Tax avoidance, however legitimate its mechanism, has become the new focus for public opprobrium in parts of the world. High-profile cases and media attention examining the tax strategies of major global companies operating primarily in the digital economy have all contributed to this shift of focus. How are the profits of multinational groups taxed? People want to know.

OECD measures to combat tax avoidance through international structuring are going to affect transactions across all industry sectors including infrastructure. We examine what is in store.

In November 2012 the G20 nations backed the OECD to produce a report on tackling the BEPS problem: ‘base erosion and profit shifting’. From that came a 15-point action plan, published in 2013, and, a year later, proposals relating to seven of the action points. These are the proposals up for scrutiny here.

The seven action points – published in September 2014 – cover matters as diverse as ‘neutralising the effects of hybrid mismatch arrangements’ and ‘guidance on transfer pricing aspects of intangibles’. To some extent, these are terms of art that have been evolving in the international tax advisory world; by their very nature, it is not always obvious to a non-tax specialist exactly what effect these could have in practice.

Not all of the areas being tackled by the BEPS project will have a marked impact on the way infrastructure projects are structured and on the underlying economics; some of them – the proposals relating to the digital economy, for instance – are unlikely to affect the infrastructure sector. It is also worth noting that some jurisdictions, such as Australia, are already trying to balance the effects of the BEPS project with a desire to ensure that investment in infrastructure is not prejudiced.

Implementation will take place through a mix of domestic legislation and changes to existing double taxation treaties. There will also be more international co-ordination on the way tax regimes are applied in cross-border situations.

BEPS: seven OECD action points published in September 2014

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A typical infrastructure project

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The main tax threats to maintaining this return are withholding taxes on interest payments and restrictions on the tax deductibility of interest amounts paid to the sponsors or equity investors.

Withholding taxes

It is quite common to see the withholding tax risk mitigated by the use of a holding company in Jurisdiction B. Given the existence of a favourable double taxation treaty between Jurisdiction A and Jurisdiction B, the project company in Jurisdiction A can then make payments of interest and other distributions (such as dividends) without withholding taxes.

Action points 6 and 15 are likely to create uncertainty in this area.

Action point 6
‘Preventing the granting of treaty benefits in inappropriate circumstances’ – targets what is known as ‘treaty shopping’. In future, it is likely that restrictions will be placed on the availability of the benefits of the treaty between Jurisdiction A and Jurisdiction B. Point 6 does not specify whether this will be by way of a ‘limitation on benefits’ article or a more general anti-treaty shopping principle. The former is designed to prevent benefits being available to a company that is not ultimately owned by investors who would benefit from equivalent treaty protection.

Either way, it is clear that the movement of travel is away from allowing SPV holding companies to benefit from favourable tax treaties where there is no real substance or where there is no reason for their establishment in a particular jurisdiction other than the availability of the treaties.

Action point 15
‘Developing a multilateral instrument to modify bilateral tax treaties’ – is regarded by the OECD as desirable because the existing bilateral treaty network is unwieldy. At the moment, a single amendment to the ‘model’ treaty can take years to find its way into each bilateral treaty as and when it is renegotiated by the participating states. A multilateral instrument will enable OECD changes to the model double tax treaty to find their way into existing treaties much faster. In practice, this will make it easier for international consensus (as embodied by the OECD) to have a real and practical impact on existing double taxation arrangements.

Existing holding structures and new transactions will have to keep a watchful eye on these developments. Pay attention in particular to whether they will lead to changes to the way in which existing treaties on which reliance is being placed are being used.

Hybrid mismatch arrangements


It is also quite common for jurisdictions that have established themselves as ‘good’ holding company jurisdictions to have rules enabling the distribution of the return from the project in a quasi-equity form. These rules apply irrespective of whether the return results from interest on shareholder loans or from dividends.

Investors may as a result be entitled to receive a return in a form which, in their home jurisdiction, is not taxed, despite the fact that a tax deduction may have been obtained for the payment in Jurisdiction A.

Action point 2
‘Neutralising the effects of hybrid mismatch arrangements’ – contemplates changes to domestic legislation to prevent tax deductions being granted in a paying jurisdiction (Jurisdiction A in the case of our example) where this is not taxed in the hands of the recipient.

We don’t yet know how these rules will apply where the instrument is taxed in the recipient jurisdiction but a return is earned in a third jurisdiction in a non-taxable form. Some jurisdictions are already using the BEPS initiative to begin ‘looking through’ intermediate holding companies where there is insufficient substance to the holding company arrangement and applying rules to prevent tax deductions for interest payments where the return is not taxed in the hands of the ultimate recipient.

Tax incentives and tax avoidance

Tax incentives are a traditional means of encouraging investment in infrastructure and are frequently deployed on projects regarded as important long-term political and economic investments. This is particularly the case in emerging markets, where concerns around political instability and country risk can make investors wary of committing funds unless they have a degree of certainty as to the tax regime that will apply. This is often combined with some form of tax holiday or other incentive given by the home government. The OECD recognises the concern that this could lead to a ‘race to the bottom’, where governments compete to offer tax incentives that may not always be critical to the decision to invest.

In the infrastructure sector, however, such commitments and incentives can and do form part of an appropriate way of encouraging investment and it will have to be recognised that such behaviour should not be penalised through measures introduced as a result of the BEPS project.