Tax Alert: OECD/G20 releases final BEPS reportOct 08, 2015
The OECD recently released (5 October 2015) the final package of measures, a 15-point set of Action Items, for a co-ordinated global approach to reform the international tax system under the OECD/G20 Base Erosion and Profit Shifting (BEPS) project.
More than securing revenues by realigning taxation with economic activities and value creation, the BEPS project aims to create a single set of consensus-based international tax rules to protect tax bases while offering increased certainty or predictability to taxpayers, and to eliminate double non-taxation. In the succeeding paragraphs, you will find an abstract of the 15-point Action Items that have been released recently as well as links to the full OECD reports.
In relation to several BEPS discussion drafts that were released in 2014 and 2015, various countries have already complied with the BEPS action items and drafted or implemented related legislation. We expect that in reaction to the publication of the final reports, more countries will introduce unilateral measures to combat base erosion and profit shifting.
Overview of the final BEPS report
Action 1: Addressing the challenges of the Digital Economy
This report sets out an analysis of the tax challenges related to the digital economy. It notes that because the digital economy is increasingly becoming the economy itself, it would not be feasible to ring-fence the digital economy from the rest of the economy for tax purposes. The report notes, however, that certain business models and key features of the digital economy may exacerbate BEPS risks, and shows the expected impact of measures developed across the BEPS Project on these risks.
The full report can be found on the OECD's website: Action 1.
Action 2: Neutralising the Effects of Hybrid Mismatch Arrangements
This report sets out recommendations for domestic rules to neutralise the effect of hybrid mismatch arrangements and includes changes to the OECD Model Tax Convention to address such arrangements. Once translated into domestic law, the recommendations in Part 1 of the report will neutralise the effect of cross-border hybrid mismatch arrangements that produce multiple deductions for a single expense or a deduction in one jurisdiction with no corresponding taxation in the other jurisdiction.
Part 1 of the report sets out recommendations for rules to address hybrid mismatches in respect of payments made under a hybrid financial instrument or payments made to or by a hybrid entity. It also recommends rules to address indirect mismatches that arise when the effects of a hybrid mismatch arrangement are imported into a third jurisdiction. The recommendations are supported by a commentary and examples to illustrate how they should apply.
Part 2 of the report sets out proposed changes to the Model Convention that aim to ensure that the benefits of tax treaties are only granted to hybrid entities (including dual resident entities) in appropriate cases. Part 2 also considers the interaction between the OECD Model Convention and the domestic law recommendations in Part 1.
The full report can be found on the OECD's website: Action 2.
Action 3: Designing Effective Controlled Foreign Company Rules
This report sets out recommendations in the form of building blocks for effective CFC rules. The recommendations are designed to ensure that jurisdictions that opted to implement them, have rules that effectively prevent taxpayers from shifting income into foreign subsidiaries. The final report sets out the following six building blocks for the design of effective CFC rules:
- definition of a CFC,
- CFC exemptions and threshold requirements,
- definition of income,
- computation of income,
- attribution of income, and
- prevention and elimination of double taxation.
The full report can be found on the website of the OECD: Action 3.
Action 4: Limiting Base Erosion Involving Interest Deductions and Other Financial Payments
The mobility and fungibility of money makes it possible for multinational groups to achieve favourable tax results by adjusting the amount of debt in a group entity. The approach recommended in the final report of action 4 ensures that an entity’s net interest deductions are directly linked to its level of economic activity, based on taxable earnings before deducting net interest expense, depreciation and amortisation (EBITDA). This approach includes three parts:
- a fixed ratio rule based on a benchmark net interest/EBITDA ratio;
- a group ratio rule which allows an entity to deduct more interest expense in certain circumstances based on the position of its worldwide group; and
- targeted rules to address specific risks.
A country may choose not to introduce the group ratio rule, but in this case it should apply the fixed ratio rule to multinational and domestic groups without improper discrimination.
The full report can be found on the OECD's website: Action 4.
Action 5: Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance
The action 5 report recognizes that preferential regimes continue to be a key pressure area. Current concerns are primarily about preferential regimes which can be used for artificial profit shifting and about a lack of transparency in connection with certain rulings. The final report sets out an agreed methodology to assess whether there is substantial activity.
In the context of intangible property (IP) regimes such as patent boxes, agreement was reached on the “nexus approach” which uses expenditures as a proxy for substantial activity and ensures that taxpayers can only benefit from IP regimes where they engage in research and development and incurred actual expenditures on such activities.
The same principle can also be applied to other preferential regimes so that such regimes are found to require substantial activity where the taxpayer undertook the core income generating activities.
In the area of transparency, a framework has been agreed for the compulsory spontaneous exchange of information on rulings that could give rise to BEPS concerns in the absence of such exchange.
The results of the application of the existing factors applied by the OECD Forum on Harmful Tax Practices, and the elaborated substantial activity and transparency factors to a number of preferential regimes, are included in the final report of action 5.
The full report can be found on the OECD's website: Action 5.
Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances
This report includes changes to the OECD Model Tax Convention to prevent treaty abuse. It first addresses treaty shopping through alternative provisions that form part of a minimum standard that all countries participating in the BEPS Project have agreed to implement. It also includes specific treaty rules to address other forms of treaty abuse and ensures that tax treaties do not inadvertently prevent the application of domestic anti-abuse rules.
The report includes changes to the OECD Model Tax Convention that highlights tax treaties as agreements not intended to create opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including treaty-shopping) and that it identifies the tax policy issues countries should consider before entering into a tax treaty with another country.
The full report can be found on the OECD's website: Action 6.
Action 7: Preventing the Artificial Avoidance of Permanent Establishment Status
This report includes changes to the definition of permanent establishment in the OECD Model Tax Convention that will address strategies used to avoid having a taxable presence in a country under tax treaties. These changes will ensure that where the activities that an intermediary exercises in a country are intended to result in the regular conclusion of contracts to be performed by a foreign enterprise, that enterprise will be considered to have a taxable presence in that country unless the intermediary is performing these activities via an independent business.
The changes will also restrict the application of a number of exceptions to the definition of permanent establishment to activities that are preparatory or auxiliary in nature and will ensure that it is not possible to take advantage of these exceptions by separating a cohesive operating business into several small operations. The changes also address situations where the exception applicable to construction sites is circumvented through splitting-up contracts between closely related enterprises.
The full report can be found on the OECD's website: Action 7.
Actions 8-10: Aligning Transfer Pricing Outcomes with Value Creation
This report contains revisions to the OECD Transfer Pricing Guidelines to align transfer pricing outcomes with value creation. The revised guidance focuses on the following key areas:
- transfer pricing issues relating to transactions involving intangibles;
- contractual arrangements, including the contractual allocation of risks and corresponding profits, which are not supported by the activities actually carried out;
- the level of return to funding provided by a capital-rich MNE group member, where that return does not correspond to the level of activity undertaken by the funding company; and
- other high-risk areas.
The report also sets out follow-up work to be carried out on the transactional profit split method which will lead to detailed guidance on the ways in which this method can appropriately be applied to further align transfer pricing outcomes with value creation.
The full report can be found on the OECD's website: Actions 8-10.
Action 11: Measuring and Monitoring BEPS
This report assesses currently available data on the impact of BEPS and concludes that significant limitations constrain economic analyses of the scale and economic impact of BEPS. Noting these data limitations, the report presents a dashboard of the following six BEPS indicators grouped into five categories.
A. Disconnect between financial and real economic activities
1. Concentration of high levels of foreign direct investment (FDI) relative to GDP
B. Profit rate differentials within top (e.g. top 250) global MNEs
2. Differential profit rates compared to effective tax rates
3. Differential profit rates between low-tax locations and worldwide MNE operations
C. MNE vs. “comparable” non-MNE effective tax rate differentials
4. Effective tax rates of large MNE affiliates relative to non-MNE entities with similar characteristics
D. Profit shifting through intangibles
5. Concentration of high levels of royalty receipts relative to research and development (R&D) spending
E. Profit shifting through interest
6. Interest expense to income ratios of MNE affiliates in high-tax locations
The report also presents a toolkit to assist countries to further evaluate the fiscal effects of BEPS countermeasures. The report concludes by making recommendations regarding data and monitoring tools to improve the analysis of BEPS in the future.
The full report can be found on the OECD's website: Action 11.
Action 12: Mandatory Disclosure Rules
According to the OECD, the lack of timely, comprehensive and relevant information on aggressive tax planning strategies is one of the main challenges faced by tax authorities worldwide. Mandatory disclosure regimes can enable countries to quickly respond to tax risks by providing early access to such information. The final report on action 12 includes an overview of mandatory disclosure regimes based on the experiences of countries that have such regimes and sets out recommendations for a modular framework for use by countries wishing to implement or amend mandatory disclosure rules in order to obtain early information on aggressive or abusive tax planning schemes and their users.
The recommendations aim to provide the necessary flexibility to balance a country’s need for better, timelier information with the compliance burdens for taxpayers. This report also sets out specific recommendations for rules targeting international tax schemes, as well as for developing and implementing more effective information exchange and co-operation between tax administrations.
The full report can be found on the OECD's website: Action 12.
Action 13: Transfer Pricing Documentation and Country-by-Country Reporting
This report contains revised standards for transfer pricing documentation incorporating a master file, local file, and a template for country-by-country reporting of revenues, profits, taxes paid and certain measures of economic activity. The revised standardised approach will require taxpayers to articulate consistent transfer pricing positions and will provide tax administrations with useful information to assess transfer pricing and other BEPS risks, make determinations about where audit resources can most effectively be deployed, and, in the event audits are called for, provide information to commence and target audit enquiries. Country-by-country reports will be disseminated through an automatic government-to-government exchange mechanism.
The implementation package is included in the final report and sets out guidance to ensure that the reports are provided in a timely manner, that confidentiality is preserved and that the information is used appropriately, by incorporating model legislation and model Competent Authority Agreements forming the basis for government-to-government exchanges of the reports.
The full report can be found on the OECD's website: Action 13.
Action 14: Making Dispute Resolution Mechanisms More Effective
This report recognises that, in spite of several attempts to make dispute resolution mechanisms work better, further progress remains to be achieved, especially at a time when the number of disputes has increased. The report proposes complementary solutions that will have a practical, measurable impact, rather than merely providing additional measures or guidance that may not be fully used or implemented.
The full report can be found on the OECD's website: Action 14.
Action 15: Developing a Multilateral Instrument to Modify Bilateral Tax Treaties
This report identifies the issues arising from the development of a multilateral instrument that modifies bilateral tax treaties. The OECD notes that without a mechanism for swift implementation, changes to model tax conventions only widen the gap between the content of these models and the content of actual tax treaties. Developing such a mechanism is necessary not only to tackle base erosion and profit shifting, but also to ensure the sustainability of the consensual framework to eliminate double taxation.
The full report can be found on the OECD's website: Action 15.
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 Source: OECD iLibrary.