The BMG participated in the plenary meeting of the Inclusive Framework on BEPS, held in The Netherlands on Thursday 22 June.
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.
We applaud the continued interest of the OECD and Working Party 6 in its work to make the profit-split approach a more viable and important tool in intercompany pricing.
In this submission we propose the development and use of defined allocation keys and weights to apply the profit-split method to actual profits of common business models (see Appendix). In our comments to the specific questions we point out that the examples in the discussion draft assume, without explicitly saying it, that the various business units of a multinational enterprise (MNE) are normally independently managed, albeit with common ownership and some top-level management over policy and direction. In contrast to this assumption, we believe that most MNEs operate as centrally-managed unitary businesses performing core functions and using intangible property in multiple countries. We therefore suggest that it is appropriate to apply the profit-split method to actual profits in these cases. Nevertheless, if Working Party 6 takes a different view, due to their belief that some level of integrated risk sharing is required for application to actual profits, the profit-split method with defined allocation keys and weights could be applied to anticipated gross profits or other measure appropriate for the specific business model. Whether our recommended approach or this alternative is chosen and inserted into the Guidelines, it would greatly simplify things for taxpayers and tax authorities alike.
A presentation was made on behalf of the BEPS Monitoring Group by Professor Kerrie Sadiq, to the first meeting of the Enlarged Framework of the OECD Committee on Fiscal Affairs, in Kyoto (Japan) on 29 June 2016. The outline of this presentation is here.
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.
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
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:
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.
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.