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.
The CCCTB adopts a sound approach to taxation of multinationals (MNEs), by treating them in accordance with their business reality as unitary firms. It aims to identify the tax base of the whole corporate group, disregarding internal transactions between the affiliates, and to apportion the taxable profit according to factors reflecting the firm’s real activity (sales, assets, employees) in each country. In our view, this is the most effective way to end both competition between states to offer tax incentives, and tax avoidance by MNEs shifting income between affiliates to minimise tax.
In our view, however, the aim should be to create a level playing field in relation to tax on corporate profits not only within the EU but worldwide. Unless this is done, EU member states will continue to compete with each other to offer tax preferences to MNEs from outside the EU. They will also continue to be vulnerable to tax competition from jurisdictions not covered by the CCCTB (including the UK, after Brexit). The CCCTB can and should be recast so that it attributes to the EU as a whole a portion of the worldwide profits of MNEs reflecting their actual activities within the EU, as well as allocating that profit among EU states, using the same criteria.
We also propose a ‘compensation mechanism’, in case another country (e.g. the US) adopts the alternative which has been proposed for a destination-based cash-flow tax with a ‘border adjustment’.
We also warn against the 2-stage approach proposed by the Commission, and criticise the proposed ‘super-deduction’ for R&D expenditures, and the so-called Allowance for Growth and Investment. As some business groups have also argued, it is better to define the tax base broadly, allowing scope for cuts in the rate (which are already taking place), than to build in selective and distorting special allowances.
16 May 2017
The BMG made a submission to the UK government in February 2017 on the UK’s implementation of the Multilateral Convention to Implement the Treaty-Related Provisions of the BEPS project.
This multilateral instrument (MLI) aims to enable rapid implementation of the tax-treaty related proposals resulting from the G20/OECD project on base erosion and profit shifting (BEPS), by amending the bilateral tax treaties of participating jurisdictions. Although we have advocated a more coherent and comprehensive approach to the problem, we support the overarching aim of the provisions in the MLI to reduce the exploitation of gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate taxation being paid. The MLI provides the easiest method of ensuring that this occurs quickly and coherently. If countries cherry-pick among the provisions of the MLI, its effectiveness would be greatly reduced, and instead of moving towards a simpler and more uniform structure of anti-abuse provisions in tax treaties, the MLI would add a new layer of complexity and potential confusion.
We would expect the UK, having been in the forefront in initiating the BEPS project and having played a major part in formulation of the proposals, to be in the lead in implementation of the outcomes. We are therefore surprised and concerned that it is proposed that the UK should adopt a selective approach to implementation. The intention apparently is to rely on general anti-abuse principles and unilateral measures, notably the Diverted Profits Tax, instead of implementing the more targeted provisions which have been agreed in the BEPS project and incorporated in the MLI.
We are especially concerned at the proposal not to adopt the provisions aiming at abuse of the taxable presence criteria provided by the permanent establishment (PE) concept. This seems based on a policy to reject attributing significant taxable profits if a MNE has an entity within the jurisdiction significantly involved in sales, even when it also has other affiliates engaged in related activities which constitute complementary functions that are part of a cohesive business operation. The approach proposed by Treasury and HMRC seems out of line with public opinion on how tax should be aligned with real economic activity, as expressed quite forcefully in several reports of the Public Accounts Committee. Treasury and HMRC policy seems to be that this should be dealt with by the diverted profits tax, which is both a unilateral and a blunt weapon. The UK rejection of the changes to the PE definition would deny them to its treaty partners, apparently aiming to offer an attractive country of residence for MNEs to carry on business outside the UK, by minimising taxation of their foreign income. However, other countries might also seek to defend their tax base with their own unilateral measures. Hence, the UK would effectively be engaging in tax competition, a beggar-thy-neighbour approach, which runs counter to the aims of the BEPS project and, we believe, to the long-term interests of the UK.
Such a partial adoption of MLI provisions, and reliance on unilateral measures and broad anti-abuse principles, would inevitably generate a higher number of conflicts. Indeed, this seems to be anticipated, by the inclusion in the MLI of a special chapter providing for mandatory binding arbitration. In our view this is putting the cart before the horse. Priority should be given to preventing disputes, by agreeing clear rules for allocation of profit which are easy to administer. We oppose the proposal that the UK should adopt mandatory binding arbitration, since this involves giving up UK sovereignty, which should be unacceptable in the key area of direct taxation.
For these reasons we have major concerns about the approach towards the MLI outlined so far by the UK Treasury and HMRC, which we explain further below, and hope that it can be reconsidered.
This discussion draft (DD) deals with attribution of profits to a host country resulting from changes to the taxable presence requirement in the definition of a permanent establishment (PE) in BEPS project’s Action 7. Although generally clear and well reasoned, it is of limited usefulness in our view, for two main reasons. These comments explain these shortcomings and suggest how they could be corrected.
First, it applies only to the 2010 version of the OECD model convention, which introduced the ‘authorised OECD approach’ (the AOA) for attribution of profits to a PE. The AOA attempts to extend to PEs as far as possible the independent entity principle as applied to associated enterprises within a multinational enterprise (MNE). A number of OECD countries have not accepted the AOA, and it has also been generally rejected by developing countries. One reason for this is that the independent entity principle is especially inappropriate for a PE, which by definition is part of the same legal entity. Hence, few actual treaties are based on the AOA, and this is also true for most national tax law rules which would apply to entities resident in non-treaty countries. States, especially developing countries (whether or not they decide to join the Inclusive Framework for BEPS), should not be pressurised into adopting the AOA. Instead, the UN Committee of Tax Experts, in liaison with the OECD, should develop its own revisions to the commentary to the UN treaty model consequent on the changes to the PE definition introduced by Action 7. Further work is clearly necessary, by a wider range of countries, and adopting a broader approach, to produce guidance that would be of use to tax payers and tax authorities, especially in the bulk of cases where the AOA is not applicable.
Secondly, the examples provided in the DD adopt a very restricted approach, which assumes that all or most significant people functions take place in the non-resident entity, and hence attribute only limited profits to the PE. They include some illustrations of when aspects of inventory and credit risk management may take place in a PE, but significantly the examples include no discussion of other sales-related functions such as marketing and advertising, which are instead assumed to be controlled by the non-resident entity, with no relevant local input. Similarly, the examples are silent regarding core business functions conducted in host countries that are often found in modern MNE business models. These simple examples may be relevant to relatively small firms based almost entirely in their home countries, which employ a foreign sales agent. But they are entirely unrealistic in relation to most large MNEs and their modern business models, which aim to be both global and local. No MNE can operate effectively by centralising virtually all its significant people functions and all its core business functions at a distance from its customers and suppliers, as is assumed in the examples provided here. Indeed, there are many well known examples of MNEs which employ significant staff in host countries engaged in both customer-facing and many core business functions. The failure of this DD to discuss such situations suggests a lack of consensus on how to deal with them, which may regrettably exacerbate the likelihood of conflicts even between OECD countries.
As the DD is now drafted with its focus on the AOA and its unrealistically simple examples, its effect is to strengthen the BEPS mechanisms used by many MNEs. This contradicts the mandate for the BEPS project, which is to align taxation and value creation.
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: