Base Erosion and Profit Shifting (BEPS) update

There have been a number of developments on the Organisation for Economic Cooperation and Development (OECD) Base Erosion and Profit Shifting (BEPS) Action Plan since our last monthly publication.

Action 2 of the BEPS Action Plan calls for the development of model tax treaty provisions and recommendations for the design of domestic tax rules to neutralise the effect of ‘hybrid mismatch’ arrangements.

According to material published by the OECD, a hybrid mismatch arrangement is a profit shifting arrangement that incorporates techniques designed to exploit a difference in the characterisation of an entity or arrangement under the laws of two or more tax jurisdictions to produce a mismatch in tax outcomes. For example, an arrangement may be classified as debt in one jurisdiction and equity in another, with the costs of the debt being deductible in the relevant jurisdiction and the income not taxable in the other.

On 19 March 2014 the OECD released for public comment, two discussion drafts dealing with Action Plan 2. These are:

  • Neutralise the effects of Hybrid Mismatch Arrangements – Recommendations for Domestic Laws; and
  • Neutralise the effects of Hybrid Mismatch Arrangements – Treaty Aspects of the Work on Action 2 pf the BEPS Action Plan.

The discussion drafts provide a number of examples of hybrid mismatch arrangements, and sets out recommendations to neutralize the tax effect of the arrangements. In the case of hybrid financial instruments, the recommendations include the adoption of a rule that would seek to align the tax outcomes for the payer and payee under the financial instrument. In this respect, the discussion draft recommends that the primary response should be to deny the payer a deduction for payments made under a hybrid financial instrument, with the jurisdiction of receipt applying a secondary or defensive rule that would require a deductible payment to be included in income in the event the payer was located in a jurisdiction that did not apply the primary rule.

Comments with respect to these two discussion drafts are to be electronically forwarded to the OECD by 2 May 2014.

Further information in relation to this discussion draft is available in this PwC Tax Insights Publication

Action 6 of the Action Plan calls for the development of model tax treaty provisions to prevent the granting of tax treaty benefits in inappropriate circumstances.

In relation to this Action, on 14 March 2014 the OECD released for public comment, a discussion draft which included a number or recommendations.

The discussion draft is divided into three primary sections.

The first addresses the development of model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances. The second concerns clarifying that tax treaties are not intended to be used to generate double non-taxation. The third deals with identifying the tax policy considerations that countries should consider before deciding to enter into a tax treaty with another country.

Comments with respect to these two discussion drafts are to be electronically forwarded to the OECD by 9 April 2014.

Further information in relation to this discussion draft is available in this PwC Tax Insights Publication

Action 1 (Tax Challenges of the Digital Economy) of the Action Plan calls for:

  • the identification of the main difficulties that the digital economy poses for the application of existing international tax rules; and
  • the development of detailed options to address these difficulties, taking a holistic approach, and considering both direct and indirect taxation.

Issues to be examined include, but are not limited to:

  • the ability of a company to have a significant digital presence in the economy of another country without being liable to taxation due to the lack of nexus under current international rules;
  • the attribution of value created from the generation of marketable location-relevant data through the use of digital products and services;
  • the characterisation of income derived from new business models;
  • the application of related source rules; and
  • considering how, the effective collection of Value Added Tax (VAT) or Goods and Services Tax (GST) with respect to the crossborder supply of digital goods and services, can be ensured.

On 24 March 2014, the OECD released a discussion draft on Action 1. Options discussed in the discussion draft include:

  • modify the exceptions contained in paragraph 4 or Article 5 (Permanent establishment) of the OECD Model Tax Convention
  • determine that an enterprise engaged in certain ‘fully dematerialised digital activities’ would have a Permanent Establishment (PE) if it maintained a ‘significant digital presence’ in the economy of another country;
  • a ‘virtual fixed place of business PE’, which would create a permanent establishment when the enterprise maintains a website on a server of another enterprise located in a jurisdiction and carries on business through that website;
  • ‘virtual agency PE’, which would seek to extend the existing dependent agent PE concept to circumstances in which contracts are habitually concluded on behalf of an enterprise with persons located in the jurisdiction through technological means, rather than through a person;
  • an ‘on-site business presence PE’,, which would look at the economic presence of an enterprise within a jurisdiction in circumstances in which the foreign enterprise provides on-site services or other business interface at the customer’s location; and
  • imposition of a final withholding tax on certain payments made by residents of a country for digital goods or services provided by a foreign e-commerce provider.

Comments on the discussion draft are to be submitted electronically to the OECD before 5.00 pm on 14 April 2014.

Further information in relation to this discussion draft is available in this PwC Tax Insights Publication.

You can also access details about PwC Global webcasts on the latest discussion drafts.

United Kingdom (UK) 2014 Budget

On 19 March 2014, the UK Chancellor delivered a generally underwhelming Budget for 2014. His focus was clearly on delivering a Budget for ‘building a resilient economy.'

Small and medium enterprises (SMEs) and savers were the main beneficiaries with some of the relevant announcements as follows:

  1. The rate of the Research and Development payable credit for loss-making SMEs will increase to 14.5 per cent from 11 per cent for qualifying expenditure on or after 1 April 2014.
  2. The Annual Investment Allowance (AIA) will be increased to £500,000 for all qualifying investment in plant and machinery from April 2014. The period of the allowance has been extended to 31 December 2015.
  3. The period in which 100 per cent Enhanced Capital Allowance Scheme (ECAs) are available to enterprise zones (EZ) has been extended to 31 March 2020. A new pilot EZ will be established in Northern Ireland.
  4. For 2015 to 2016, the starting rate for savings income will reduce from 10 per cent to 0 per cent, and the maximum amount of savings income that can qualify for this rate will increase to £5,000.
  5. From 1 July 2014 the overall Individual Savings Account (ISA) annual subscription limit will be increased to £15,000 and this full amount will be permitted to be held in cash, stock and shares, or any combination of the two.

Anti-avoidance measures announced were not ground-breaking and included:

  1. Legislation to be included in Finance Bill 2014 to extend accelerated payment of tax to users of arrangements disclosed under the Disclosure of Tax Avoidance Schemes (DOTAS) rules, and to taxpayers involved in planning held to contravene the General Anti-Abuse Rule (GAAR), so that the tax amount in dispute is held by Her Majesty Revenue and Customs (HMRC) until the dispute is resolved.

Legislation will also require taxpayers who have used arrangements which are defeated in another party's litigation to pay the disputed amount to HMRC on demand.

  1. With immediate effect, legislation applies to prevent companies from obtaining a corporation tax advantage by transferring profits between companies within a group. This appears to be wide-ranging and complements the provisions announced at Autumn Statement in relation to similar arrangements that used derivative contracts.

Publishing of a paper setting out UK priorities for the G20-OECD project for countering base erosion and profit shifting (BEPS).