OECD releases final report on Base Erosion and Profit Shifting (BEPS)
OECD releases final report on Base Erosion and Profit Shifting (BEPS)
On October 5, the Organization for Economic Co-operation and Development (OECD) released its final package of reports from its Base Erosion and Profit Shifting (BEPS) project—effectively, a comprehensive set of recommendations for reforming the international tax regime. Although the recommendations don’t carry the force of law, their release has been widely anticipated, and they could prove very influential in the international tax world.
Background. According to the OECD, the current international tax rules have revealed weaknesses that create opportunities for BEPS. As a result, it required policy makers to restore confidence in the system and ensure that profits are taxed where economic activities take place and value is created.
Undertaken at the request of the G20 leaders, the work to address BEPS is based on the 2013 G20/OECD BEPS action plan, which identified 15 Actions to put an end to international tax avoidance.(See Weekly Alert ¶ 7 07/25/2013.)
The final BEPS package. The final BEPS package (a series of reports that, for ease, are collectively referred to as “the report”) includes the following:
- New minimum standards that are intended “to tackle issues in cases where no action by some countries would have created negative spill overs (including adverse impacts of competitiveness) on other countries”;
- Reinforced international standards on tax treaties and transfer pricing;
- Common approaches and best practices for domestic law measures;
- Analytical reports with recommendations concerning the digital economy and multilateral instruments; and
- A detailed report on measuring BEPS.
The OECD has structured the 15 BEPS Actions around three fundamental “pillars” and “horizontal areas of work” (e.g., the digital economy), which generally span multiple actions.The three pillars are:
- Pillar I: creating coherence between the interaction of the domestic laws of the various countries (Coherence);
- Pillar II: re-establishing the link between substance requirements and international taxation standards (Substance); and
- Pillar III: increasing transparency and certainty for businesses and governments (Transparency and Certainty).
Pillar I: Coherence.The coherence pillar includes the following four BEPS action items.
- …Action 2: Neutralize the Effects of Hybrid Mismatch Arrangement. Hybrid mismatch arrangements exploit differences in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions to achieve, for instance, double non-taxation or long-term deferral. The report provides a recommended approach that would facilitate the convergence of national practices through domestic and treaty rules to neutralize such arrangements. It would help to prevent double non-taxation by eliminating the tax benefits of mismatches, multiple deductions for a single expense, deductions in one country without corresponding taxation in another, and the generation of multiple foreign tax credits for one amount of foreign tax paid. The report contains both recommendations for changes to domestic law as well as to the OECD Model Tax Convention.
- …Action 3: Strengthen CFC Rules. The report sets out “building blocks” for effective rules on controlled foreign corporations (CFCs). The recommendations are designed to, among other things, prevent taxpayers from shifting income into foreign subsidiaries. The report identifies the challenges to existing CFC rules posed by mobile income (e.g., from intellectual property), acknowledges competing policy goals (i.e., between worldwide and territorial taxation), and aims to strike a balance in the recommendations between taxing foreign income and maintaining competitiveness.
- …Action 4: Limit Base Erosion via Interest Deductions and Other Financial Payments. The report recommends a common approach to interest deductibility and aims to ensure that an entity’s net interest deductions are directly linked to the taxable income generated by its economic activities. The report also recognizes that a separate approach may be required for the banking and insurance sectors and noted that work with respect to those sectors is expected to be completed next year.
- …Action 5: Counter Harmful Tax Practices More Effectively. Concerns in this area focus largely on “preferential regimes” which can be used for artificial profit shifting. The report sets out a minimum standard to assess whether there is substantial activity in a preferential regime.
Pillar II: Substance.The following five BEPS action items fall under the substance pillar.
- …Action 6: Prevent Treaty Abuse. The report includes a minimum standard on preventing treaty abuse that specifically addresses treaty shopping (i.e., where a person who is not a resident of a jurisdiction nonetheless attempts to obtain the benefits of a tax treaty concluded by that jurisdiction), proposed rules that would provide safeguards to prevent treaty abuse and offer a certain degree of flexibility regarding how to do so, and policy considerations to be taken into account when entering into tax treaties with certain low- or no-tax jurisdictions.
- …Action 7: Prevent the Artificial Avoidance of PE Status. Tax treaties generally provide that the business profits of a foreign enterprise are taxable in a jurisdiction only to the extent that the enterprise a permanent establishment (PE) in that jurisdiction to which the profits are attributable. The report notes the importance of defining a PE and calls for changes to prevent the exploitation of exceptions to PE status that are provided in the current OECD Model Tax Convention (2014).
- …Actions 8 – 10: Assure Transfer Pricing Outcomes Are in Line with Value Creation. Transfer pricing rules are generally used to determine, on the basis of the arm’s length principle, the conditions for transactions among related parties (e.g., within a multinational enterprise (MNE) group). The BEPS transfer pricing work has focused on three key areas: transfer pricing issues relating to controlled transactions involving intangibles, contractual allocations of risk (and whether they are respected), and other high-risk areas. The final report contains rules intended to ensure that transfer pricing rules secure outcomes that better align operational profits with the economic activities which generate them, and also provides guidance on transactions involving cross-border commodity transactions as well as on low value-adding intra-group services.
Pillar III: Transparency and Certainty.The transparency and certainty pillar includes the following four BEPS action items.
- …Action 11: Measuring and Monitoring BEPS. The report, while acknowledging the challenges in measuring the scope of BEPS (which include complexity of the transactions and limitations on available data, among other things), notes that the global corporate income tax (CIT) revenue losses stemming therefrom could be significant—as high as $100 to $240 billion per year. The report provides a “dashboard” of six BEPS indicators that provide strong signals that BEPS exists and suggest it has been increasing over time. The OECD’s research also found significant non-fiscal economic distortions arising from BEPS. The report suggested that BEPS monitoring will require countries to improve the collection, compilation, and analysis of data.
- …Action 12: Require Taxpayers to Disclose Aggressive Tax Planning Arrangement. The report notes that early access to comprehensive and relevant information on aggressive tax planning strategies would provide tax authorities worldwide with the opportunity to quickly respond to tax risks through informed risk assessment, audits, or changes to legislation. The report provides a modular framework of guidance drawn from best practices for use by countries without mandatory disclosure rules and for analysis by countries that do have such rules to potentially enhance their effectiveness.
- …Action 13: Re-examine Transfer Pricing Documentation. According to the OECD, improved and better-coordinated transfer pricing documentation would increase the quality of information provided to tax administrations and limit the compliance burden on businesses. To this end, the report contains a 3-tiered standardized approach, including a minimum standard on country-by-country reporting (CbCR). Specific recommendations include requiring MNEs to provide tax administrations with high-level information regarding their global business operations and transfer pricing policies in a “master file” that is to be available to all relevant tax administrations; requiring that detailed transactional transfer pricing documentation be provided in a “local file” specific to each country; and requiring large MNEs to file a CbCR (generally in the ultimate parent entity’s jurisdiction, shared automatically with other governments) that would provide 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 and other indicators of economic activities.
- …Action 14: Make Dispute Resolution Mechanism More Effective. As the changes introduced by the BEPS project may lead to some uncertainty and could, without action, increase double taxation and Mutual Agreement Procedure (MAP) disputes in the short term, the report outlines a minimum standard with respect to the resolution of treaty-related disputes that includes a strong commitment to effectively and timely resolution of disputes through the MAP and the establishment of an effective monitoring mechanism to ensure that the minimum standard is met.
Horizontal areas of work.The following two BEPS action items fall under the “horizontal areas” of work.
- …Action 1: Address the Tax Challenges of the Digital Economy. The report notes that rules and implementation mechanisms have been developed to help collect value-added tax (VAT) based on the country where the consumer is located in the case of cross-border business-to-consumers transactions. These measures are intended to level the playing field between domestic and foreign suppliers and facilitate the efficient collection of VAT due on these transactions. Technical options to deal with the broader tax challenges raised by the digital economy have been discussed and analyzed, which raise systemic issues regarding the existing framework for the taxation of cross-border activities that go beyond BEPS issues. The OECD and G20 countries have agreed, to this end, the monitor developments and analyze data then later make a determination as to whether further work on the options discussed should be carried out.
- …Action 15: Development of a Multilateral Instrument. Drawing on the expertise of public international law and tax experts, the report concludes that a multilateral instrument to implement the BEPS treaty-related measures and amend bilateral tax treaties is both desirable and feasible, and that negotiations for such an instrument should be convened quickly. Thus far, nearly 90 countries are working together on the development of a multilateral instrument capable of incorporating the tax treaty-related BEPS measures into the existing network of bilateral treaties, which will be open for signature by all interested countries in 2016.
Next steps. Following delivery of the BEPS measures to G20 leaders during their annual summit on November 15 through 16 in Antalya, Turkey, the focus will shift to designing and putting in place an inclusive framework for monitoring BEPS and supporting implementation of the measures, with all interested countries and jurisdictions invited to participate on an equal footing.
Political reaction. In a press release, House Ways & Means Committee Chairman Paul Ryan (R-WI), reacting to the final report, said that “[w]hile the details still require close review, this proposal will only increase the pressure for American businesses to move overseas. And it could put huge new burdens on American job creators.”He called for tax reform to “bring our tax code into the 21st century, allowing companies to bring back their earnings without penalty and making our tax rates more competitive with the rest of the world.”
Rep. Ryan and Senate Finance Committee Chairman Orrin Hatch (R-UT) had expressed concerns about the BEPS project earlier this summer in a letter to Treasury Secretary Jacob Lew specifically taking issue with CbCR and modification of the PE rules. The lawmakers also acknowledged the significance that the project carries “in the global community,” but emphasized that authority for writing the tax laws of the U.S., including those that pertain to cross-border activities of U.S. companies, lays with Congress.
References: For U.S. tax treatment of foreign income in general, see FTC 2d/FIN ¶ O-1000 et seq.; United States Tax Reporter ¶ 8644 et seq.; TG ¶ 30350 et seq.