OECD BEPS action plan: a game-changer for multi-national enterprises?

OECD BEPS Action Plan: A Game-Changer for Multi-National Enterprises? CONTACT Joo Khin NG, Partner +65.6389.3089 [email protected] 3 CORPORATE BUSINESS TRANSACTIONS In 2013, the Organisation for Economic Cooperation and Development (OECD) announced its Action Plan on Base Erosion and Profit Shifting (BEPS). 1 The key objective of the BEPS Action Plan is summarised as follows: Fundamental changes are needed to effectively prevent double nontaxation, as well as cases of no or low taxation associated with practices that artificially segregate taxable income from the activities that generate it. A number of actions can be undertaken in order to address the weaknesses in the current rules in an effective and efficient manner. This Action Plan calls for fundamental changes to the current mechanisms and the adoption of new consensus-based approaches, including anti-abuse provisions, designed to prevent and counter base erosion and profit shifting. 2 Under the 2013 initiatives, 15 actions were to be delivered by 2015. Fast forward to September 2014 and the OECD published its recommendations on seven out of the 15 areas of the BEPS Action Plan. The seven reports address the following aspects: • tax challenge of the digital economy (Action 1) • neutralising the effects of hybrid mismatch arrangements (Action 2) • countering harmful tax practices more effectively, taking into account transparency and substance (Action 5) • preventing the granting of treaty benefits in inappropriate circumstances (Action 6) • guidance on the transfer pricing aspects of intangibles (Action 8) • guidance on transfer pricing documentation and country-by-country reporting (Action 13) • developing a multilateral instrument to modify bilateral tax treaties (Action 15)3 According to the OECD, the September 2014 BEPS outputs should only be regarded as being in an interim form. Although the seven deliverables as set out above have been agreed to, one or more of them may be impacted by some of the decisions to be taken with respect to the 2015 deliverables with which they interact. The 2014 deliverables are expected to be packaged together with the remaining 2015 deliverables for presentation to the G20 Finance Ministers in October 2015 for acceptance. A plan for the follow-up work and a time table for their implementation are also being prepared.The recommendations arising from the BEPS Action Plan when fully implemented are expected to have a far-reaching effect in the way that crossborder businesses are to be carried out. It will be a game-changer for many multi-national enterprises (MNEs). The international business environment has been noticeably impacted by the OECD’s initiatives. Action Highlights We set out below some of the highlights concerning the seven action items covered by the reports. Action 1: Digital Economy The report provides a detailed analysis of the digital economy, its business models, and its key features. It is clear from the report that a lot more work has to be done to consider the options that are potentially available to address the broader tax challenges of the digital economy. The report concludes that value-added tax collection in the business-to-consumer context is one area that needs to be urgently addressed. The main thrust of this aspect of review is to ensure that taxation of the digital economy is realigned with economic activities and value creation. According to the report, the changes introduced by the digital economy have raised systemic challenges regarding the ability of the current international tax framework to ensure that profits are taxed where economic activities occur and where value is created. Although the report does not recommend the adoption of a virtual permanent establishment standard, it does suggest that an enterprise engaged in “fully dematerialised digital activities” could be deemed to have a taxable presence in a country if it maintained a “significant digital presence.” Action 2: Hybrid Mismatches Hybrid mismatches refer to cross-border arrangements that take advantage of differences in the tax treatment of financial instruments, asset transfers and entities to avoid paying tax in both countries or to achieve long-term deferral of tax not intended by either country. The focus of Action 2 is on arrangements that exploit the differences in the tax treatment of an entity or instrument under the laws of the different countries to produce multiple deductions for the same economic expense or deductions without any symmetrical taxation. One common example cited is where a financial instrument is treated as a debt in one country but a share in another country such that a payment under that instrument is deductible when it is paid but is treated as a tax-exempt dividend in the country of receipt. General and specific recommendations are made for domestic hybrid mismatch rules and model treaty provisions to address the concerns. Action 5: Harmful Tax Practices Improving transparency is a key priority in the revamp of the work on harmful tax practices mandated by the BEPS Action Plan. The framework for the exchange of information to promote transparency has been enhanced. 4 CORPORATE BUSINESS TRANSACTIONS Spontaneous exchange of information on taxpayer-specific rulings has been introduced where such rulings relate to a preferential tax regime (such as one that offers advantageous treatment to non-residents or enterprises that are inactive in the domestic market). What the OECD is trying to discourage in a situation where a preferential tax regime does not encourage companies to shift profits from the value creation location to another location where such profits may be taxed at a lower rate. For instance, the practice of offering a tax incentive to encourage companies to locate activities associated with the development, manufacture, and exploitation of patents in a country (commonly referred to as “patent boxes”) is not frowned upon as long as the preferential regime is used to attract real activity. The common goal of the BEPS Project is to ensure that profits are taxed where substantial activities take place. A newly elaborated “substantial activity” factor has been introduced. Action 6: Treaty Abuse The OECD and G20 countries have unanimously agreed to “clearly reject” treaty-shopping practices. Drafts of a specific anti-abuse rule based on a “limitation-on-benefits” provision and a more general anti-abuse rule based on a “principal purpose” test have been put forward for consideration. To ensure that treaty abuse is adequately and properly addressed, both specific and general anti-abuse rules are being introduced. Specific anti-abuse rules ensure greater certainty in how known strategies that abuse tax treaties are identified and dealt with whereas general anti-abuse rules (sometimes in the form of judicial doctrines) offer protection against abusive transactions that have not previously been addressed or seen. This approach accounts for the many different anti-abuse rules. The OECD Model Tax Convention is expected to be updated once the draft rules are finalised and adopted. Action 8: Transfer Pricing – Intangibles The BEPS Project has determined that only the “arm’s-length principle” will be used for dealing with transfer pricing issues. The adoption of alternative transfer pricing methods (e.g. formulary apportionment) has been rejected on the basis that the adoption of such methods would require, among other things, international consensus on a number of key issues that would not be attainable within the short or medium term. Supplemental guidance has been provided for determining arm’s-length conditions for transactions involving intangibles. The complete guidance (expected to be ready this year) will ensure that allocation of profits associated with the transfer and use of intangibles is in accordance with value creation. Benefits from corporate synergies are to be allocated to the group members that have contributed to the synergetic benefits—such benefits cannot be isolated and allocated to an entity in a low tax environment. Guidance on ownership of intangibles, intangibles whose valuation is uncertain at the time of the transaction, and the application of profit splits and other methods has been developed but will only be finalised after the 2015 deliverables have been completed. 5 CORPORATE BUSINESS TRANSACTIONS Action 13: Transfer Pricing Documentation A country-by-country reporting template has been introduced. This template requires MNEs to report 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. Other information that has to be included in a country-by-country report (CbCR) comprises (i) total employment; (ii) capital; (iii) retained earnings; (iv) tangible assets; (v) listing of all entities that business is conducted through in a particular tax jurisdiction; and (vi) the nature of the main business activities carried out by each entity. While CbCR information is not made public, it should be noted that the availability of such information makes it easier for tax administrations to determine if a company has engaged in practices that have the effect of artificially shifting substantial amounts of income to zero-or low-tax countries. Armed with the information comprised within a CbCR (together with information available from transfer pricing master and local files), tax administrations will be able to assess transfer pricing risks and decide where the audit resources should be effectively deployed. Country-by-country reporting is pending implementation. Action 15: Multilateral Instrument In order to be able to expedite and streamline the implementation of the measures developed to address BEPS, the OECD is looking into the development of a multilateral instrument that would allow bilateral tax treaties to be modified—i.e. without having to deal with each of the tax treaties that are currently in force to implement the BEPS measures introduced from time to time. Why the increasing concerns about BEPS strategies? The OECD recognises that most BEPS strategies are not illegal, since these strategies do no more than take advantage of existing tax rules that have not caught up with today’s global environment and the increasing importance of intangibles and risk management. Notwithstanding that BEPS strategies can be legal, the need to address BEPS remains, as BEPS can lead to distortion of competition and inefficient allocation of resources arising from investment decisions towards activities with lower pre-tax rates of return but higher after-tax returns. 2015 Deliverables OECD has identified the following as the 2015 deliverables: • strengthening the controlled foreign company rules (Action 3) • limiting base erosion via interest deductions and other financial payments (Action 4) • countering harmful tax practices more effectively (re: transparency and substance) (Action 5) 6 CORPORATE BUSINESS TRANSACTIONS • preventing the artificial avoidance of permanent establishment status (Action 7) • assuring that transfer pricing outcomes are in line with value creation (Actions 8-10) • establishing methodologies to collect and analyse data on BEPS and the actions to address it (Action 11) • requiring taxpayers to disclose their aggressive tax planning arrangements (Action 12) • making dispute resolution mechanisms more effective (Action 14) • developing a multilateral instrument (Action 15) The complete package of recommendations for the BEPS Project is expected to be ready by the end of 2015. Impact on Singapore The jury is still out on how the final outcome of the BEPS Project will affect Singapore as a regional hub for MNEs. With a large number of MNEs making Singapore the corporate and procurement base for their regional operations, will Singapore lose its competitive advantage as a result of the slew of measures that are being introduced to tackle the BEPS concerns? At this juncture, while there has been no indication as to whether CbCR will be implemented in Singapore, the Inland Revenue Authority of Singapore (IRAS) did publish earlier this year its revised version of the Transfer Pricing Guidelines. The guidelines clarified, among others, IRAS’s views on compliance matters, transfer pricing documentation, and adjustments as well as exclusions. With a growing emphasis on transfer pricing in the international tax arena, IRAS has strongly advised taxpayers to maintain accurate transfer pricing documentation that would enable them to keep accurate financial and economic analyses and ensure that appropriate transfer pricing methods are used. The recommended period for transfer pricing documentation updates is once every three years. Section 34D of the Income Tax Act of Singapore empowers IRAS to make an upward transfer pricing adjustment if a taxpayer is unable to substantiate with transfer pricing documentation that the transfer prices as charged are at arm’s length.