Monthly Archives: February 2015

Presentation at the Regional Meeting in Lima

The BMG was represented by Veronica Grondona at the regional meeting for Latin America and the Caribbean on the BEPS process, organised by CIAT and the OECD, in Lima (Peru) on 28th February.

She made a presentation based on a paper in Spanish which was also circulated to meeting participants. It includes comments both on the BEPS process in general, and some more specific discussion of technical details, based on submissions made by the Group.

Harmful Tax Practices: Agreement on the Modified Nexus Approach

We have now published our submission in response to the consultation on the ‘modified nexus approach‘ under the BEPS Action Point 5 on Harmful Tax Practices.

It begins with some general comments on the approach adopted for dealing with tax advantages given by states which damage other countries’ tax base, termed harmful tax practices, and then provides comments on the specific proposals for applying the nexus approach to innovation boxes.


In many ways this issue goes to the heart of the dilemma posed by the approach adopted by the G20 and the OECD to the BEPS problem. Many countries have been tempted to offer special tax advantages or regimes which in effect work in a beggar-thy-neighbour way, and create a race to the bottom in corporate taxation. The mandate from the G20 to reform tax rules to ensure that multinationals are taxed according to `where economic activities take place and value is created’ necessarily entails closer coordination of tax rules. Hence, it could be said to involve limits on state sovereignty, which the G20 has also said should be preserved. Yet without such closer coordination states have been losing their power to tax multinationals effectively. The problem is how to design coordination measures which require the least intrusion into national governments’ regulatory space.

The approach adopted to ‘harmful tax practices’ has been to establish general criteria, and evaluate states’ measures against these. This falls between two stools, depending on the form of enforcement. If the procedure is voluntary it is toothless and ends by encouraging states to devise new measures; but if backed by the possibility of counter-measures (either collective or unilateral) monitoring of compliance would be highly intrusive for both companies and states. This can be seen in particular in the current proposals relating to the economic substance criterion for innovation boxes, which involve complex rules and a ‘track and trace’ system for company expenditure. In our view regimes such as the patent box are unnecessary and undesirable, as encouragement for R&D can already be easily provided through investment allowances.

The OECD approach will simply legitimize ‘innovation box’ regimes and hence supply a legal mechanism for profit shifting, encouraging states to provide such benefits to companies. It will be particularly damaging to developing countries, which may be used as manufacturing platforms, while their tax base will be drained by this legitimized profit-shifting. Such measures should simply be condemned and eliminated.

This issue again clearly shows why a better approach to taxing companies where economic activities take place would be extension of the profit split method. As we have urged in our other submissions, the use of the profit split method applied with concrete and easily determinable objective allocation keys would be much easier to administer and far less intrusive both for states and enterprises, and would also leave states free to decide their own tax rates, as well as investment allowances.


The Use of Profit Splits in the Context of Global Value Chains

We have now published our submission in response to the consultation on BEPS Action 10: The Use of Profit Splits in the Context of Global Value Chains


The BMG welcomes this report from the OECD, which confirms that the time has arrived for expanded use of the profit split method, placed on a more regularised and systematic foundation. In our view there is a serious need to develop a simple-to-apply reliable approach to determining how profits will be apportioned amongst the members of a centrally managed multinational group. Specifically, we suggest that the Transfer Pricing Guidelines should include clear guidance stating concrete allocation keys and weightings for all business models now commonly being used. Anticipating the likely emergence of new business models, the Guidelines should also articulate the principles on which concrete allocation keys and weightings should be determined. Such simple and clear rules would be easier to administer, and greatly reduce conflicts both between tax authorities and companies, and among tax authorities. They would make an enormous step towards achieving the aim set by the G20 that multinationals should be taxed ‘where economic activities take place and value is created’.

Transfer Pricing: Risk, Recharacterisation, and Special Measures

We have now published our submission in response to the consultation on BEPS Action Points 8, 9 & 10 Revisions to Chapter I of Transfer Pricing Guidelines (including Risk, Recharacterisation, and Special Measures)


We applaud this discussion draft (DD) as an attempt to reconsider the basic approach, which has too long dominated transfer pricing regulation, that taxation of a multinational corporate group must treat its various component parts as if they were independent entities and focus on the pricing of transactions between them. This independent entity assumption runs totally counter to the current reality existing within these centrally-managed groups, and produces a system which is terribly subjective, often very discretionary, and impossibly difficult to administer.

To examine the details of intra-firm transactions, this independent entity assumption requires tax administrations to use specialist staff, normally in short supply in developed countries and often non-existent in developing countries, with legal expertise in complex structures and transactions, economic analysis capabilities, and specific knowledge of the characteristics of each business sector.

Despite this willingness to reconsider the basic approach, the draft still clings to that mistaken independent entity assumption by continuing to require that inter-affiliate transactions should be the starting point. These transactions are then evaluated in terms of the functions performed, assets owned and risks assumed by the affiliated entities, and the draft attempts to analyse these three factors: Functions-Assets-Risks (F-A-R), especially Risks. The draft rightly recognizes that in an integrated multinational corporate group ‘the consequences of the allocation of assets, function, and risks to separate legal entities is overridden by control’. We cannot agree more with this, since the greater competitiveness and generally higher profits of a corporate group operating in an integrated way derives from the benefits of synergy, so that the whole is greater than the sum of its parts. It is generally difficult or impossible to decide what proportion of the total profits to attribute to particular F-A-Rs within the various group members, especially when central control allows a multinational to transfer at its sole discretion intangible assets, functions, and risks amongst group members solely for purposes of tax minimisation.

Hence, we agree with the analyses in the draft, for example that concerning ‘moral hazard’, which suggests that a contract between associated enterprises in which one party contractually assumes a risk without the ability to manage the behaviour of the party creating its risk exposure is clearly a sham. Following the approach of the DD, this means that non-recognition or other adjustments must be made to appropriately interpret the actual transaction as accurately delineated. Our preferred approach, however, is to begin from the assumption that contracts between associated enterprises cannot be likened to market transactions between independent parties, for that very reason, so that the starting point should be an assumption that contracts between related entities should be disregarded.

Our preference, as we have urged in our separate comments on another report, is that the profit split method should be regularized and systematized, by clarifying the methodology for defining the aggregate tax base to be split, and specifying definite concrete and easily determinable objective allocation keys for all commonly used business models, also including the principles for choosing such keys for new business models as they appear in the future.

Part II proposes some ‘special measures’ which could be applied in defined ‘exceptional circumstances’, which in effect attempt to deal with some of the gaping wounds of the current transfer pricing system. We generally support these as at least an improvement on current formulations: particularly Option 1 (Hard to Value Intangibles); Option 2, first variant (Independent Investor); and Option 4 (Minimum Functional Entity). While we support Option 3 (Thick Capitalisation), in our view it must not form part of the Transfer Pricing Guidelines but belongs in the rules on Controlled Foreign Corporations, which are being separately considered. We detail strong reasons for this view.

We consider that there is merit in the concept of Option 5 (Ensuring appropriate taxation of excess returns), but as presently described it would be counter-productive and only continue to encourage BEPS behaviour, particularly if x% (the defined ‘low-tax rate’) is below the general corporate tax rate in the home country and is both the trigger for application of the CFC rule and the rate of tax to be applied under the CFC rule in the home country of the MNE. We propose that the trigger for applying this Option 5 should be an average effective rate of tax defined as a percentage that is very close to the general corporate tax rate in the home country. In particular, we recommend that it be no less than 95% of that home country rate.

Overall, these amendments to the Transfer Pricing Guidelines, although extensive, would for that very reason make them even more complex, subjective, and, for the most part, impossible for most countries’ tax authorities to administer. These and other drawbacks mean that the overriding need at the present juncture is for rules which are easily administered and that provide results for taxpayers and countries that all regard as fair. In the immediate term, we therefore strongly urge a clear shift towards a systematised and regularised application of the Profit Split method. A next step is a fundamental reappraisal of the Guidelines, and a complete rewriting especially of chapter 1. It should begin by a reversal of the independent entity assumption and an acceptance of the principle that each multinational corporate group must be considered according to the business reality that it operates as an integrated firm under central direction.

Limitation of Interest Deductions

We have now published our submission in response to the consultation on BEPS Action Point 4 Interest Deductions.


We warmly welcome the proposals in this report, which could greatly reduce the opportunities for tax avoidance by multinationals using internal financial structures to reduce their taxes artificially by inflated deductions of interest from taxable profits. We support its main proposal, that countries should introduce a limit on such interest deductions based on the consolidated net interest expense of the whole multinational corporate group to third parties, apportioned to each group member according to its earnings before tax, interest, depreciation and amortisation (EBITDA). However, we also make some comments and suggestions.

Firstly, more attention should be paid to the problem of divergence between the standards for financial accounting and those for taxation. Since consolidated financial statements will at least initially be used, we suggest that companies should be required to identify and adjust for any material differences caused by inconsistent financial accounting rules and differing accounting and tax treatments of significant items, at both the group and entity levels. Any allocation of net interest expense based on group accounting must be based on data drawn from the consolidation process where (i) all intra-group transactions have already been eliminated from consideration and (ii) the accounts of subsidiary entities have, if necessary, been restated from the local accounting standards to those of the group financial statements. In the longer term, we strongly urge the OECD to work on the development of an international standard for tax accounting for such purposes, which could build on the work already done in the EU’s Common Consolidated Corporate Tax Base.

Secondly, it should be recognised that the adoption of any allocation rule entails a move away from the separate entity principle, but in this case only in relation to charging for costs. As we noted in our response to the report under AP10 on Low Value Added Services, which also proposed an apportionment method, many tax authorities, especially in developing countries, may be reluctant to accept an apportionment method for joint costs, as they can be used to reduce taxable profits in source countries. We nevertheless support an apportionment approach in general, since it is in line with business reality, and results in rules which are much easier to administer. In the case of interest, we support a cost apportionment since (i) allocation based on earnings reflects economic activity and hence to some extent benefit; and (ii) evidence shows that this method would restrict interest deductions to a level which will normally be well below that resulting from the interest cap or thin capitalisation rules that countries currently apply.

However, as we have argued in several submissions, we would generally favour a move to more comprehensive profit apportionment solutions. Hence, we strongly encourage the systematisation and expanded use of the profit split method, which fairly and easily apportions both costs and revenues. This would be the most effective way to achieve the aims of the BEPS project as laid down by the G20 leaders, to ensure that multinationals are taxed ‘where economic activities take place and value is created’.

Transfer Pricing Aspects of Cross-Border Commodity Transactions

We have now published our submission to the consultation on BEPS  Action Point 10 Transfer Pricing Aspects of Cross-Border Commodity Transactions.


Consideration of the so-called Sixth Method of transfer pricing adjustment for commodities, as used in a number of countries especially in Latin America, is important. However, in our view this report misunderstands the method and the reasons for using it, and its proposals are inappropriate.

The Sixth Method has been adopted by a number of developing countries because it has a number of advantages, but they have also in practice experienced difficulties applying it. Its advantages are that since many commodities are traded on public exchanges, a quoted price can provide a clear and relatively objective point of reference. Hence, it can provide a basis for rules which are easy to administer and do not involve either subjective judgment or detailed examination of facts and circumstances.

However, this does not mean, as the report suggests, that such a quoted price can be used as a ‘comparable uncontrolled price’ (CUP) to adjust the terms of transactions within a multinational corporate group. Independent parties trading commodities settle their agreements in open markets and generally based on future prices, which is quite different from transactions between related parties within large corporate groups. These are generally vertically-integrated, so that the commodity is transferred to the related party for processing and perhaps eventual use in manufacturing; or they are large diversified commodity traders and brokerages. Transfers within such large integrated corporate groups cannot be regarded as in any way equivalent to transactions between unrelated parties, and should not be regarded as the starting point.

The report points to some of the many factors to be taken into account in comparing a quoted price with the actual relationships between a commodity producer and the rest of the MNE group. In our view, these many differences mean that the aim should not be to conduct an exhaustive and detailed comparability analysis of all the contracts involved to arrive at the ‘correct’ price. This would undermine the main advantage of the Sixth Method, which is to provide a clear and objective standard, which is easy to administer.

We suggest that quoted prices should be used as a guide, taking into account the comparability factors mentioned in the report (and others), on the basis of which the tax authority should establish a benchmark price. Such a price should be one that results in an appropriate level of profit for the affiliate based on its activities in the country, and taking into account the value it creates for the MNE as a whole. This includes the benefits of providing a source of supply combined with the management of stocks and of ultimate delivery, and access to raw materials which is a type of location-specific advantage.