During the seminar ‘BEPS is picking up steam’ the audience was updated on the latest international tax developments. Now that the implementation is well under way, speakers from Loyens & Loeff explained how it is affecting MNEs’ business and spoke about ways of dealing with accompanying issues. The core message was that MNEs’ business set-up and tax efficiency can go hand in hand in a post-BEPS world. Often coupled with the transfer of some functions to their group company in Belgium, Luxembourg, the Netherlands or Switzerland. At the same time, the fear is that based on ATAD stricter rules than necessary will be implemented in the Netherlands. To the extent that MNEs have not already done so, they can still raise their voice in the debate. But they have to be quick!
Convincing TP documentation and creating a consistent story matching external communications (like the corporate website and LinkedIn) reduce TP corrections and with that litigation exposure and mutual agreement procedures. Thorough TP documentation may give an opportunity to reduce MNEs’ tax burden.
For years, clear transfer pricing (TP) rules have existed with best practices which were applied much less detailed than indicated in the OECD TP Guidelines. The best practices were generally accepted by the tax authorities. With the new OECD TP Guidelines and the state aid developments, the question arises whether it is time to update these best practices and adhere to the 2017 OECD TP Guidelines?
MNEs may have different objectives they would like to meet with their TP documentation, like:
- Be compliant with the minimum requirements;
- Have no surprises and minimise disputes; or
- Reduce their tax burden
A quick poll among the audience learned that 59% of the MNEs has the second objective as main objective. Depending on their objectives, MNEs may apply one or more of the following strategies with respect to their TP documentation:
- Address red flags from their CbCR in their Master File/Local File;
- Put good contracts in place and live up to them;
- Substantiate choices in TP documentation, not only positive ones, but also negative ones;
- Align TP documentation with external communications like the corporate website and LinkedIn profiles of employees.
Convincing TP documentation and a consistent story by applying these strategies reduce litigation exposure and mutual agreement procedures (MAPs). Recent case law (the Zinc case) also shows the importance of sound TP documentation in order to avoid TP corrections being applied. Implementing these strategies and the 2017 OECD TP Guidelines, furthermore, give MNEs a stronger case if they end up in litigation or when they are under scrutiny of the European Commission in a state aid investigation. Comprehensive TP documentation may also give MNEs the opportunity to reduce their tax burden when substantiating the choices made in their TP documentation. Where traditionally TP reports were prepared based on best practices, MNEs can now work on a well-founded substantiation of their TP. This may result in the outcome that a lower profit allocation should be considered at arm’s length than based on best practices.
EU State aid and taxation – State of play
MNEs may check the potential financial exposure by applying the Commission’s reasoning to their structure
The acceptance of certain specific transfer prices outside the framework of domestic tax law and administrative practice can constitute illegal state aid. However, the European Commission goes one step further. It relies on the 2010 and even the 2017 OECD TP Guidelines to review cases going back to the 1990s. Even if those were not adopted by an EU Member State at the time.
There also seems to be a new topic on the Commission’s enforcement agenda: did a Member State sufficiently apply its own anti-abuse rules or are there selective advantages hidden in those rules (or in their application). Not to mention what the possible implications may be once Member States have implemented anti-abuse rules following the Anti Tax Avoidance Directive (ATAD).
What should MNEs do? At this stage they may check the potential financial exposure by applying the Commission’s reasoning to their structure. At the same time, MNEs could assess whether restructuring is opportune at this moment.
Will the judge become stricter with respect to international tax planning?
It is not expected that public concern will have much influence on the judge’s decisions on international structures.
The question is whether public concern about taxavoiding behaviour of some large MNEs will influence the attitude of the Dutch judge in disputes where such behaviour is present. The judge will only intervene if a tax structure infringes the purpose and scope of the law, using the fraus legis doctrine. However, in international structures such a doctrine cannot be applied unreservedly. Reasons are the freedom of the entrepreneur in structuring his entrepreneurial activities and disparities as a result of another qualification given to a legal relationship than in the Netherlands. Moreover, the Supreme Court will refrain from quickly applying a tax treaty clause due to treaty abuse. Due to these special aspects, a judge has less freedom to interpret the existing law and tax treaties generously in order to achieve a result that is socially desirable. Therefore, it is not expected that public concern will have much influence on the judge’s decisions on international structures.
EU Court of Justice’s view: how can ‘substance’ get you out of tax avoidance discussions
MNEs are recommended to have documentation that substantiates the choices they have made.
The message is: get used to the main purpose test. It is included in the legislation implemented under the ParentSubsidiary Directive, the ATAD to be implemented as of 1 January 2018 and in the Multilateral Instrument (MLI). Nevertheless, it can be deduced from case law of the EU Court of Justice that despite this main purpose test, MNEs should have the right to choose the most efficient structure for their commercial activities. In addition, a large tax advantage in itself is not sufficient: the structure needs to be artificial. Disparities as a result of different qualifications by two states are not considered abusive. For the answer to the question how ‘substance’ can get you out of tax avoidance discussions, it is important to consider: what are relevant facts and circumstances? The EU Court of Justice will look for an economic reality rather than economic activities and the overall assessment of the group, rather than that of an individual company. What substance is needed depends on the function of a company. For example, whether it is a joint venture, a pure holding company or an investment platform. Or is its purpose the concentration of voting rights? In any case MNEs are recommended, as with their TP, to have documentation that substantiates the choices they have made. Should substance-related disputes with the tax authorities remain unresolved, litigation seems the only option. If so, Loyens & Loeff’s litigation team can assist, Also if a case should have to be defended before the EU Court of Justice (in disputes in no matter which EU country).
How the MLI impacts MNEs’ business
MNEs are recommended to start identifying their risks and tax exposures under the MLI and prepare a PPT defence file to substantiate their position.
The MLI will affect more than 1,100 tax treaties out of over 3,000 tax treaties worldwide. In the Netherlands 47% of the tax treaties would be affected and in Luxembourg as many as 68%! It is expected that the MLI will have a broad impact on tax treaties as of 2019.
One of the most discussed MLI measures is the introduction of a principal purpose test (PPT) to combat treaty shopping. All 78 jurisdictions that signed the MLI opted at least for a PPT. Under the PPT no tax treaty benefits are granted if one of the principal purposes of a transaction or arrangement is obtaining a tax treaty benefit. This applies to a wide range of treaty benefits, including taxes on dividends, interest, royalties and capital BEPS is picking up steam 5 gains. The application of the PPT needs to be assessed for each source country. An interesting question is to what extent business reasons and genuine economic activity will keep a company out of the PPT application. It is expected that most countries will find common ground that business reasons and genuine economic activity will be a way to stay out of the PPT. These would make the PPT workable in practice, without unduly harming businesses, and to mitigate double taxation. For EU situations, EU case law should be of help, although various EU jurisdictions may still take a different approach for now.
Increasing and centralizing relevant functionality of holding, financing and licensing companies would typically strengthen the PPT position for MNEs’ structures. It is recommended that MNEs assess possibilities for centralisation in their group worldwide in relation to the source countries relevant for them and add and combine functions, activities and people to a central company. In our experience, some MNEs are already working on this. They combine holding companies with other activities, bring leadership positions from various EU countries together in one central Dutch holding company or bring relevant finance people from abroad to work in the Netherlands.
Another MLI provision for MNEs to be aware of is the expansion of the scope of the permanent establishments (PEs) concept, for instance the lowered threshold for agency PEs. The Netherlands decided to apply this measure. As there is limited guidance, states can take different views as to the existence of an agency PE, which may result in disputes between states.
Under the MLI, the tie-breaker rule for dual resident entities will change. The Netherlands signed up for this MLI provision, which means that the country of tax treaty residence of a dual resident entity is determined by mutual agreement between the treaty jurisdictions. The place of effective management is no longer decisive, although this factor evidently plays a role in the MAP. Until the MAP settles with a tax residence outcome, there are no tax treaty benefits for the dual resident entity. There is no grandfathering either. This provision will therefore have a major impact on existing dual resident entities, and action is needed at short notice. It is recommended that MNEs identify their risks and tax exposures under the MLI relevant to their structures and take appropriate action where necessary. This includes mapping out what relevant tax treaties will be amended and to what extent. Loyens & Loeff built a database and quick scan tool which enables them to make such assessment quickly for clients. In addition, MNEs are recommended to prepare for possible restructurings and to draft a PPT defence file, in anticipation of discussions with tax authorities in relevant source countries and, possibly, court cases. More information can be found on Loyens & Loeff’s website: www.loyensloeff.com/mli.
Digital economy tax – Pandora’s box of international taxation?
It cannot be ruled out that rules introduced for the digital economy will provide arguments for tax disputes in the traditional economy. MNEs are recommended to stay tuned with the latest developments.
Under the current system, taxing rights are attributed to the country where people, assets and risks are situated. No taxation other than VAT is allocated to the consumer’s country. This is no longer the politically desired outcome. Various options are on the table: from equalization tax to virtual PE, including less conventional options. All options contain elements of taxation allocated to the consumer’s country. The EU and OECD seem to be struggling to decide on a solution. Why is this so difficult? Digital companies move into the space of traditional businesses. At the same time, traditional companies become more active online. Where do you draw the line? The bottom line is that the digital economy cannot be ring-fenced. Any attempt to implement a ring-fenced tax will bear the risk of arbitrary taxation, inequities, double taxation, distortions and manipulation for avoidance.
At this stage, it is still uncertain what the solution will be. It is anticipated that the EU and OECD will probably publish proposals in March/April 2018. The expectation is that the EU will propose to introduce an equalization tax for the short term and that the OECD will propose the virtual PE concept as the solution for the longer term. BEPS is picking up steam 6 An important question is how to mitigate interference of the solution with the existing taxing framework, as the digital economy cannot be ring-fenced. Even if a technical ring-fence is achieved, it cannot be ruled out that rules introduced for the digital economy will provide arguments for tax disputes in the traditional economy. What to do at this stage? MNEs are recommended to stay tuned with the latest developments. Loyens & Loeff will follow, and participate in, the public debate and provide information through its website: www.loyensloeff.com/det.
What to expect from The Hague and Brussels?
The fear is that due to a lack of insight into the impact of the proposed measures, the ATAD implementation will result in stricter rules than necessary. MNEs can still raise their voice in the debate.
The most important items coming from The Hague are the ATAD implementation, MLI implementation and withholding taxes. From Brussels they are the mandatory disclosure rules and the agreement reached on the blacklist jurisdictions.
As to the atmosphere about these topics, it is the impression that the new government is focusing more on the ‘abuse part’ than on the investment climate, whereas the former government was treating these two elements on a more equal footing. An example is the ATAD implementation, in which the government seems to choose a strict interpretation for every element thereof. The proposal is to implement option A, whereas mostly Dutch active business enterprises suffer from option A, which thus puts them at a disadvantage when doing business abroad. The EUR 1 million safe harbour for the interest deduction does not include the possibilities of a group escape and transitional rules which the ATAD offers. Parliament has to discuss the ATAD implementation and the legislative bill is expected in June. The fear is that due to a lack of insight into the impact of the proposed measures, stricter rules than necessary will be implemented. To the extent that MNEs have not already done so, they can still raise their voice in the debate. But they have to be quick!