US tax form (illustrative).
(photo credit: INGIMAGE)
The Group of 20 summit in Hamburg last weekend wasn’t only about North Korea and Syria. The G-20 also reaffirmed their commitment to create a globally fair modern international tax system.
Background – BEPS
A report by the OECD to the G-20 leaders before the summit sheds light on which companies with international operations are more likely to receive a knock on the door or an inquisitive email from their tax office.
In recent years, governments around the world felt that international tax planning by multinational groups was going too far, and tax revenues not far enough.
In October 2015, the OECD duly published a series of recommendations against BEPS, which is short for base erosion and profit shifting – i.e. shifting profits offshore. Some 100 governments around the world started enacting or adopting these recommendations or at least some of them, including Israel.
On June 7, to speed up the process, more than 70 ministers and other high-level representatives participated in the signing ceremony of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting.
Here are some of the things that may arouse the attention of a tax official: BEPS inclusive framework
The OECD has declared four BEPS action reports to be of highest priority. They are referred to collectively as the inclusive framework because the OECD wants to rope in as many countries as possible – about 100 so far.
Action 5 deals with “harmful tax practices” and focuses especially on companies that receive overgenerous tax rulings from particular countries. A favorite area concerns intellectual property (IP) and research and development (R&D).
In the context of beneficial IP tax regimes such as patent boxes in the UK, Cyprus and many other countries, agreement was reached on the “nexus approach.”
Taxpayers should only benefit from IP regimes where they engaged in research and development and incurred actual expenditures on such activities. So a system of automatic notification of tax rulings to other tax authorities is being implemented.
Israel grants preferred enterprise tax breaks to hi-tech companies that conduct R&D in Israel and meet certain other requirements.
Action 6 deals with the abuse of tax treaties, also known as treaty shopping. Many tax treaties will now be subject to an overriding “good principal purpose” requirement, or a “limitation of benefits” clause to ensure that entities from third countries don’t use phony shell companies in a tax-treaty country.
Article 13 deals with country-by-country tax reports by multinationals with annual revenues over €750 million. They are now required to report on their entities in each country and highlight which entities in which countries show the most profits with the least tax and personnel. Until now, tax authorities were largely blinkered.
And groups of all sizes must now file a transfer-pricing “master file” on the group as a whole and a “local file” for transfer-pricing purposes, with plenty of international information but less numerical data.
Article 14 seeks to improve the resolution of disputes between taxpayers and tax authorities via mutual-agreement procedures in tax treaties.
Clearly, Actions 5, 6 and 13 will enable tax authorities to select companies for tax audits.
Other BEPS actions should not be overlooked by companies, especially those dealing with finance arrangements, interest deductibility, transfer pricing and permanent establishments (branches, warehouses and agents).BEPS statistical indicators
The report to the G-20 reveals that the OECD has developed a dashboard of indicators that may reveal bad “BEPS behaviors” and the use of tax havens. What are these (bad) BEPS behaviors? First, the OECD says a high ratio of foreign direct investment (FDI) to gross domestic product (GDP) in a country indicates BEPS, because FDI can include purely financial activity – money flowing through.
Second, the OECD has noticed that multinationals tend to make higher rates of profit in tax havens. For example, in 2013, low-tax, high-profit affiliates accounted for 45% of total income, while only 12% of total income was reported by higher- tax, lower-profit affiliates.
Third, a high ratio of royalties to R&D spending could suggest a country has more IP rights than would be expected given its R&D expenditure, and such a high ratio may provide an indication of BEPS – for example, multinational groups moving intangibles into tax havens where generally little of the value-creating R&D activity has occurred.
Fourth, borrowing from both related parties and third parties appears to be more concentrated in group affiliates in countries with higher statutory tax rates. By placing debt in locations with high tax rates, firms can lower their overall tax liability.To sum up
Any group with international activity should check that it is not showing any signs of BEPS bad behavior. Prevention is better than cure.As always, consult experienced tax advisers in each country at an early stage in specific cases.
Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.