On October 5 the Organization for Economic Cooperation and Development published a final comprehensive package of measures aimed at multinational corporations, large and small, that engage in BEPS – base erosion profit shifting.
These are the most fundamental changes to international tax rules in almost a century according to OECD Secretary-General Ángel Gurría.
The BEPS package was endorsed by G20 (a group of 20 major economies) finance ministers on October 8. This follows hot on the heels of another OECD initiative – the common reporting standard for automatic information exchange, which is aimed mainly at individuals and trusts with undisclosed wealth. Israel is an OECD member.
Some BEPS measures may have immediate effect as they merely involve a change of administrative and tax policy, others would require legislation. The OECD refers to the BEPS recommendations as “soft law.”
Israeli importers and exporters, hi-tech and trading groups will all be in the BEPS firing line. The changes are so broad that many businesses may be affected even if they haven’t engaged in serious tax planning.
The OECD estimates that global corporate income tax revenue losses due to BEPS could be between 4 percent and 10% of related global revenues, i.e. $100 billion to $240b. annually. The affiliates of multinationals in low tax countries report almost twice the profit rate (relative to assets) of their global groups.
The BEPS package is more than 1,000 pages long. Below we summarize it briefly, but this is only the tip of the iceberg. We will review some topics in greater detail in subsequent articles.
Nevertheless, if you are engaged in international business operations or cross-border investments, you are urged to take specific professional advice regarding their circumstances.
It is too late for wait-and-see.What’s in the BEPS package?
The OECD BEPS Package of October 2015 consists of a series of reports on particular subjects – each referred to as an Action.
Action 1 deals with the tax challenges of the digital economy. Are separate tax rules needed for online transactions in cyberspace? The OECD concludes that the digital economy is increasingly becoming the economy itself. Therefore, other Actions below cover all forms of business including digital enterprises.
Action 2 deals with neutralizing the effects of hybrid mismatch arrangements. In plainer English, that means plugging tax loopholes caused by different tax treatment in different countries regarding hybrid companies (e.g. US LLCs) and hybrid instruments (e.g. subordinated loans).
The OECD recommends amending domestic laws and/or tax treaties to prevent an expense deduction if the item is not taxed in the recipient country. Failing that, the recipient country may tax the item after all.
Action 3 deals with the taxation of shareholders of an offshore controlled foreign corporation.
Countries like the US, the UK and Israel already have CFC rules, so little change is expected here.
Action 4 deals with interest payments on regular loans (not hybrids) within a group that create a large expense for an onshore borrower company and little or no tax for the lender company in a sunnier climate.
The OECD recommends limiting the expense deduction to 10%-30% of EBITDA (earnings before interest, taxes, depreciation and amortization). This limit might be increased if the group’s worldwide borrowings are higher. Israel has no such limitation on interest expenses at present, but it does collect a withholding tax of up to 25% on outbound payments.
Action 5 deals with harmful tax practices, meaning over generous tax breaks granted by some countries. The OECD recommends that countries only grant tax breaks if the taxpayer entity itself conducted the core income-generating activities concerned, for example R&D – no outsourcing.
It seems Israeli preferred enterprise tax breaks (usually 9%-16% company tax) should not be affected.
Action 6 deals with preventing the abuse of tax treaties by means of “treaty shopping” or other strategies. The fear is that companies in onshore countries will make deductible payments to shell companies in other countries with favorable tax treaties and favorable tax regimes.
The OECD recommends that countries amend their tax treaties to say that non-taxation or reduced taxation is not intended. In addition, tax treaties should include limitation of benefit (LOB) clauses and principal purpose of transaction (PTT) rules.
Action 7 tightens up permanent establishment rules in tax treaties. A company resident in country A may be taxed in country B if it does business via a PE in country B. A PE is a fixed place of business or a dependent agent.
Due to perceived abuses involving “commissionaires,” the OECD now recommends treating as dependent agents anyone in country B that concludes contracts or plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the company in country A.
This will not apply to independent agents acting in the ordinary course of their business.
But it will apply to any agent acting exclusively or almost exclusively for a closely related foreign company, where one controls the other, or both are under common control.
This is not as innocent as it sounds. For example, if an Israeli company sells abroad using a foreign marketing subsidiary as its agent, that Israeli company would have a PE in each country concerned and have to start paying taxes in each country. And vice versa for foreign companies with an Israeli agent.
In addition, a PE will now include most warehouses. This is aimed at online traders in one country with a warehouse in another country.
Furthermore, there are rules to avoid the fragmentation of taxable long term construction and assembly projects into a series of short term projects.
Actions 8-10 deal with aligning transfer pricing outcomes with value creation. Transfer pricing refers to the pricing of transactions between related parties – tax planning is possible.
The OECD recommends “careful delineation of the actual transaction,” based not only on any contract between the related parties but also their conduct. If an offshore company is allocated risks and profits, it should control those risks and have the financial capacity to assume those risks. If that company merely contributes cash (a “cash box” company), it should only be entitled to a risk-free return.
There are detailed recommendations relating to hard-to-value intangibles which may prevent tax authorities taxing their transfer within a group with hindsight if certain conditions are met.
There are also detailed rules for commodities, based on market prices – which are intended to help third world countries.
Action 13 supplements the transfer pricing recommendations by requiring groups to file transfer pricing studies that contain a high level group “master file” and a more detailed “local file.”
Furthermore, the OECD recommends that groups with consolidated annual revenues of €750 million file “Country-by-Country” reports showing activities, results and taxes paid in each country, starting with 2016.
Until now, onshore tax authorities have little idea of the profitability of offshore subsidiaries of multinational groups.
Action 11 deals with measuring and monitoring BEPS statistically. It is hoped that country-by-country data will help.
Action 12 deals with mandatory disclosure rules relating to tax shelters. Countries like the US, the UK and Israel already have such rules, so little change is expected here.
Action 14 deals with making dispute resolution more effective. This means letting aggrieved taxpayers resort to a mutual agreement procedure (MAP) pursuant to a tax treaty. Certain countries (not Israel) have also agreed to a mandatory binding arbitration procedure.
All OECD countries (including Israel) will be subject to a peer review that will name and shame tax authorities that don’t settle disputes within an average time frame of 24 months, among other things.
Action 15 deals with plans to let governments sign up to a multilateral instrument (treaty) that will serve to amend existing tax treaties and implement the BEPS package rapidly.
The OECD has undoubtedly provided world governments a magnum opus for collecting far more tax revenues fast.
How will they spend the money? How will stock exchanges react? Will new loopholes emerge? What about value-added and similar taxes? Time will tell....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.
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