Submission to OECD on the Multilateral Instrument

The BMG submitted on 30 June 2016 these Comments on Action 15 on the proposed Multilateral Instrument which will amend existing tax treaties to implement changes agreed in the BEPS project.

Summary

The reports resulting from the project on Base Erosion and Profit Shifting (BEPS) include a number of proposals for changes in tax treaties, formulated as amendments to the OECD Model Convention and its Commentaries. The Multilateral Instrument (MLI) is intended to provide a method for quickly amending existing bilateral treaties. Hence, it must take the form of an actual self-standing treaty, and not a model. However, there are differences in the texts of the actual treaties to be amended, especially those involving developing countries, and based on the UN model. Hence, we suggest that the MLI should be accompanied by Country Schedules, bilaterally agreed, to ensure clarity as regards which treaties are amended and how. This would ensure that tax authorities, taxpayers and courts know which treaties have in fact been amended and their new language.

The core provisions of the MLI should be the basic provisions for preventing abuse of tax treaties and eliminating double non-taxation. Several variants have been proposed in BEPS Action 6, and it is essential that the MLI includes options which are suitable for developing countries. The revisions of the Permanent Establishment definition have been drafted in relation to the OECD Model, and a variant should be included which is compatible with the UN model, in consultation with the UN Committee.

The proposals for strengthening the Mutual Agreement Procedure (MAP) for resolving tax treaty disputes are unsuitable for developing countries, and should remain purely voluntary. This applies in particular to Mandatory Binding Arbitration, which we regard as illegitimate for all countries. Tax treaty provisions are binding in domestic law, and can be enforced through national tribunals. Accordingly, MNEs should not be given further privileges over other taxpayers. The MAP is an ‘amicable procedure’, and it is not appropriate to try to convert it into a supranational dispute settlement procedure. It is contrary to the due process of law, and indeed in many countries regarded as unconstitutional, for contentious interpretations of legal provisions to be made by secret and unaccountable administrative procedures, rather than by courts or tribunals in an open legal process. To make it mandatory for all conflicting interpretations to be resolved would provide a guarantee that aggressive tax planning would be riskless, and create an incentive to continue BEPS behavior. The main cause of the increase in tax disputes is the subjective basis of the transfer pricing rules, and it is inappropriate to expect the MAP to resolve issues which negotiators have failed to deal with in a principled manner.

 

Treaty Entitlement of Non-Collective Investment Vehicle Funds

The BMG has now made a submission to the consultation on Non-CIV Funds, under BEPS Action 6 on preventing the granting of treaty benefits in inappropriate circumstances. Although presented in technical terms the proposals raise wider policy issues, since they could result in granting tax treaty benefits to hedge funds and private equity funds even if formed in tax havens.

Summary

This consultation document concerns proposals put forward by interested parties and not the Committee on Fiscal Affairs, which is now asking for comments. We regret that the document did not explain the policy issues, to facilitate a wider public engagement. This is especially important since the proposals concern the BEPS Action 6 measures to prevent treaty abuse, which are a core commitment for the expanding group of countries participating in the BEPS process, and may become a global standard through tax treaties.

Non-CIVs typically include private equity funds, hedge funds, trusts or other investment vehicles that generally do not have the key characteristics of CIVs. In particular, they are usually both unregulated and narrowly held, since they are aimed at sophisticated investors. Governments are therefore right to be concerned that these non-CIVs could be used to allow access to treaty benefits, in particular reduced withholding taxes at source, for investors who would not otherwise be entitled to such benefits, and who may be able to evade being taxed on such income.

We believe that any rules created to deal with these non-CIVs should require a positive demonstration by any non-CIV desiring treaty benefits that it can verify the bona fides of all its investors. To ensure taxation of income flowing through a fund which itself is exempt from tax, measures should be in place to ensure that its investors comply with their obligations to pay tax on payments to them from the fund. Hence, we consider that, to be eligible for treaty benefits, investment funds must be subject to

  • Regulation which includes know-your-customer requirements, and
  • Obligations to participate in comprehensive, automatic exchange of information for tax purposes.

Where, a fund is not itself able to verify the identity of all its customers because it receives investments from other funds, it must verify that its investors are subject to the same obligations. This would provide an incentive to ensure that jurisdictions hosting financial centres comply with the appropriate global standards, not only for financial regulation, but more importantly in this context for preventing tax evasion.

In addition, it is critical that high threshold tests be set to ensure that eligible funds are in fact widely held and are genuinely channels for portfolio investment. In particular:

  • No one investor or group of related investors should own above 1% of the fund,
  • The fund should have a maximum of 10% of its assets in any one investment,
  • It should not own more than 5% of any such investment, and
  • A minimum of 95% of funds investing in such a fund should be entitled to the same or similar treaty benefits.

Submission on US Draft Regulations on Country by Country Reporting

The BMG has now made a submission to the US Treasury on its draft Regulations for Country by Country Reporting.

Overall, we applaud this implementation of Country-by-Country Reporting (CbCR) in accordance with the recommendations of the 5 October 2015 Final Report on Action 13 of the G20/OECD project on Base Erosion and Profit Shifting (BEPS). The proposed regulation as drafted will be an important contribution to the ability of the IRS to enforce U.S. tax laws. Recent estimates by Kimberly Clausing suggest that profit shifting likely cost the U.S. government between $77 and $111 billion in corporate tax revenue in 2012, and that these revenue losses have increased substantially in recent years.

A strong and effective CbCR program will provide the IRS with an important tool to identify situations not only involving potential transfer pricing issues, but also potential application of judicial concepts and other laws, such as determining whether income is effectively connected with a trade or business being conducted in the U.S. Often, the real business of some low- or zero-taxed foreign group members is being conducted by group members located within the U.S. Where this is found, the IRS can potentially choose to impose tax through re-characterization under judicial concepts, through transfer pricing adjustments, or through application of the effectively connected income rules. Often, where the facts support it, applying the effectively connected income rules will provide a more statutory basis to assess tax, which will be assessed at higher effective tax rates due to the §884 branch profits tax and the potential loss of deductions and credits under §882(c)(2) where a foreign group member has previously filed no U.S. tax return.

We wish to add as well that effective CbCR will better allow the IRS to target their examinations on both domestic MNEs and foreign-based MNEs. Importantly, foreign-based MNEs include inverted MNEs and foreign MNEs that have acquired U.S.-run multinational businesses. Especially for these purposes, it is of extreme importance that the IRS fully and actively participates in the automatic exchange of CbCRs among treaty partners as contemplated by BEPS Action 13.

The U.S. is the most important single country whose actions will help define the BEPS process and its degree of future success. The resolute actions of the Treasury and the IRS, both in timely publishing effective regulations and in implementing sharing through information exchange mechanisms, will provide a meaningful leadership position that sets an example for the rest of the world.

 

 

Submission to UK Treasury Consultation on Deduction of Interest Expense

The BEPS Monitoring Group has made a submission to the UK Treasury in its consultation on limiting the deductibility of interest expense.

Summary

An effective scheme for limitation of interest deductions could be a major step in stemming BEPS behaviour by multinational enterprises (MNEs). A common technique for such global corporate groups to reduce tax liability in countries, including the UK, is the use of intra-group structured financing arrangements to attribute excess debt to operating affiliates and hence shift earnings out of countries where they have real activities while reporting profits for their cash-box affiliates in jurisdictions where they are lightly taxed.

An effective solution would be to 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). This would treat MNEs in line with the business reality that they are integrated and centrally-directed corporate groups, and help ensure that they are taxed fairly in each country. MNEs, like other companies, should be allowed to deduct their actual interest expense to third parties, no more and no less.

Such a group ratio rule (GRR) was proposed by the BEPS project, which we supported. However, the final report weakened the proposal by recommending the use of a fixed cap in conjunction with an optional GRR, allowing countries to fix their cap in a ‘corridor’ between 10% and 30% of EBITDA. In our view, if the system is to be effective it is essential to fix the cap at the lowest limit of 10%. Evidence put forward by business groups themselves shows that there are wide variations in the debt ratio between economic sectors and even different firms, so relying on a fixed cap is inappropriate. Since 80% had a group ratio below 30% and a majority was even below 10%, it is clear that fixing the cap higher than 10% would allow continued earnings stripping and tax avoidance by MNEs.

 

Submission to the European Commission on the CCCTB

The BEPS Monitoring Group has made a submission to the European Commission in its public consultation on the Common Consolidated Corporate Tax Base. It also relates to the proposal for a common EU directive implementing the proposals from the BEPS project, which the Commission is expected to publish at the end of January 2016.

The BEPS project: End of the first phase

The publication today of the final reports of the G20/OECD project on Base Erosion and Profit Shifting (BEPS) marks an important milestone on the road to reform of the international system for taxation of multinational enterprises (MNEs). Nevertheless, much remains to be done to construct an international tax system fit for the 21st century.

The OECD announced that cooperation will continue for a further five years to 2020, through ‘a framework … to better involve other interested countries and jurisdictions’. This will include both coordination and monitoring of the implementation of the proposals, and continued work on uncompleted topics. A key unresolved issue is the development of principles for allocation of profits, including the profit split method for transfer pricing.

Further, the report on digitalisation of the economy agrees that this phenomenon has greatly exacerbated the weaknesses of a system designed nearly a century ago. This entails going beyond the BEPS project, to re-examine the basic concepts of residence and source, and principles to determine where profit should be considered to be earned. It identifies some far-reaching options to be considered, including a new test of significant economic presence, and consideration of formulary apportionment. This work is also expected to take five years.

Our General Evaluation shows in detail that the BEPS outputs mainly aim at patching up the existing system, making the rules even more complex and in many cases contradictory. They will provide considerable strengthening of the existing rules, giving better tools to tax authorities, but only if they have the capacity and will to use them. The subjective and discretionary nature of many of the principles will make them hard to administer especially for smaller countries, and increase the likelihood of conflicts. They do little to stop the competition between states to offer corporate tax breaks to attract multinationals, involving beggar-thy-neighbour policies which damage all.

The urgency in the BEPS project to make rapid repairs to a rickety system led those involved to neglect the need to begin by diagnosing the causes of its failures. However, some proposals begin to lay the foundation for a new approach, which in our view is essential, enabling the MNE to be considered as a single firm and ensuring that profits are allocated according to economic activity in each country. We hope that the next phase will provide the opportunity to tackle this key issue.

Notes to Editors

The BMG is a network of researchers on various aspects of international tax, supported by a number of civil society organizations which research and campaign for tax justice, under the umbrella of the Global Alliance for Tax Justice. We are the only independent commentators to have produced detailed comments on each and every report and discussion draft produced for the BEPS project, available at BEPS Monitoring Group. Neither those detailed comments nor this General Evaluation have been been approved in advance by our supporting organizations, which do not necessarily accept every detail or specific point made here, but they support the work of the BMG and endorse its general perspectives.

Media contact: Sol Picciotto, Coordinator, BEPS Monitoring Group
s.picciotto@lancs.ac.uk ; +44-771-362-5555.