National tax laws and respective governments are faced with huge challenges through globalization and the digital economy. In a borderless world of products and services, the mismatch of domestic tax rules leaves loopholes that allow profits to go untaxed. Multinational enterprises manage to benefit from such tax gaps by allocating profits to specific countries and, therefore, reduce their overall taxes. In the absence of the need to relocate physical assets, transferring intangibles in general and intellectual property (IP) in particular between subsidiaries in different countries is an effective way to exploit such tax gaps by shifting profits cross-border.
While national tax regimes, in general, ensure the match between deductible expenses in the hand of one taxpayer with taxable income of another taxpayer, there is a lack of similar coordination with regard to international transactions. In order to prevent double non-taxation (or at least a reduced taxation under certain conditions) in such cases, the OECD scheduled a plan for “new international standards to ensure the coherence of corporate income taxation at the international level” and published an Action Plan on 19 July 2013 at the G20 leadership meeting.
This article provides a brief summary of the content and the national attempts regarding IP in relation to BEPS.
The OECD Action Plan on BEPS
With a view toward preventing and reducing misuse of international taxation rules, the OECD Action Plan focuses on 15 action points, including—among others—the approach to neutralize the effect of hybrid mismatch arrangements, to strengthen CFC rules and to prevent treaty abuse. In particular, with respect to intangibles, the OECD seeks to limit base erosion via financial payments from the provision of intangibles and intends to assure that transfer pricing outcomes are in line with the value creation.
In this regard certain rules ought to be established to stop BEPS by moving intangibles among group members. Such not-yet- drafted rules shall involve provisions that:
- Adopt a broad and clearly delineated definition of intangibles
- Ensure that profits associated with the transfer and use of intangibles are appropriately allocated in accordance with value creation (and not solely because an entity has contractually assumed risks or has provided capital)
- Develop transfer pricing rules or special measures for transfers of hard-to-value intangibles and
- Update the guidance on cost-contribution arrangements (also known as cost-sharing agreements or “CSAs”)
The expected results include changes to the OECD Transfer Pricing Guidelines and the OECD Model Treaty. According to the plan, the schedule targets a two-year timeline and should be completed in September 2014 and 2015, respectively.
Although the concrete outcome of the above-mentioned action points can hardly be predicted, with respect to the definition of intangibles, the OECD might refer to a definition set forth in its Discussion Draft “Revision of the special considerations for intangibles in Chapter VI of the OECD Transfer Pricing Guidelines and Related Provisions” dated 6 June 2012. The Discussion Draft defines intangibles as “something which is not a physical asset or a financial asset, and which is capable of being owned or controlled for use in commercial activities”. While this specific definition only addresses transfer pricing matters, it is likely that at least a similar broad definition may be adopted for BEPS purposes. However, it is doubtful whether any definition meets the ambitious objective of a clear and broad definition, since the definition provided by the Discussion Draft leaves various questions unanswered and has already been criticized as too vague.
In addition, in focusing on the well-known structures the OECD identified for tax-reduction purposes, it must be expected that those structures might likely be opposed. With regard to IP, the OECD, inter alia, identified licensing agreements between a high-tax jurisdiction and a foreign branch in a low-tax jurisdiction and the interposition of hybrid entities or interposing conduit companies as structures to be avoided. It will be necessary to monitor if and to what extent such structures will no longer be accepted under future OECD standards.
National Reaction on Preventing BEPS
Together with the OECD Action Plan, the German Federal Ministry of Finance published FAQs that explain and provide comments on the OECD approach from a German perspective. While the FAQs generally highlight the OECD approach and Germany fully supports the BEPS Action Plan, the necessity of an agreement on related international taxation principles and a fair tax competition between different countries are highlighted. Further, that the commentary stresses that a “general attack” on multinational entities is not envisaged, because it may affect the attractiveness of Germany as a place for technology and business. Furthermore and in line with the foregoing, substantial changes to the existing OECD standard regarding the allocation of taxable income should be avoided from a German perspective. With respect to IP, such an OECD standard, as a rule, allocates the taxation right to the state of the IP owner’s residence without any withholding tax in the state of source. The contrary,(i.e., taxation in the state of source), shall only apply if the beneficial owner of the royalties carries on business in the state of source through a permanent establishment to which the IP is effectively connected. The extent to which the OECD standard qualifies as too much of a change is not clear at the moment, from a German perspective.
Even though Germany has already established several national provisions safeguarding a broad German tax basis (e.g., through CFC rules set forth in the German Foreign Tax Law, various provisions that partially suspend double-tax treaties (treaty override) and sections addressing the phenomena of hybrid entities in some double-tax treaties), the German tax law still leaves room for what the OECD refers to as an “aggressive tax planning technique”. Remarkable and in contrast to applicable German tax law, is the OECD approach that may add the principle of “value creation” to the current existing (hypothetical) arm´s-length tests.
Conclusion and Perspective
The political discussion about profit shifting is not a new one; neither on a national nor an international basis. According to the German Federal Ministry of Finance, the mutual understanding and the will of the G20 set forth in the Action Plan on BEPS to find a solution on a common basis, distinguishes the new approach from former approaches, however. If and to what extent this ambition can be achieved, and whether substantial changes in the taxation allocation principles are capable of consensus, remains to be seen. The specific provisions related to implementation of the OECD Action Plan on BEPS are scheduled to be discussed at the G20 meeting in September 2013. In any case, future developments regarding BEPS have to be tracked carefully in order to be able to appropriately adjust any profit-shifting structures, if necessary.