We have made a submission to the an All-Party Parliamentary Group in the UK, chaired by Margaret Hodge M.P., former chair of the Public Accounts Committee.
It deals with some of the immediate issues of implementation in the UK, and the longer-term issues which were not resolved in the BEPS project.
The BEPS Monitoring Group has made a submission to the UK Treasury in its consultation on limiting the deductibility of interest expense.
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.
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 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.
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.
We have now published our General Evaluation of the final outputs of the BEPS Project. It is based on the detailed comments which we have produced on each and every report and discussion draft produced for the BEPS project, available on this site. This overall evaluation will be supplemented by a more detailed Handbook analyzing and commenting on all the proposals.
The G20 mandate for the BEPS project was that international tax rules should be reformed to ensure that multinational enterprises (MNEs) could be taxed ‘where economic activities take place and value is created’. This implied a new approach, to treat the corporate group of a MNE as a single firm, and ensure that its tax base is attributed according to its real activities in each country. Unfortunately, the BEPS project has continued to emphasise the independent entity principle, which starts from the fictitious assumption that affiliates of a corporate group act like separate legal persons, while attempting to counteract its harmful consequences. The BEPS outputs will provide considerable strengthening of the existing rules, giving better tools to tax authorities if they have the capacity and will to use them. Overall, however, the proposals offer a patch-up of existing rules, making them even more complex and in many cases contradictory, and do not provide a coherent and comprehensive set of reforms. Nevertheless, this is an important first step on a longer road.
Some of the proposals do mark a significant step forward, enabling the MNE to be considered as a single firm and to ensure that profits relate to economic activity in each country. The proposed template for country by country reports is a major advance, although the arrangements for access by all relevant tax authorities create unnecessary obstacles: publication would be a far easier and better solution. Proposals were also made for limiting deductions of interest by apportioning the consolidated group costs of interest payable to third parties, but these were watered down to recommendations prioritising a fixed cap. Similarly, ensuring taxation of a group’s worldwide profits could have been achieved by stronger rules on controlled foreign corporations, but the final report contains only weak recommendations, which will continue to encourage competition between countries to reduce corporate taxes, and to motivate MNEs to shift profits. The proposals on harmful tax practices may slow but will not halt tax competition, since they continue the approach dating back to 1998, based on voluntary rules and secretive self-policing, which has had very limited effects. Already it can be seen that the attempt to apply the broad principles of ‘nexus’ and ‘substance’ to innovation boxes is leading only to a complicated system attempting to restrict some aspects, while legitimising the concept. Instead of eliminating such schemes, this is already leading to the opposite: their increased adoption by many states and a consequent decline in corporate taxation.
The aim of tax treaties has too long been regarded as only the prevention of double taxation, disregarding the equally important purpose of ensuring appropriate taxation, which we proposed should be an explicit provision in all treaties. Instead, inclusion of an anti-abuse rule is proposed, which should at least include a standard principal purpose test. To be effective, this will need systematic information exchange to verify the tax status of recipients, as will the proposals for dealing with treaty abuses by using hybrid entities or instruments through complex rules for denying deductions. Abuse of the separate entity principle by fragmenting functions will be only partially dealt with by the proposal to deem that an entity has a permanent establishment (taxable presence) if activities can be said to be ‘preparatory or auxiliary’ to sales. This very limited approach allows firms to continue to fragment non-sales-related functions and attribute higher profits to countries where they will be lightly taxed.
The continued reliance on the separate entity fiction has also led to increased complexity of rules on transfer pricing, to allow tax authorities to recharacterise transactions between related parties, but only following a detailed and ad hoc ‘facts and circumstances’ analysis and searches for ‘comparables’. This subjective and discretionary approach will increase enforcement and compliance costs and generate conflicts. Recognising this, and responding to business concerns, it is proposed to strengthen dispute resolution procedures, including an increased use of arbitration. However, it is inappropriate and illegitimate to seek to remedy the failure to agree clear rules by providing procedures conducted in complete secrecy to deal with the inevitable disagreements in their application.
These outcomes are clearly only a start. Implementation by states will take time and should be monitored, and key issues remain to be dealt with. The main shortcoming is the failure to develop clear rules for the attribution of profit. Further work is planned on the profit split method, which could provide a way forward. The report on digitalization of the economy recognizes that it raises key issues going beyond the BEPS project, including the basic concepts of residence and source, and where profit should be considered to be earned. Although the BEPS project itself can only be said to have been at best a partial success, it has succeeded in opening space for more far-reaching changes. It should be seen as part of a longer process, involving a wider range of organisations and countries, especially developing countries. This should aim at finally reforming international tax rules to ensure fairness for all, and make them fit for the 21st century.
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.
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.
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.
The BMG has now published its comments on the Revised Discussion Draft under Action 6, Prevent Treaty Abuse.
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.
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.
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.
The BMG has submitted its comments on the proposals under the BEPS Project Action 8 for Revisions to Chapter VIII of the Transfer Pricing Guidelines on Cost Contribution Arrangements.
This report consists of a draft revised chapter of the OECD Transfer Pricing Guidelines, with no indication of the changes made, or explanation of the reasons or intended effects, which makes the issues effectively inaccessible to all except the insider community of practitioners. This along with several other reports will result in extensive revisions and additions to the Guidelines, but it will be a piece-meal patch-up, incoherent and in some respects contradictory. The revised text could be adopted and have effect around the world, even in countries outside the OECD and G20, without the need for adoption by states. We therefore recommend that it should be regarded as only provisional, and a more fundamental reconsideration should be begun, in conjunction with the UN Tax Committee.
There can be good reasons for MNEs to share within the group the costs of activities which benefit various parts. However, such collaborative arrangements within MNEs are generally coordinated administratively, and are very different from contractual arrangements negotiated between genuinely independent enterprises each with its own separate business. Based on the mistaken starting point that CCAs between related parties should be treated as if they had been negotiated by independent ones, the proposals in this draft are contradictory and imprecise, difficult to administer, and in their present form would be ineffective in preventing MNEs from using CCAs for BEPS purposes. The suggestion that contributions should be priced according to the value of the benefits and not normally on their costs will again lead tax authorities into the quagmire of searching for non-existent comparables or estimating hypothetical values. On the other hand, it accepts that costs should usually be shared by applying an appropriate allocation key, and aims to prevent inappropriate outcomes by allowing subsequent adjustments to valuations and introducing the requirement that participants in a CCA must have the ‘capability and authority to control’ risks.
We support these proposals, as necessary measures to check CCAs from being used for profit-shifting, and indeed suggest that they should be strengthened. We nevertheless deplore the increased complexity which is needed to make the Guidelines effective, due to the adoption of a mistaken approach. In view of the many tax planning mechanisms available to MNEs for fragmenting activities and attributing functions to different entities, separating supposedly routine activities, such as contract manufacturing or distribution, from supposedly high-value functions such as design, financial services, or IP management, to allow MNEs also to plan allocation of joint costs without considering apportionment of profits is a continued encouragement to BEPS behaviour.
The BEPS Monitoring Group 