Worldwide Tax News
OECD Publishes Final BEPS Package
On 5 October 2015, the OECD published the final reports for all 15 Action Items of the OECD/G20 Base Erosion and Profit Shifting Project, which have been 2 years in the making. These final reports will be presented to the G20 finance ministers on 8 October 2015 and to the G20 leaders during the summit held in Turkey 15-16 November 2015.
The following is a summary of the Action Items and final deliverables.
Concerning Action 1, the consensus is that the digital economy cannot be ring-fenced and subject to taxation separately. Rather, BEPS issues in the digital economy should be addressed along with the issues in the broader economy overall, in particular the issues covered by Actions 3 (CFC Rules), 7 (Preventing Artificial Avoidance of PE) and 8-10 (Transfer Pricing).
While the report on Action 1 does not recommend specific measures to be adopted regarding the digital economy, it does provide an overview of potential options countries may adopt in domestic legislation. These include:
- A new significant economic presence nexus based on a sustained interaction with a country via technology, with thresholds based on the amount of revenue derived from the country;
- A withholding tax on digital transactions; and
- An equalization levy.
The report also looks at the collection of value added tax (VAT) on digital supplies, including VAT on the import of low-value goods purchased online and B2C supplies of digital services and intangibles.
The final report for Action 2 generally reaffirms the 2014 report. It includes guidance on the implementation and operation of the new rules that:
- Apply to all types of hybrid arrangements and are designed to work whether all countries implement the rules or not;
- Are targeted at related party and structured transactions;
- Eliminate the benefit of hybrid mismatches without affecting other tax outcomes; and
- Have been designed to avoid double non-taxation without raising issues of double taxation.
Outstanding issues that have been resolved in the final report include:
- Guidance on the treatment of payments under a CFC regime;
- Guidance on the imported mismatch rule; and
- The treatment of hybrid regulatory capital under the hybrid financial instrument rule.
The final report on CFCs provides recommendations for jurisdictions to implement/amend effective CFC rules, but does not include a minimum standard to be applied. The report recognizes both shared and jurisdiction-specific CFC policy considerations and covers:
- The definition of CFC, including transparent entities and PEs, and an anti-hybrid rule to prevent avoidance of CFC rules;
- CFC exemptions and threshold requirements, including the use of white lists;
- The definition of CFC income, including more flexibility and options for different policy objectives;
- Rules for computing and attributing income; and
- Rules for the prevention or elimination of double taxation.
The report also sets out how it coordinates with other Action Items, including Actions 1 (Digital Economy), 2 (Hybrid Mismatches), 4 (Interest Deductions), 5 (Countering Harmful Tax Practices) and 8-10 (Transfer Pricing).
Action 4 is focused on the design of rules to prevent base erosion through interest expense, for example through the use of related-party and third party debt to achieve excessive interest deductions, or to finance the production of exempt or deferred income. The final reports looks to directly link interest deductions to taxable economic activity, provides a common approach that is flexible enough to meet the needs of different countries, and takes into account actual net interest expense of a group.
In the report, the OECD takes a combination approach to address BEPS issues with the use of an EBITDA-based fixed ratio rule combined with a group ratio rule.
- The Fixed ratio rule allows net interest deductions up to a fixed net interest/EBIDTA ratio of 10% to 30% that applies to interest paid to both third parties and intra-group. For determining the appropriate ratio, the report includes factors a country may consider, including whether the group ratio rule is also adopted, whether unused interest capacity or disallowed interest expense may be carried forward/back, the interest rates in the country, etc.
- The group ratio rule is an optional rule that allows an interest deduction based on the interest/EBIDTA of a group. Countries may apply a different group ratio rule or no rule at all.
The final report also includes rules designed to protect the fixed and group ratio rules from circumvention through planning, and addresses specific BEPS issues. It also provides for an optional de minimis threshold to remove low risk entities, provisions for carry forward/back, and an exclusion for third party funding of certain public-benefit assets.
The Action 5 final report follows up on the 2014 report, in which it was generally agreed that:
- All preferential regimes must require substantial activity based on a nexus approach;
- A framework should be developed for transparency and mandatory exchange of information on tax rulings; and
- A review of existing regimes of OECD members and associates should be conducted.
Under the approach developed for IP regimes, the amount of income benefiting from a preferential regime is dependent upon the amount of R&D expenditure of the benefiting taxpayer using a ratio of qualifying expenditure/total expenditure (the Nexus ratio). Qualifying expenditure includes R&D cost directly incurred in connection with an IP asset, including outsourcing of activities to unrelated parties, but does not include outsourcing to related parties or acquisitions, although 30% uplift is permitted.
The basic result is a taxpayer will be able to benefit from a preferential regime fully if it has only qualifying expenditure. However, if it also has costs with related parties or acquisitions, the use of those costs as qualifying expenditure in the Nexus ratio is limited to 30% of the actual qualifying expenditure. For example, if qualifying expenditure is 100, up to 30 (100 X 30%) of non-qualifying expenditure may be included as qualifying expenditure.
IP assets that may qualify for a preferential regime are defined as:
- Patents defined broadly, including utility models, IP assets that grant protection to plants and genetic material, orphan drug designations, and extensions of patent protection;
- Copyrighted software; and
- Other IP assets that are similar to patents (i.e. non-obvious, useful, and novel), are substantially similar to the above two asset types, and are certified through a transparent certification process by a government agency (benefits limited to taxpayers that have no more than EUR 50 million annual group revenue, and no more than EUR 7.5 million annual revenue themselves).
Under the new approach, marketing-related IP assets such as trademarks can never qualify for a beneficial regime.
No new entrants to a preferential regime not consistent with the nexus approach will be allowed from 30 June 2016. If a new regime with a nexus approach takes effect before that date, no new entrants to the non-nexus regime will be allowed once the new regime takes effect. Countries are allowed to grandfather participants in an existing non-nexus regime for up to 5 years from the date no new entrants are permitted.
The report also covers the application of a substantial activities test for the benefits of non-IP regimes, such as headquarter regimes, service center regimes, shipping regimes, holding company regimes, etc. It looks at the main factors of the various regime types that may be used when examining substantial activity. It does not provide detailed rules as provided for IP regimes.
The final report sets out 6 categories of rulings for mandatory automatic exchange, including:
- Rulings related to preferential regimes;
- Unilateral APAs and other transfer pricing rulings;
- Rulings given unilateral downward adjustments;
- Permanent establishment rulings;
- Related party conduit rulings; and
- Other rulings subsequently agreed to give rise to BEPS concerns.
Such rulings should be exchanged with:
- The countries of residence of related parties (25% threshold) with a transaction covered by a ruling, and the country of the head office or the PE as applicable in the case of a PE ruling, and
- The countries of the immediate parent company and the ultimate parent company.
The exchange of information should begin by 31 December 2016 for past rulings issued on or after 1 January 2010 and still in effect on 1 January 2014. New rulings issued on or after 1 April 2016 should be exchanged within 3 months of their issuance.
The report includes a review of 43 existing regimes of OECD and G20 countries.
The main purpose of this action is to counter the unintended consequences of tax treaties, including double non-taxation and other tax avoidance arrangements through treaty shopping. The final report includes:
- The recommendation that treaties include a clear statement that the parties to the treaty have a common intention to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through evasion or avoidance, including through treaty shopping;
- A limitation on benefits (LOB) rule that will be added to the OECD Model Convention to limit the availability of benefits based on the legal nature, ownership in, and general activities of, residents of a Contracting State to ensure there is a sufficient link between an entity and its State of residence; and
- A general treaty anti-abuse rule that will be added to the OECD Model Convention, which includes a principal purpose test aimed at arrangements resulting in treaty abuse that may not be covered by the LOB rule. If the principal purpose of a transaction or arrangement is obtaining the benefits of the treaty, the benefits would be denied unless granting of the benefits would be in accordance with the object and purpose of the treaty.
Countries may implement both the LOB and general anti-abuse rules, the anti-abuse rule alone, or the LOB rule plus supplemental provisions to deal with conduit financing arrangements not already covered in tax treaties.
Additional targeted rules developed include:
- Rules to address dividend transfer transactions designed to artificially lower withholding taxes payable on dividends;
- Changes to Article 13(4) of the OECD Model Convention to prevent transactions that circumvent the provisions allowing source taxation of shares of companies deriving their value primarily from immovable property;
- Changes to the rules determining tax residence for the purpose of treaty benefits in cases of dual-residence; and
- Anti-abuse rules for permanent establishments situated in third States where the State of residence exempts the income of PEs in third States and where shares, debt-claims, rights or property are transferred to PEs set up in countries that do not tax such income or offer preferential treatment.
Regarding the interaction between treaty and domestic anti-abuse rules, the final report includes a new rule that treaties do not restrict a State's rights to tax its own residents. It also includes that treaties do not restrict a State from imposing departure or exit taxes on residents that cease to be a resident of the State.
The final report for Action 7 addresses BEPS issues related to the avoidance of permanent establishment, including:
- The use of commissionaire arrangements to replace a distributor through which a foreign enterprise sells its products;
- Fragmenting business activities in order to take advantage of the PE exemptions for preparatory and auxiliary activities; and
- Other strategies, including splitting-up of construction contracts in order to gain a PE exemption based on the amount of time of activities, and strategies for selling insurance (specific rules for insurance were not ultimately included).
Commissionaire and similar arrangements are addressed by adjusting the wording of the paragraphs 5 and 6 of Article 5 of the OECD Model Convention and Commentary in line with the policy that when the activities of an intermediary are intended to result in regular contracts to be performed by a foreign enterprise, that foreign enterprise will be deemed to have a taxable presence unless the intermediary is performing the activities in the course of an independent business.
Fragmenting business activities are addressed with a new anti-fragmenting rule that will be added as paragraph 4.1 of Article 5 of the Model Convention. The rule states that the exemption provided under paragraph 4 will not apply if the same enterprise or a closely related enterprise carry on activities in the same place or another place in the same Contracting State, provided the activities constitute complementary functions that are part of a cohesive business operation, and:
- That place or the other place constitutes a PE, or
- The overall activity resulting from the activities of the enterprise(s) in the same place or the two places is not of a preparatory or auxiliary nature.
Splitting-up of contracts is addressed through the principal purpose test in the general anti-abuse rule developed under Action 6. For countries that do not include the general anti-abuse rules in a treaty, a more automatic rule may be included that specifically deals with splitting-up of contracts.
Regarding insurance PE issues, it was decided that it would be inappropriate to address insurance through a separate PE rule, and such issues should instead be addressed through the changes made to paragraphs 5 and 6 of Article 5 of the Model Convention.
Regarding profit attribution, no major changes to the attribution rules are needed. However, additional follow-up work will be undertaken on the attribution of profits to PEs taking into account the new PE rules covered above, with necessary guidance issued before the end of 2016.
Actions 8-10: Aligning Transfer Pricing Outcomes with Value Creation
Action 8, 9 and 10 are grouped together in a single final report as they all deal with aligning transfer pricing outcomes with value creation.
In particular, the report includes amended transfer pricing guidance on:
- The application of the arm's length principle, which is revised and expanded;
- Commodity transactions;
- The transactional profit split method;
- Low value-adding intra-group services; and
- Cost contribution arrangements.
Overall, the new guidance is meant to ensure that the transfer pricing rules result in outcomes where operational profits are allocated to the economic activities that generate them. Key points of the report include:
- The revised guidance requires accurate delineation of the actual transactions between related parties by analyzing the contracts between parties with the actual conduct of the parties, and in certain cases the conduct may supplement or even replace the contractual arrangements;
- For risks contractually assumed by a party, if the party cannot meaningfully exercise control of the risk or does have the financial capacity to assume the risk, the risk will be allocated to the party that does exercise control and has the financial capacity;
- Regarding intangibles, the guidance clarifies that legal ownership does not necessarily create entitlement to all profits, or even any profits, from the exploitation of intangibles;
- Regarding group funding, if a group member provides funding but does not control the risk, then it will be only entitled to a risk-free return, or less if the funding has no commercially reasonable basis; and
- The guidance ensures that the transfer pricing methods will allocate profits to the most important economic activities, including that it will no longer be possible to allocate the synergistic benefits of operating as a group to members other than those contributing to such benefits.
Commodity transactions are covered as part of Action 10 of the BEPS project. Additional guidance is added to the transfer pricing guidelines to clarify that:
- The use of the comparable uncontrolled price (CUP) method can be appropriate for cross-border commodity transactions between related parties;
- Quoted or publicly available prices can be used as a reference to determine the arm’s length price; and
- Reasonably accurate comparability adjustments should be made when needed.
In addition, guidance has also been developed on the adoption of a deemed pricing date for commodity transactions by tax authorities based on available evidence if the date is not clearly identified.
Action 10 also includes work on revised guidance on the use of the transactional profit split method in the context of global value chains in cases where it may be difficult to apply one-sided transfer pricing methods to determine outcomes that are in line with value creation. The scope of the guidance covers:
- The most appropriate method;
- Highly integrated business operations;
- Unique and valuable contributions;
- Synergistic benefits;
- Profit splitting factors; and
- Use of profit splits to determine TNMM range, royalty rates and other payment forms.
Follow-up work will be undertaken to provide detailed guidance on the use of the transactional profit split method during 2016 and finalized in 2017.
Intangible assets are covered as part of Action 8. Under the guidance developed, group members are to be compensated based on the value they create through functions performed, assets used and risked assumed in the development, enhancement, maintenance, protection and exploitation of intangibles assets. The main areas covered include:
- Identifying intangibles;
- Ownership of intangibles and transactions involving the development, enhancement, maintenance, protection and exploitation of intangibles;
- Transactions involving the use or transfer of intangibles; and
- Supplemental guidance for determining arm's length conditions in cases involving intangibles.
The new intangibles guidance completely replaces the existing guidance.
The work on low value adding intra-group services is part of Action 10. The work includes the introduction of a simplified method for low value-adding services that result in base erosion, such as excessive management fees and head office expenses. The method involves specifying a wide category of common intra-group services with a limited mark-up on costs, applying a consistent allocation key for all recipients of those services, and requiring specific reporting on the determination of the specific cost pool.
The simplified method is elective and, if elected, must be applied on a consistent group-wide basis.
Cost contributions arrangements (CCA) are part of Action 8. The work is intended to align CCA guidance with the work on intangibles, ensuring that transactions covered by a CCA are consistent with the arm's length principle and produce outcomes consistent with how and where value is created.
Action 11: Measuring and Monitoring BEPS
Action 11 is meant to ensure that tools are available to monitor and evaluate the effectiveness and economic impact of the actions taken to address BEPS on an ongoing basis. The final report includes an analysis of currently available data, the indicators and economic effects of BEPS, and tools and data for monitoring BEPS in the future.
Going forward, the OECD will work with governments to produce a regular corporate tax statistics publication, which will include information based on country-by-country reports, and will monitor the implementation of the BEPS Project deliverables and impact.
Action 12: Mandatory Disclosure Rules
The work on Action 12 involves the development of a mandatory disclosure rule that countries can implement to require the disclosure of certain transactions prior to the filing of the tax return. The disclosure requirements could apply to promoters, taxpayers or both. The main purpose of disclosure is for increased transparency regarding potentially aggressive and abusive tax planning.
The report provides a modular framework for countries to implement disclosure rules that balance the specific information needs of the tax administration with the burden on the taxpayer. It also provides special rules for international tax schemes, and provides for enhanced information sharing through the expanded Joint International Tax Shelter Information and Collaboration Network of the OECD Forum on Tax Administration.
The final report on Action 13 reiterates the transfer pricing documentation requirements issued in 2014, which include:
- A Local File detailing information relating to specific intercompany transactions at the local country level;
- A Master File providing an overview of a group's global transfer pricing practices; and
- A Country-by-Country (CbC) report providing a high-level transfer pricing risk assessment of a group's global operations.
No changes have been made in the final report regarding the implementation of the new requirements or what they entail.
Several countries have already proposed or implemented legislation for the introduction of the new requirements. The first year covered will be the tax year beginning 1 January 2016, with the first filing of the documentation due in 2017. The first exchange of CbC reports between tax administrations will take place within the first 6 months of 2018, while the second and subsequent exchanges are to take place within 3 months of the end of the year a report is filed (i.e. 15 months after the close of the relevant tax year).
A signing ceremony for the multilateral competent authority agreement on the exchange of CbC reports will take place in January 2016.
The report on Action 14 sets out:
- The elements of a minimum standard for the resolution of treaty disputes;
- Best practices for dispute resolutions;
- A framework for monitoring dispute resolutions; and
- A commitment to mandatory binding MAP arbitration.
According to the report, the minimum standard will:
- Ensure that treaty obligations related to mutual agreement procedures (MAP) are fully implemented in good faith and that MAP cases are resolved in a timely manner;
- Ensure the implementation of administrative processes that promote prevention and timely resolution of treaty related disputes; and
- Ensure that taxpayers can access MAP when eligible.
The implementation of the minimum standard will be reviewed through peer-based monitoring, with the assessment methodology finalized in the first quarter of 2016.
The final report on Action 15 contains nothing new. The 2014 report concluded that the use of a multilateral instrument for the implementation of developed treaty provisions is feasible, and the OECD has moved forward with the process.
The development of the instruments began with a procedural meeting in May 2015, and will continue with substantial negotiations during an inaugural meeting on 5 November 2015, which the U.S. had decided to join. The instrument is expected to open for signature in 2016.
The OECD will continue its work on the BEPS Project, including the preparation of a framework by early 2016 to support the implementation and monitoring of the BEPS deliverables, with a particular focus on supporting developing economies as mandated by the G20.