Tag Archives: tax evasion and avoidance

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.

Treaty Entitlement of Non-Collective Investment Vehicle Funds

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.

Summary

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

  • Regulation which includes know-your-customer requirements, and
  • Obligations to participate in comprehensive, automatic exchange of information for tax purposes.

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:

  • No one investor or group of related investors should own above 1% of the fund,
  • The fund should have a maximum of 10% of its assets in any one investment,
  • It should not own more than 5% of any such investment, and
  • A minimum of 95% of funds investing in such a fund should be entitled to the same or similar treaty benefits.

Submission on US Draft Regulations on Country by Country Reporting

The BMG has now made a submission to the US Treasury on its draft Regulations for Country by Country Reporting.

Overall, we applaud this implementation of Country-by-Country Reporting (CbCR) in accordance with the recommendations of the 5 October 2015 Final Report on Action 13 of the G20/OECD project on Base Erosion and Profit Shifting (BEPS). The proposed regulation as drafted will be an important contribution to the ability of the IRS to enforce U.S. tax laws. Recent estimates by Kimberly Clausing suggest that profit shifting likely cost the U.S. government between $77 and $111 billion in corporate tax revenue in 2012, and that these revenue losses have increased substantially in recent years.

A strong and effective CbCR program will provide the IRS with an important tool to identify situations not only involving potential transfer pricing issues, but also potential application of judicial concepts and other laws, such as determining whether income is effectively connected with a trade or business being conducted in the U.S. Often, the real business of some low- or zero-taxed foreign group members is being conducted by group members located within the U.S. Where this is found, the IRS can potentially choose to impose tax through re-characterization under judicial concepts, through transfer pricing adjustments, or through application of the effectively connected income rules. Often, where the facts support it, applying the effectively connected income rules will provide a more statutory basis to assess tax, which will be assessed at higher effective tax rates due to the §884 branch profits tax and the potential loss of deductions and credits under §882(c)(2) where a foreign group member has previously filed no U.S. tax return.

We wish to add as well that effective CbCR will better allow the IRS to target their examinations on both domestic MNEs and foreign-based MNEs. Importantly, foreign-based MNEs include inverted MNEs and foreign MNEs that have acquired U.S.-run multinational businesses. Especially for these purposes, it is of extreme importance that the IRS fully and actively participates in the automatic exchange of CbCRs among treaty partners as contemplated by BEPS Action 13.

The U.S. is the most important single country whose actions will help define the BEPS process and its degree of future success. The resolute actions of the Treasury and the IRS, both in timely publishing effective regulations and in implementing sharing through information exchange mechanisms, will provide a meaningful leadership position that sets an example for the rest of the world.

 

 

Submission to UK Treasury Consultation on Deduction of Interest Expense

The BEPS Monitoring Group has made a submission to the UK Treasury in its consultation on limiting the deductibility of interest expense.

Summary

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.

 

Comments on BEPS Action 8: Hard-to-Value Intangibles

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.

Summary

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.