Tag Archives: tax evasion and avoidance

February 2018

The BMG has made a submission to the UK Treasury consultation on a Royalties Withholding Tax

SUMMARY

These proposed provisions are an extension of the Diverted Profits Tax introduced in 2015, and the royalty withholding tax of 2016. The need for such unilateral measures clearly shows the failure so far to reach a multilateral solution to ensure that multinational enterprises (MNEs) can be taxed ‘where economic activities occur and value is created’, which was the aim of the G20/OECD project on base erosion and profit shifting (BEPS). While we regret the need for such unilateral measures, we agree that they are necessary, provided they are properly designed to contribute to a possible multilateral solution, and do not further exacerbate international tax competition.

The present proposals are novel for the UK, in claiming to tax payments for intellectual property rights (IPRs) by treating them as as sourced in the UK if used in connection with sales made in the UK, even if neither the payor nor the receiver has a taxable presence in the UK. However, the target is multinational corporate groups, which the consultation document points out will in practice usually have such a taxable presence through related entities. Such multinationals take advantage of the independent entity principle in international tax, by attributing functions such as sales and ownership of IPRs to group entities outside a jurisdiction, although other functions such as sales support may be fulfilled by local related entities. This allows their often enormous sales in the UK to escape tax not only in the UK but also in the country where such sales revenue is attributed, due to the royalty deduction, if the payments flow to an entity notionally located in a low-tax jurisdiction.

Counteracting such strategies results in highly complex measures such as the present proposals. Our comments analyse the legal difficulties they present, and offer some suggestions for ameliorating possible negative and unforeseeable effects. It is especially important to ensure that there are no such effects on taxation by other jurisdictions, especially developing countries. The proposal should be explicitly formulated as an anti-avoidance measure, hopefully short-term, and accompanied by powers for HMRC to issue suitable guidance to prevent harmful impacts on other countries.

These measures clearly show that effective taxation of MNEs requires that they be treated in accordance with the economic reality that they operate as unitary firms under central direction. Both the UK government and MNEs and their tax advisers should accept that this means explicitly moving away from the independent entity principle, rather than covertly as in these proposals. The government should advocate and support multilateral measures in this direction, instead of needing to resort to unilateral measures such as this, which make the system increasingly complex, uncertain and hard to administer.

Offshore Indirect Transfers of Assets

October 2017

The BMG has now submitted its comments on the discussion draft from the Platform for Collaboration on Tax for a Toolkit on Taxation of Offshore Indirect Transfers of assets.

Summary

We welcome this discussion draft, which deals with an important issue of particular interest to developing countries, and was only partly dealt with in the G20/OECD project on base erosion and profit shifting (BEPS).

We agree with the argument it makes that principles of inter-nation equity clearly support the right of the country where an asset is located to tax the gains on its transfer, even if the seller and/or acquirer are not resident in that country. The country is of course free to decide whether and at what rate to tax such gains, taking account of the effects of such taxation on investment in the development of such assets. This right should therefore not be restricted by tax treaties, and we support the proposals in the BEPS project for inclusion in all treaties of a provision equivalent to article 13(4) of the model treaties. This can most effectively be done if all countries sign the Multilateral Convention on BEPS and adopt its article 9(4). This Toolkit should be amended to clearly and unambiguously urge all countries to do so.

In our view, the proposals should extend to indirect transfers of all kinds of assets, without limitation to immovable assets. This is in accordance with the global consensus that profits and gains should be taxed in the jurisdiction where the economic activities giving rise to them are located. The reference to article 13(5) of the UN model in the DD is therefore misleading, and should be amended, to provide countries that choose to tax a wider range of gains the necessary guidance to address movable assets such as shares.

We make a number of other comments which we hope would help improve the DD.

Comments on Draft Additional Guidance on Attribution of Profits to a Permanent Establishment

14 September 2017

The BMG has made a submission on Attribution of Profits to a Permanent Establishment in response to the OECD Discussion Draft.

Summary

A major motivator in initiating the entire BEPS project was to end BEPS motivated planning by centrally managed groups. Such planning often attributes sales to zero or low-taxed entities and separates sales through fragmentation from related core functions such as marketing, order fulfilment, and customer support performed by other group entities. Under Action 7 of the BEPS project some modest changes were agreed, so that in defined circumstances a non-resident entity could now be found to have a taxable presence (permanent establishment – PE) in a country in which it makes sales. The current proposals aim to clarify how profits should be attributed to such a PE.

We agree that attribution of profits depends on an analysis of the functions performed by the PE, but in our view this must not be done in isolation. A holistic approach should be adopted, which considers all the activities carried out in the country by the relevant entities in conjunction. Where a multinational chooses to carry out itself activities such as marketing, sales, order fulfilment, and customer support, it does so in order to take advantage of the synergies so created, thereby giving the customer a seamless experience and itself (i.e., the group) a significant market advantage. Hence, it is the cumulative importance of all group activities that should be considered when evaluating the value which is created in the country.

Due to this cumulative importance, our view is still that article 7 should be applied prior to article 9, since this would result in both better focus by taxpayers and tax authorities, and a practical reduction in the resources needed by both tax authorities and taxpayers for compliance.

A holistic approach will also lead in some circumstances to a different transfer pricing method being the most appropriate method. In particular, where such related functions are performed by highly integrated associated entities and are viewed holistically, the profit-split method is likely to prove more appropriate than one-sided methods.

A holistic approach is also important since the DD is meant to apply to all versions of article 7 of the model convention, and whether or not a state has accepted the changes adopted by a majority of OECD states in 2010, described as the authorized OECD approach (AOA). While the AOA has some merits, it has been used to further exacerbate a fragmented approach to the attribution of profits, which (along with the independent entity principle in general) has been a principal enabler of BEPS. Adoption of the holistic approach which we suggest could, we believe, allow some of those helpful features of the AOA to be retained, while ensuring that BEPS structures are not allowed to continue due to a narrow interpretation applying the independent entity principle to an entity which is not even legally separate.

Our Specific Comments section includes a number of concrete suggestions to make the DD more internally consistent and effective in its application.

Comments on the Draft Revised Guidance on Profit Splits

14 September 2017

The BMG has made a submission on the Draft Revised Guidance on Profit Splits.

This discussion draft (DD) offers a rewrite of Section C in Part III of Chapter II of the Transfer Pricing Guidelines. Such a rewrite is overdue, as there has not been a comprehensive re-examination of the profit-split method (PSM) since it was included in the Guidelines in 1995.

This DD is written in a much clearer way than the existing section and we welcome the effort that has been made. However, we regret that the opportunity has not been taken to develop and extend the PSM to make it easier to use. In our view this would be the most effective way forward to achieving the central mandate of the BEPS project, to ensure that multinationals are taxed ‘where economic activities occur and value is created’.

In these comments we provide a specific approach that would allow easy use for tax authorities and taxpayers alike. The principal reason for this is that solely objective factors (e.g. personnel, assets, etc.) are used to apportion profits. This approach would ignore internal group-controlled and tax-motivated arrangements such as intercompany contractual terms. It would also dispense with the need for subjective value judgments, greatly reducing the potential for conflict and uncertainty.

Presentation to the Inclusive Framework on BEPS

The BMG participated in the plenary meeting of the Inclusive Framework on BEPS, held in The Netherlands on Thursday 22 June.

Francis Weyzig representing the Group made a presentation, based on a short document, circulated in advance to participants in both English and French.

 

Hard-to-Value Intangibles

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 European Commission’s Proposals for a Common and Consolidated Corporate Tax Base

The BMG has now published its comments on the CCCTB  – the European Commission’s proposals for Common Corporate Tax Base, and for a Common Consolidated Corporate Tax Base.

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

UK Implementation of the Multilateral Convention on BEPS

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.

Summary

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.

Attribution of Profits to Permanent Establishments

The BMG has made a Submission to the OECD on its consultation on revisions to the guidance on Attribution of Profits to Permanent Establishments.

Summary

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.

Presentation to the Enlarged Framework on BEPS of the OECD Committee on Fiscal Affairs

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.