactions should in principle remain as it is today until the content of the multilateral instrument is known and it becomes clear which countries will accede to the instrument. Also, countries can agree on the inclusion of anti-abuse provisions in bilateral treaty negotiations. However, we expect that source countries will feel strengthened by the final report to scrutinize claims for benefits under existing tax treaties as well. Action 7: Prevent the artificial avoidance of PE status Changes to OECD Model Tax Convention The final report on Action 7 proposes to lower the PE threshold in the OECD Model Tax Convention and, accordingly, the bar for establishing taxable presence of non-resident enterprises in the source country. The report is in substantive terms similar to the drafts released on 31 October 2014 and 15 May 2015. The purpose of the modifications is to target PE threshold avoiding strategies involving commissionaire arrangements, the utilization of specific activity exemptions, and the artificial fragmentation of business activities among related parties. The proposals are technical by nature. If adopted by countries, either through a multilateral instrument or in their tax treaty networks, PE numbers would likely rise. The envisaged lowering of the PE threshold may fuel future discussions with tax authorities, not only on PE status but also on PE profit attribution. We expect to see an increase in compliance costs and administrative burdens in this area. The OECD announces to undertake follow-up work on PE profit attribution in 2016. 6 Actions 8-10: Aligning transfer pricing outcomes with value creation Revised transfer pricing guidance The final reports on Action 8-10 focus on three key areas: (i) Action 8 deals with transfer pricing issues relating to transactions involving intangibles. (ii) Action 9 considers contractual allocation of risks, and profit allocation to those risks. (iii) Action 10 focuses on other high-risk areas, including transactions which are not deemed commercially rational (recharacterisation) and the use of transfer pricing in a way which results in diverting profits from the most economically important activities of the Multinational Enterprise (“MNE”) group. In this respect, the OECD released a partial revision of Chapters I-III and VI-VIII of the OECD Guidelines (“Revised Guidance”). The Revised Guidance states the following: - The actual transaction between the associated enterprises must be carefully delineated by analysing the contractual relations between the parties in combination with the conduct of the parties. The conduct will supplement or replace the contractual arrangements if the contracts are deemed incomplete or if they are deemed to be not supported by the conduct. - Risks contractually assumed by a party that cannot in fact exercise meaningful and specifically defined control over the risks, or does not have the financial capacity to assume the risks, will be allocated to the party that does exercise such control and does have the financial capacity to assume the risks. - Legal ownership alone does not necessarily generate a right to all (or indeed any) of the return that is generated by the exploitation of the intangible. The group companies performing important functions, controlling economically significant risks and contributing assets will be entitled to the “appropriate” return. - Contributions made to a Cost Contribution Arrangement should not be measured at cost where this is unlikely to provide for a reliable basis for determining the value of the relative contributions of participants. - Allocation of profit to a “capital-rich MNE group member” that does not control the financial risks associated with its funding will be limited to (i) no more than a risk-free return, or (ii) less if the transaction is not commercially rational. - Synergistic benefits of operating as a group will be allocated to the members contributing to such synergistic benefits. - The CUP method can be used for commodity transactions whereby quoted prices can be used as reference and reasonably accurate adjustments should be made where needed. - A simplified approach (a 5% profit mark-up on the relevant costs) can be used for low-value-added services. The final report does not introduce so-called “special measures”. Follow-up work will be done on the transactional profit split method, which will be carried out during 2016 and finalised in the first half of 2017 primarily relating to allocation of profits to a PE. In the comments on the draft reports, interested parties have submitted strong arguments supporting the position that the actual behaviour of independent companies does not follow the Revised Guidance. Arguably, the Revised Guidance reflects in certain respects “desired” pricing instead of at arm’s length pricing. In many countries (including the Netherlands), the OECD Guidelines are not directly applicable. Irrespective of the legal implementation, however, the Revised Guidance provides tax administrations with substantive additional tools to attack what they perceive as aggressive international tax planning. In conjunction with the tax transparency measures adopted under Action 13, we expect a significant increase in transfer pricing related disputes and litigation. 7 Action 11: measuring and monitoring BEPS Recommendations on data collection and analysis The OECD estimates that the global loss of tax revenue due to BEPS is between USD 100 billion and USD 240 billion per year. In addition to identifying six indicators of BEPS activities, the final report on Action 11 contains recommendations on improved access to and enhanced analysis of available data to measure BEPS, and on an internationally consistent method of presentation. The report provides analytical tools to assist countries in evaluating the effects of BEPS and the impact of measures to counter BEPS. Action 12: Require taxpayers to disclose their aggressive tax planning arrangements Guidance based on best practices The final report on Action 12 sets out options and provides best practice recommendations for the design of a regime on the mandatory disclosure of potentially aggressive or abusive tax planning arrangements. This modular approach gives countries wishing to introduce a mandatory disclosure regime the flexibility to choose the options that best fit their needs. The key design features addressed in the report include the following: - who reports (the taxpayer/user of the scheme, the promotor or both); - what information to report (dealing with e.g. thresholds and hallmarks); - when to report (timing); and - the consequences of compliance and non-compliance. The report also makes specific recommendations for the design of mandatory disclosure rules in relation to international tax schemes, and identifies opportunities to enhance the exchange of information obtained by countries through such rules. This final report may not only be used as guidance by countries wishing to introduce a mandatory disclosure regime, but may also result in amendments to mandatory disclosure regimes already in place. Action 13: Re-examine transfer pricing documentation Minimum standard Action 13 deals with the development of rules regarding transfer pricing documentation to enhance transparency for tax administrations. The OECD developed a three-tiered standardised approach to transfer pricing documentation: 1. Master file. High-level information regarding the group’s global business operations and transfer pricing policies in a “master file” must be available to all relevant tax administrations. 2. Local file. Detailed transactional transfer pricing documentation must be provided in a “local file” specific to each country, identifying material related party transactions, the amounts involved in those transactions, and the company’s analysis of the transfer pricing determinations they have made with regard to those transactions. 8 3. Country-by-Country Report. Large MNEs are required to file a Country-by-Country Report that will provide annually and for each tax jurisdiction in which they do business the amount of revenue, profit before income tax and income tax paid and accrued. MNEs are also required to report their number of employees, stated capital, retained earnings and tangible assets in each tax jurisdiction. Finally, MNEs must identify each entity within the group doing business in a particular tax jurisdiction and to provide an indication of the business activities each entity engages in. The new Country-by-Country Reporting requirements are to be implemented for fiscal years beginning on or after 1 January 2016 and apply, subject to a review in 2020, to MNEs with annual consolidated group revenue equal to or exceeding EUR 750 million. It is acknowledged that some jurisdictions may need time to follow their particular domestic legislative process in order to make necessary adjustments to the law. The expected impact for MNEs is an increased compliance burden, more questions during audits and potentially risks of double taxation. To prepare for this, MNEs are advised to develop an action plan and build a strategy. With the right approach the MNE will be more efficient, accurate, and prepared for discussions and audits. Action 14: Make dispute resolution mechanisms more effective Minimum standard In the final report on Action 14, the OECD recognizes that dispute resolution mechanisms should be improved, particularly considering the likely increase of treaty-related disputes as a result of the implementation of the other Actions of the BEPS Action Plan. The final report intends to strengthen the effectiveness and efficiency of the mutual agreement procedure (MAP) process by developing a minimum standard, which will be subject to a peer-based monitoring mechanism and complemented by a set of best practices. The implementation of the minimum standard and the best practices require amendments to the OECD Model Tax Convention and its Commentary, domestic law and regulations, and administrative procedures. In spite of the plea of the business community for mandatory binding arbitration, the OECD was unable to reach consensus in this regard. However, a group of 20 countries, including the Netherlands, Belgium, Luxembourg, Switzerland, Germany, France, the UK and the US have committed to adopt and implement mandatory binding arbitration. Therefore, a mandatory binding MAP arbitration provision will be developed as part of the multilateral instrument envisaged by Action 15. Although it is disappointing that no mandatory arbitration mechanism was included, the new measures are an important first step in improving the effectiveness of MAPs. www.loyensloeff.com Although this publication has been compiled with great care, Loyens & Loeff N.V. and all other entities, partnerships, persons and practices trading under the name ‘Loyens & Loeff’, cannot accept any liability for the consequences of making use of this issue without their cooperation. The information provided is intended as general information and cannot be regarded as advice. Disclaimer Action 15: Develop a multilateral instrument The final report on Action 15 incorporates the 2014 deliverable on the feasibility of the development of a multilateral instrument to modify bilateral tax treaties. The final report repeats the conclusion that it is both desirable and feasible to develop a multilateral instrument with a view to streamline the implementation of various tax treaty related BEPS measures. Based on this analysis, the final report includes a mandate for the formation of an ad hoc group to develop a multilateral instrument, which was approved by the OECD Committee on Fiscal Affairs and endorsed by the G20 Finance Ministers and Central Bank Governors in February 2015. The ad hoc group, so far consisting of around 90 countries, started its work in May 2015 and aims to open the multilateral instrument for signature by 31 December 2016. Participation in the development of the multilateral instrument is voluntary and open to all interested countries. It does not entail any commitment to sign such instrument once it has been finalised. Should you have any questions or if you would like to receive additional information, please contact us.