David Cameron and the other G20 leaders have strongly endorsed the OECD 'Action Plan' to reduce or prevent tax avoidance by multinational corporations – particularly in a cross border and digital environment. Mr Cameron said he would call on fellow leaders to ensure "that we break down the walls of corporate secrecy, once and for all, and that companies pay their fair share".
There are five main principles underlying the Action Plan proposals and G20 plans:
- Re-establish the international coherence of corporate income taxation
- Restore the full effects of and benefits of international tax standards
- Improve transparency, certainty and predictability
- Introduce enhanced automatic information exchange between tax authorities around the globe; and
- Improve the tax collection, information exchange mechanisms and tax administration regimes in developing countries.
These principles are divided into (frequently interrelated) 15 action points. The action points are described in more detail in the table below. The long stop date for implementation of these proposals is the end of 2015 – a deadline that the G20 leaders have recently given their full backing to. In fact, the G20 want automatic information exchange in place by February 2014!
The technical tax principles underlying many of the Action Plan proposals will, in large, be familiar to UK corporate taxpayers (as they appear to derive from key parts of the UK tax code such as the debt cap and CFC rules and the DOTAS principles). Nevertheless, the advent of these initiatives may require UK based companies to, amongst other things, revisit intra group arrangements, cross border debt structures, and arrangements which rely on aggressive interpretations of double tax treaties or on the application of multiple treaties as a result of these proposals.
Going forward, UK based multinational companies will want to pay close attention to the proposals as they develop and ensure that practical ramifications are fed into the tasks forces that will no doubt be established by the OECD to formulate and implement the new polices.
The approach of fixing the existing tax legislative framework (instead of adopting wholesale reform) will no doubt reassure some tax directors but the price may well be additional complexity and compliance costs as domestic regimes struggle to 'fit a square peg into a round hole'.
Part of the OECD solution, it appears, is to use a multilateral treaty mechanism to exchange information, require disclosure and involve developing countries. The use of such an instrument raises a raft of separate issues – notably:
- Whether and when such an instrument would be enforceable without domestic ratification?
- How will it play out in those jurisdictions that are not members of the OECD? Does it give those countries a comparative advantage for multinationals seeking to avoid or reduce the impact of the new OECD proposals?
- How will (in) consistency in interpretation by local courts and revenue authorities be addressed?
- Whether such an instrument is in fact the answer and is it better to start with a 'blank page'?
The UK government has not yet indicated how it proposes to address concerns over timing, enforceability and impact on domestic tax systems and governance strategies but George Osborne observed that the G20 adoption of the OECD Action Plan was a "huge milestone on the road to making the international tax rules fairer" so perhaps UK compliance with the OECD / G20 final and agreed proposals may be a fait accompli.
1. Background: what is the BEPS problem?
The basic BEPS problem is defined by the Action Plan as follows:
No or low taxation is not per se a cause of concern, but it becomes so when it is associated with practices that artificially segregate taxable income from the activities that generate it.
The project is driven by the concern that many multinationals, especially those operating in the digital economy, are paying very little corporate income tax which potentially has a direct impact on corporate tax revenue and indirectly impacts on tax revenue generally if the tax system falls into disrepute. Apart from revenue issues, BEPS also raises economic efficiency and fairness concerns.
2. What are the likely outcomes of the Action Plan?
The current rules governing the taxation of the digital economy are explicitly recognised as a weak point in the international taxation environment. The OECD stance to date has been to apply the same tax principles to e-commerce as to other areas of business with only some slight modification, particularly an optional services permanent establishment (PE) provision. Now it is recognised that this approach has not succeeded so this work is going back into the BEPS melting pot which is to include a review of the application of the indirect taxes as well as corporate/ income tax.
It is only by substantially changing the current international PE threshold for taxing business profits that the concerns underlying the recent publicity over the very low taxes paid by new economy companies in the country of their customers can be addressed. The other changes referred to below which affect the digital economy will result in the profits of new economy companies being moved from tax havens to the countries where their workforce is largely located, rather than the country of their customers.
Establishing the international coherence of corporate income taxation
Where traditional OECD work has been concerned with double taxation; the BEPS focus is double non-taxation. It involves four actions, two of which have been in the news, hybrid mismatches and interest (and similar) deductions.
"There is a need to complement existing standards that are designed to prevent double taxation with instruments that prevent double non-taxation in areas previously not covered by international standards and that address cases of no or low taxation associated with practices that artificially segregate taxable income from the activities that generate it."
It looks like international tax arbitrage may finally come to an end, which may be one of the easier wins for the BEPS project, although it involves some big (unspecified) issues such as ending the US check-the-box rules. Many countries have moved to limit interest deduction over recent years (see for example, the UK debt cap rules) and the BEPS work here involves reviewing this experience to develop best practice and (in association with other work below) to resolve the interrelationship of transfer pricing rules and interest deduction limits.
The OECD proposes to examine reinforced CFC regimes to help restore cohesion. The essence of the OECD CFC proposals appears to conflict with the recent international trend of watering down of CFC regimes because of their impact on international business and the lack of a clear policy justification for taxing ultimate parent companies when the ownership of multinationals is now widely dispersed among residents of many countries. Of course, the broad focus of the 'new' UK CFC regime is to tax what the legislation defines as UK 'source' income. It is possible that the OECD may follow the UK lead and look to the source of profits (perhaps, as in the UK, combined with various anti avoidance rules) in such a way as to avoid distortion of international business. This would seem a sensible approach as the UK CFC rules were developed in conjunction with the very businesses that are under the microscope of the Action Plan and do not appear to have adversely affected the UK government's campaign to hold the UK out as the holding company jurisdiction of choice. It is worth noting that the UK regime was not singled out in the Action Plan.
In the 'harmful tax practices' area, the Action Plan states that "governments must continue to work together to tackle harmful tax practices and aggressive tax planning. A realignment of taxation and relevant substance is needed to restore the intended effects and benefits of international standards…" The Action Plan acknowledges that preferential tax regimes continue to be a concern – particularly as the OECD seems to consider that such regimes have triggered a 'race to the bottom' (whether taking the form of ring fencing particular incomes or reducing corporate income tax rates) which would 'ultimately drive applicable tax rates on certain mobile sources of income to zero for all countries, whether or not this was the tax policy a country wished to pursue'. The Action Plan seeks to "develop solutions to counter harmful regimes more effectively, taking into account factors such as transparency and substance". To this end, priority will be given to "improving transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, and on requiring substantial activity for any preferential regime".
Restoring the full effects and benefits of international standards
Here, the work will focus on treaties and transfer pricing.
The first action is to prevent treaties being used for tax avoidance, particularly bringing about double non-taxation through the use of conduit companies. The Action Plan recognises that problems often arise from the interaction of treaties and domestic law (such as unlimited participation exemptions or lack of domestic withholding taxes on outbound payments) and proposes to redress this with amendments to the Model and recommendations on domestic law.
There is also a suggestion that countries will be encouraged not to enter into tax treaties with tax havens. Once the UK main rate of corporation tax reaches 20% (in 2015), the UK will be treated as a tax haven in certain other jurisdictions (such as Japan). Does the OECD propose that Japan should terminate the double tax treaty with the UK?
The second action under this heading concerns the PE threshold. The focus here is cases where despite a substantial sales effort in a country no PE results – principally through commissionnaire and stripped-risk distributor arrangements or exploiting the preparatory and auxiliary exception by splitting of activities. This potential broadening of the agency PE will also ensure that such PEs will give rise to additional profits being taxed, to overcome the zero sum argument which has had some success in court cases, that even if an agency PE results, no additional profits can be taxed.
Whilst the OECD analysis appears to focus on whether or not a PE exists, for UK companies the issue will likely be how such a proposal will dovetail with the 'new' UK branch exemption regime. If the UK PE regime stands up to enquiry in a post BEPS world and the company adheres to robust transfer pricing policies (as revised), then it is hoped that the income from such PEs remains, on the whole, outside the UK tax net.
The three transfer pricing actions address intangibles, the application of transfer pricing principles to risk and capital allocation, and transactions which occur little or not at all between unrelated parties. The OECD continues its opposition to formulary apportionment but the emphasis has changed to "the practical difficulties associated with agreeing to and implementing the details of a new system consistently across all countries".
Implicitly the OECD is finally recognising the theory of the firm – that firms generate additional profits to those available in the market as otherwise they would not exist and hence the application of a market paradigm to allocate profits is likely to miscarry. The outcome is likely to be allocation of profits to countries where activities occur rather than where capital and asset ownership (particularly of intangibles) is located.
This potential change is very significant and profit splits are likely to become much more common and base-eroding payments denied, even if the latter involves a partial move away from the current triumph of transfer pricing principles over other tax policies. It is explicitly recognised that treaty rules departing from current transfer pricing principles may need to be developed.
Strengthening the rules to prevent treaty abuse
The Action Plan also suggests changes to the OECD Model Tax Convention to include an anti-treaty abuse provision and also to recommend changes to the design of domestic rules to prevent the granting of treaty benefits in "inappropriate circumstances". "Work will also be done to clarify that tax treaties are not intended to be used to generate double non-taxation and to identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country."
HMRC would no doubt argue that these suggestions do not extend UK domestic law in light of the General Anti-Abuse Rule (GAAR) (which in essence seeks to prevent tax advantages arising from tax planning that is egregious) and the decision of the Court of Appeal in Bayfine1 in which it was held that a claim for treaty relief was not allowable because, on a purposive construction, the "purpose of a double tax treaty was the avoidance of double taxation and the prevention of fiscal evasion" and the concept of 'fiscal evasion' included tax avoidance which in turn meant not permitting tax credits to be double dipped in the UK and US.
Perhaps though, the OECD proposals could be a 'back door' mechanism for achieving what HMRC failed to do when it published a technical note in 2011 setting out draft legislation which would have operated to prevent taxpayers from relying on the provisions of a UK double tax treaty where there is a "scheme" (which was extraordinarily widely defined) with a main purpose or one of its main purposes being to obtain a benefit under the treaty. It was explicitly acknowledged at the time that the legislation was intended to override the provisions of double tax treaties, past, present and future and would have removed treaty protection from structures already in place, as well as blocking it for future structures. In response to significant pressure, HMRC retracted the technical note and withdrew the draft legislation.
Transparency, certainty and predictability
Certainty and predictability are mentioned at a number of points in the Action Plan as important values for business but any exercise like BEPS which seeks to turn much of the current international tax framework on its head inevitably involves a period of uncertainty.
The only specific action in the Action Plan that relates to transparency, certainty and predictability: the improvement of the mutual agreement procedure - is unclear. Perhaps the revised procedure will impose tax arbitration on all countries.
Transparency is used in the Action Plan not in relation to exchange of information but in the context of company provided information. The three specific actions on the transparency front are (a) developing methodologies and obtaining information to measure the extent that BEPS is occurring, (b) requiring taxpayers to disclose aggressive tax planning arrangements, and (c) improving transfer pricing documentation apparently to require companies to disclose the amount of profits, sales, taxes paid etc country-by-country.
The first of these underlines the problem that much of the evidence for BEPS is anecdotal and no one is precisely sure what the scope of the issue is in revenue and other terms, as noted above.
The second and third actions focus on disclosure of uncertain tax positions but it is surprising for the disclosure of country-by-country information, to which some multinationals already seem reconciled, to appear in the guise of transfer pricing documentation.
The UK already has significant tax information disclosure regimes – notably DOTAS, the FATCA intergovernmental agreement (IGA), and the forthcoming FATCA style information exchange agreements with the Crown Dependencies and Overseas Territories. Imposing regimes similar to these in multi-party and multi-jurisdictional scenarios is likely to be complex and lead to material compliance costs. Issues pertaining to information security, data protection etc will also need to be overcome.
In terms of country-by-country reporting, it is not clear whether the OECD will require this information to be made in a company's annual accounts or to a single revenue authority or to any revenue authority that is listed. If the former, it will be interesting to see what impact, if any, it has on corporate governance and tax disclosure generally.
3. Are treaties the solution?
The Action Plan makes it clear that traditional instruments for forging an international consensus on tax principles consisting of development of and changes to the Model Convention and Commentaries are not fit for this purpose on their own.
The Action Plan favours a multilateral treaty mechanism, acting in tandem with domestic law changes in many cases. The development of such a treaty is now one of the actions scheduled to be completed at the very end of the process. Does this mean that little will happen until then? That is not the message conveyed by the Action Plan but the issue of the instruments to be used to deliver (as opposed to encourage) action over a short timeframe is still not clear.
4. Specific action points
Click here to view table.
5. Other Transparency Issues
In parallel with the BEPS project (and sometimes apparently as part of it) there have been two other critical developments in international taxation in the name of transparency, involving exchange of information and disclosure of ownership of legal entities.
The G20 leaders have repeatedly reiterated their support for automatic exchange of information. Recently, in fact, the G20 leaders asserted that they wanted to develop a multilateral and bilateral information exchange standard which would ultimately be accepted and put into practice by all jurisdictions which would be operative between G20 members by the end of 2015 at the latest.
The fact that the information exchange standard will be automatic means that the existing Tax Information Exchange Agreements (TIEAs) – particularly those with tax havens - under which information is provided on a 'request' basis will be superseded.
In a nutshell the four steps are:
- Enact domestic legislation to support exchange under the IGAs initially sponsored by the US to deal with issues arising under FATCA;
- Select a legal basis for the exchange of information, the favoured mechanism being the Multilateral Convention on Mutual Administrative Assistance;
- Adapt the scope of the reporting and due diligence requirements and coordinate guidance to ensure consistency and reduce cost; and
- Develop common or compatible IT standards.
Tony Frost and Richard Vann