Monthly Archives: June 2015

Comments on BEPS Action 8: Hard-to-Value Intangibles

The BMG has now published its comments on the Discussion Draft under Action 8, which proposes revised text for the OECD Transfer Pricing Guidelines on Hard to Value Intangibles.

Summary

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. This discussion draft (DD) proposes that, in specific circumstances, the price of the asset transfer can be adjusted subsequently by tax authorities, taking into account the income actually generated. However, the DD specifies a number of conditions which must apply for this approach to be adopted.

Although desirable, in our view the proposals do not go far enough in two respects. First, the mechanism adopted should itself discourage transfers taking advantage of ex ante pricing, which is where most BEPS concerns and risk arise. Second, the DD must aim to reduce the endemic and serious problem of information asymmetry between a tax authority and a company. This is rooted in the requirement under the arm’s length principle to evaluate internal transfers within a firm, since the tax authority can never know a firm’s business better than the firm does.

Hence, we suggest instead a reversal of the burden of proof, with a presumption that any intra-firm transfer of HTVIs should be subject to pricing based on subsequent consideration of the actual income produced, unless the taxpayer can show that specified criteria were satisfied. We also propose two additional criteria for such a showing: proof that the transfer did not result in a significantly lower effective tax rate, and a ‘purpose test’ requiring satisfactory evidence of the legal and commercial reasons for the transfer. This reversal of the burden of proof will create a much stronger incentive for firms to cease tax-motivated transfers of intangibles. In addition, to provide more certainty, we suggest an APA-like ruling process.

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Joint Statement to the G20

The BMG, together with the Global Alliance for Tax Justice, has prepared a statement of Key Points on Tax Issues, summarising our views on the BEPS Action Plan proposals to date. This is being presented by the C20 Steering Group to the G20 Sherpas on 16-17 June 2015. It has also been sent to Pascal de St Amans, Head of the OECD Centre for Tax Policy and Administration, who has forwarded it to the Chair of the Committee on Fiscal Affairs, which is responsible for the BEPS Project.

Comments on BEPS Action 6: Prevent Treaty Abuse

The BMG has now published its comments on the Revised Discussion Draft under Action 6, Prevent Treaty Abuse.

Summary

A key test of whether the BEPS project can be a success is whether it will result in the inclusion of effective anti-abuse provisions in all tax treaties, not only prospectively, by formulating suitable provisions in the model treaty, but also more directly and quickly, by inclusion of such provisions in the proposed Multilateral Convention (MC), which aims to amend existing treaties.

The RDD proposes a ‘simplified’ limitation of benefits (LoB) provision, and as a minimum standard either (i) a combination of a principal purpose test (PPT) and an LoB provision, or (ii) a PPT provision alone, or (iii) an LoB rule plus some mechanism for dealing with conduit arrangements which are not already covered by other treaty provisions. However, the LoB provision is stated as only a bare outline with a direction to include whatever wording each pair of negotiating states can agree, while the full detailed wording of an LoB article is only in the Commentary, for use by states which prefer not to include a PPT provision.

This approach has exacerbated the concerns we expressed on the previous draft, that it would make it harder for small developing countries to conclude suitable treaties, and result in a kaleidoscope of different provisions, very likely leaving a continued scope for treaty shopping and increasing complexity for tax authorities as well as tax payers.

Furthermore, the RDD does not discuss how such provisions might be included in the MC, and the proposed ‘flexible’ format would make such inclusion difficult if not impossible.

Our comments also include a number of specific technical suggestions.

Comments on BEPS Action 7: Revised Discussion Draft on
Preventing Artificial Avoidance of Permanent Establishment Status

Under international tax rules, whether a foreign company can be taxed on profits earned from activities in a country depends on whether it has a Permanent Establishment (PE). Devised a century ago, this concept has become easy to avoid, and is clearly inappropriate for the post-industrial age. The BEPS Action Plan proposed only a relatively modest reconsideration of some aspects of the rules, although it should also be considered under Action 1 relating to the Digital Economy.

The BMG has now published its comments on the OECD Revised Discussion Draft, the latest and final proposals under this action point.

Summary of BMG Comments

We are concerned that this revised discussion draft (RDD) seems to have given too much weight to the quantity of comments received on the initial draft, failing to take into account that since the vast majority came from the same community of MNEs and their paid tax advisers, it is hardly surprising that they tend to agree. In particular the RDD picks out the comments which defended ‘the fundamental concept of the independence of legal entities’, without mentioning our submission pointing out that it flies in the face of business reality to claim that associated entities within a multinational corporate group operate as independent parties, a view which is supported by economic theory and practice, and by most independent commentators.

We welcome that nevertheless a majority of the Working Party agreed to the proposed anti-fragmentation rule, although it has been given very limited scope. Indeed, the Working Party has interpreted its mandate very narrowly, focusing essentially on commissionaire arrangements and sales-related activity, so that its proposals will only deal with a few types of corporate fragmentation, those related to delivery of goods to customers. The proposals on commissionaire arrangements leave unclear whether they will apply even to activities such as marketing, while failing to deal with many other types of functional fragmentation which facilitate BEPS.

The RDD does not deal at all with the reality of the modern world in which real value is created through scientific research and the development and testing of products and services, in continuous processes of innovation and improvement. This is not just a ‘digital economy’ issue. Spending on innovation is key to the success of many businesses today. This must be reflected in Article 5 with sufficient nuance that MNEs will not continue to undervalue for source countries the value that is truly created within their borders.

The report also does not deal with the key issue of attribution of profits, which has been deferred to be dealt with after the G20 deadline for the BEPS project, perhaps in conjunction with the continued work on the Digital Economy. The weakness of these proposals is confirmed by the introduction by some OECD countries (e.g. Australia, UK) of unilateral measures to tax ‘diverted profits’. Developing countries should also take measures to protect their tax base, e.g. through withholding taxes on fees for services, but these are blunt instruments (applying to gross payments rather than profits). An internationally coordinated approach would clearly be far better both for business and revenue authorities.

The BEPS project is in our view seriously weakened by this failure to reconsider the permanent establishment concept to provide a definition of taxable presence more suited to the 21st century.