The BMG has made a submission to the UK Treasury consultation on a Royalties Withholding Tax
These proposed provisions are an extension of the Diverted Profits Tax introduced in 2015, and the royalty withholding tax of 2016. The need for such unilateral measures clearly shows the failure so far to reach a multilateral solution to ensure that multinational enterprises (MNEs) can be taxed ‘where economic activities occur and value is created’, which was the aim of the G20/OECD project on base erosion and profit shifting (BEPS). While we regret the need for such unilateral measures, we agree that they are necessary, provided they are properly designed to contribute to a possible multilateral solution, and do not further exacerbate international tax competition.
The present proposals are novel for the UK, in claiming to tax payments for intellectual property rights (IPRs) by treating them as as sourced in the UK if used in connection with sales made in the UK, even if neither the payor nor the receiver has a taxable presence in the UK. However, the target is multinational corporate groups, which the consultation document points out will in practice usually have such a taxable presence through related entities. Such multinationals take advantage of the independent entity principle in international tax, by attributing functions such as sales and ownership of IPRs to group entities outside a jurisdiction, although other functions such as sales support may be fulfilled by local related entities. This allows their often enormous sales in the UK to escape tax not only in the UK but also in the country where such sales revenue is attributed, due to the royalty deduction, if the payments flow to an entity notionally located in a low-tax jurisdiction.
Counteracting such strategies results in highly complex measures such as the present proposals. Our comments analyse the legal difficulties they present, and offer some suggestions for ameliorating possible negative and unforeseeable effects. It is especially important to ensure that there are no such effects on taxation by other jurisdictions, especially developing countries. The proposal should be explicitly formulated as an anti-avoidance measure, hopefully short-term, and accompanied by powers for HMRC to issue suitable guidance to prevent harmful impacts on other countries.
These measures clearly show that effective taxation of MNEs requires that they be treated in accordance with the economic reality that they operate as unitary firms under central direction. Both the UK government and MNEs and their tax advisers should accept that this means explicitly moving away from the independent entity principle, rather than covertly as in these proposals. The government should advocate and support multilateral measures in this direction, instead of needing to resort to unilateral measures such as this, which make the system increasingly complex, uncertain and hard to administer.
Corporate Tax and the Digital Economy
The BMG has made a submission to the UK Treasury consultation on Corporate Tax and the Digital Economy
Despite the reforms recommended by the G20/OECD project on base erosion and profit shifting (BEPS), as well as the unilateral measures taken by the UK, the measures taken so far have only patched up existing rules. In our view fundamental reforms are needed. Digitalisation affects the whole economy, and many firms use multi-channel models, so there should not be a special regime for digital businesses.
Reforms of international tax rules should be based on the following principles:
(i) neutrality between business models, both digital and non-digital, but also regardless of the extent or form of digitalisation, including multi-channel models;
(ii) ending the advantages enjoyed by multinationals of amassing large untaxed earnings which can be used to fund their growth and so reinforce their dominant monopoly positions;
(iii) adopting a new approach to taxation of MNEs which would treat them in accordance with the business reality that they operate as global firms, and applying clear, simple, and preferably standardized criteria for allocating their worldwide profits to countries where they have a real business presence and away from countries where few or no activities take place.
The UK should work for multilateral solutions on as wide a basis as possible. Suitably designed short-term measures may be appropriate until such wide reforms are in scope, provided they are:
(i) in line with the principle stated in the G20 Declaration on International Tax in 2013 of taxing multinationals ‘where economic activities occur and value is created’;
(ii) do not damage developing countries and emerging economies; and
(iii) where possible taken in concert with other countries.
Tax Challenges of the Digital Economy
The BMG has made a new submission on Tax Challenges of the Digital Economy in response to the Request for Comments by the OECD in connection with the work of the Task Force on the Digital Economy, preparing a report for the G20.
Digitalisation has further exacerbated the fundamental flaws in international tax rules. The ability to do substantial business in a country without a significant physical presence has long been a problem especially in relation to services. The importance of intangibles and the ability to transfer ownership of such assets to affiliates in low-tax jurisdictions was pioneered long ago by pharmaceutical companies.
Although digitalisation has resulted in important changes in business models, their effects are less significant for those rules than the transformations resulting from the emergence and growth of multinational enterprises (MNEs) since those rules were devised almost a century ago. MNEs have exploited the ‘independent entity’ principle, by creating complex corporate groups and fragmenting their functions to allocate a high proportion of their global income to low-taxed affiliates. The BEPS project has so far aimed only to patch up these rules, and has not resolved the central challenge of how profits should be allocated according to where ‘economic activities occur and value is created’. This requires a paradigm shift, to move away from the independent entity principle, and treat MNEs in accordance with the economic reality that they are unitary firms.
The BEPS issues raised by digitalised products or services are not caused by small companies, such as software firms, selling digital products to customers around the world, but by the giant web-based MNEs. These firms usually do have a significant physical presence in countries where they have a significant level of consumers, but they fragment their activities, and attribute functions such as sales, order fulfillment, production, marketing and customer support to different affiliates.
The main changes due to digitalisation are (i) the closer relationship it both requires and enables between producers and consumers; (ii) the digital services that are often supplied with no direct charge to users, while their inputs are monetised through revenue generated through services provided to other customers, especially advertising; and (iii) the ability that digitalisation gives for some firms to recharacterise themselves as pure intermediaries between producers and consumers. The various unilateral and defensive measures introduced or proposed by countries (diverted profits tax, equalisation levy, etc) may be necessary in the short term but are only interim solutions.
We propose a new definition for taxable presence based on significant presence; a holistic approach in attributing profits to take account of the combined contributions of all the affiliates of a MNE within a country; and a shift towards allocating aggregate profits of all relevant associated enterprises based on factors reflecting the drivers of profit for typical business models.
Offshore Indirect Transfers of Assets
The BMG has now submitted its comments on the discussion draft from the Platform for Collaboration on Tax for a Toolkit on Taxation of Offshore Indirect Transfers of assets.
We welcome this discussion draft, which deals with an important issue of particular interest to developing countries, and was only partly dealt with in the G20/OECD project on base erosion and profit shifting (BEPS).
We agree with the argument it makes that principles of inter-nation equity clearly support the right of the country where an asset is located to tax the gains on its transfer, even if the seller and/or acquirer are not resident in that country. The country is of course free to decide whether and at what rate to tax such gains, taking account of the effects of such taxation on investment in the development of such assets. This right should therefore not be restricted by tax treaties, and we support the proposals in the BEPS project for inclusion in all treaties of a provision equivalent to article 13(4) of the model treaties. This can most effectively be done if all countries sign the Multilateral Convention on BEPS and adopt its article 9(4). This Toolkit should be amended to clearly and unambiguously urge all countries to do so.
In our view, the proposals should extend to indirect transfers of all kinds of assets, without limitation to immovable assets. This is in accordance with the global consensus that profits and gains should be taxed in the jurisdiction where the economic activities giving rise to them are located. The reference to article 13(5) of the UN model in the DD is therefore misleading, and should be amended, to provide countries that choose to tax a wider range of gains the necessary guidance to address movable assets such as shares.
We make a number of other comments which we hope would help improve the DD.
Comments on Draft Additional Guidance on Attribution of Profits to a Permanent Establishment
14 September 2017
The BMG has made a submission on Attribution of Profits to a Permanent Establishment in response to the OECD Discussion Draft.
A major motivator in initiating the entire BEPS project was to end BEPS motivated planning by centrally managed groups. Such planning often attributes sales to zero or low-taxed entities and separates sales through fragmentation from related core functions such as marketing, order fulfilment, and customer support performed by other group entities. Under Action 7 of the BEPS project some modest changes were agreed, so that in defined circumstances a non-resident entity could now be found to have a taxable presence (permanent establishment – PE) in a country in which it makes sales. The current proposals aim to clarify how profits should be attributed to such a PE.
We agree that attribution of profits depends on an analysis of the functions performed by the PE, but in our view this must not be done in isolation. A holistic approach should be adopted, which considers all the activities carried out in the country by the relevant entities in conjunction. Where a multinational chooses to carry out itself activities such as marketing, sales, order fulfilment, and customer support, it does so in order to take advantage of the synergies so created, thereby giving the customer a seamless experience and itself (i.e., the group) a significant market advantage. Hence, it is the cumulative importance of all group activities that should be considered when evaluating the value which is created in the country.
Due to this cumulative importance, our view is still that article 7 should be applied prior to article 9, since this would result in both better focus by taxpayers and tax authorities, and a practical reduction in the resources needed by both tax authorities and taxpayers for compliance.
A holistic approach will also lead in some circumstances to a different transfer pricing method being the most appropriate method. In particular, where such related functions are performed by highly integrated associated entities and are viewed holistically, the profit-split method is likely to prove more appropriate than one-sided methods.
A holistic approach is also important since the DD is meant to apply to all versions of article 7 of the model convention, and whether or not a state has accepted the changes adopted by a majority of OECD states in 2010, described as the authorized OECD approach (AOA). While the AOA has some merits, it has been used to further exacerbate a fragmented approach to the attribution of profits, which (along with the independent entity principle in general) has been a principal enabler of BEPS. Adoption of the holistic approach which we suggest could, we believe, allow some of those helpful features of the AOA to be retained, while ensuring that BEPS structures are not allowed to continue due to a narrow interpretation applying the independent entity principle to an entity which is not even legally separate.
Our Specific Comments section includes a number of concrete suggestions to make the DD more internally consistent and effective in its application.
Comments on the Draft Revised Guidance on Profit Splits
14 September 2017
The BMG has made a submission on the Draft Revised Guidance on Profit Splits.
This discussion draft (DD) offers a rewrite of Section C in Part III of Chapter II of the Transfer Pricing Guidelines. Such a rewrite is overdue, as there has not been a comprehensive re-examination of the profit-split method (PSM) since it was included in the Guidelines in 1995.
This DD is written in a much clearer way than the existing section and we welcome the effort that has been made. However, we regret that the opportunity has not been taken to develop and extend the PSM to make it easier to use. In our view this would be the most effective way forward to achieving the central mandate of the BEPS project, to ensure that multinationals are taxed ‘where economic activities occur and value is created’.
In these comments we provide a specific approach that would allow easy use for tax authorities and taxpayers alike. The principal reason for this is that solely objective factors (e.g. personnel, assets, etc.) are used to apportion profits. This approach would ignore internal group-controlled and tax-motivated arrangements such as intercompany contractual terms. It would also dispense with the need for subjective value judgments, greatly reducing the potential for conflict and uncertainty.
Presentation to the Inclusive Framework on BEPS
The BMG has submitted comments on a further discussion draft from the OECD relating to transfer pricing of hard-to-value intangibles.
The transfer of intangible property rights to related entities is one of the main techniques used by multinational enterprises (MNEs) to avoid taxes through base erosion and profit shifting (BEPS). Such assets are especially hard to value if they are transferred at an early stage, since their income-generating potential will be speculative, although best known to the firm itself. The three examples in the discussion draft all involve a transfer of such rights that have been only partially developed. Specifically, the examples involve a patented pharmaceutical compound that is partially through its clinical trials.
Although the draft still claims to apply the fiction of the arm’s length principle, it allows for transfer pricing adjustments based on actual outcomes, due to “information asymmetry” and its negative effects. Our comments support this approach, and propose some specific ways to strengthen it further.
The European Commission’s Proposals for a Common and Consolidated Corporate Tax Base
The BMG has now published its comments on the CCCTB – the European Commission’s proposals for Common Corporate Tax Base, and for a Common Consolidated Corporate Tax Base.
The CCCTB adopts a sound approach to taxation of multinationals (MNEs), by treating them in accordance with their business reality as unitary firms. It aims to identify the tax base of the whole corporate group, disregarding internal transactions between the affiliates, and to apportion the taxable profit according to factors reflecting the firm’s real activity (sales, assets, employees) in each country. In our view, this is the most effective way to end both competition between states to offer tax incentives, and tax avoidance by MNEs shifting income between affiliates to minimise tax.
In our view, however, the aim should be to create a level playing field in relation to tax on corporate profits not only within the EU but worldwide. Unless this is done, EU member states will continue to compete with each other to offer tax preferences to MNEs from outside the EU. They will also continue to be vulnerable to tax competition from jurisdictions not covered by the CCCTB (including the UK, after Brexit). The CCCTB can and should be recast so that it attributes to the EU as a whole a portion of the worldwide profits of MNEs reflecting their actual activities within the EU, as well as allocating that profit among EU states, using the same criteria.
We also propose a ‘compensation mechanism’, in case another country (e.g. the US) adopts the alternative which has been proposed for a destination-based cash-flow tax with a ‘border adjustment’.
We also warn against the 2-stage approach proposed by the Commission, and criticise the proposed ‘super-deduction’ for R&D expenditures, and the so-called Allowance for Growth and Investment. As some business groups have also argued, it is better to define the tax base broadly, allowing scope for cuts in the rate (which are already taking place), than to build in selective and distorting special allowances.
16 May 2017