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 BMG has now submitted its Comments on the proposals under Action Point 12 of the OECD-G20 BEPS Project on Mandatory Disclosure Rules.
Legal requirements for disclosure in advance of schemes for tax avoidance are a useful instrument for tax enforcement. However, in most countries where they have been introduced they affect mainly small and medium enterprises and wealthy individuals, and do not cover most avoidance by large multinational enterprises (MNEs). This is because they target standard schemes which are widely marketed by promoters, whereas MNEs generally use arrangements tailored to their specific needs, even if based on standard techniques. For example, it seems that the tax clearances arranged by PwC in Luxembourg over a period of eight years for 343 MNEs were not notified under the UK’s DOTAS requirements.
This DD mainly discusses standard schemes, but also includes some relevant proposals to adapt disclosure requirements to international corporate tax avoidance, which we support, with some suggested modifications. In our view, however, more needs to be done in this respect. Hence, we recommend extension of notification requirements to providers not only promoters, and put forward some hallmarks based on common international tax avoidance structures. In addition, we suggest that further specific hallmarks should be identified as part of the work on the other specific BEPS Action Plan points, to ensure that mandatory disclosure schemes can play a part in helping tax administration monitor compliance during the implementation phase of the BEPS project.
Like all methods of improving compliance, mandatory disclosure must balance deterrence with cooperation. However, there should be safeguards against the pitfalls experienced by some forms of ‘cooperative compliance’, which have led to public concerns about ‘sweetheart deals’. An important safeguard is greater transparency, and we recommend that the proposals should include (i) provisions for access to information derived from notification by a wide range of other tax authorities, and (ii) standards for reporting to the public of information and data from disclosure arrangements, to facilitate independent evaluation of the effects of such schemes.