Your Taxes: Tax treaties undergo plastic surgery

BEPS takes aim at nearly all importers, exporters and e-commerce traders, large and small, even if they didn’t engage in aggressive tax planning.

US tax form (illustrative) (photo credit: INGIMAGE)
US tax form (illustrative)
(photo credit: INGIMAGE)
The world’s tax treaties have just undergone instant plastic surgery. Unfortunately, they aren’t as pretty as they used to be. One of the surgeons in attendance was the Israeli finance minister, Moshe Kahlon.
It all happened on June 7 in Paris, when the OECD held a grand signing ceremony for a new multilateral BEPS tax convention. This is a treaty of treaties that aims to close international tax loopholes resulting from base erosion and profit shifting (BEPS). So far, 76 countries, including Israel, have signed the multilateral BEPS convention, and more are expected to follow suit shortly. The United States did not sign it.
When a country signs up to the multilateral convention and notifies the OECD it has done so, it amends its existing tax treaties in one fell swoop. In many countries, little or no further parliamentary process is needed. The OECD calls this “ground-breaking.” The first modifications to bilateral tax treaties are expected to go into effect in early 2018.
Who is affected?
The OECD is clearly the new tax sheriff in town. BEPS takes aim at nearly all importers, exporters and e-commerce traders, large and small, even if they didn’t engage in aggressive tax planning. How can they dodge the OECD’s bullets? Background to BEPS: Many multinational groups have engaged in TESCM, or Tax Efficient Supply Chain Management.
For example, in August 2016, the EU issued a €13 billion tax assessment to Apple after it used its Irish subsidiary to sell products to customers across the EU without tax in those countries and only 0.005% tax in Ireland thanks to a favorable tax ruling there. The case is under appeal.
The OECD estimates that tax revenue losses from BEPS are estimated at $100b. to $240b. annually.
To stop more profits “disappearing” offshore, the OECD published its BEPS recommendations in October 2015 to help governments close gaps in existing international rules.
What’s in BEPS?
First, the OECD recommends making it easier for governments to claim that a foreign company has a taxable “permanent establishment” (PE) on its soil by adding warehouses, fulfillment houses, persuasive agents and related company agents, among others, to the definition of PEs.
Second, transfer-pricing rules and disclosure requirements are to be tightened to take into account where value is generated by real people (not lawyers and accountants).
Third, rules against “treaty shopping” are to be strengthened.
Fourth, techniques involving hybrid companies, hybrid financial instruments and thin capitalization are to be blocked.
Fifth, cozy tax rulings are to be made transparent.
Sixth, hindsight taxation may be allowed if intellectual property is shifted offshore at bargain-basement values.
Seventh, mutual-agreement procedures in tax treaties are to be beefed up, but many remain skeptical they will really work.
That’s not all; the BEPS recommendations run to more than 1,000 pages.
Dodging the BEPS bullets
Every company engaged in international activity or e-commerce should immediately adapt to the changes already wrought by the multilateral BEPS convention and other changes being enacted around the world. Otherwise, multiple taxation may ensue.
First reread any tax treaties you rely on; the BEPS multilateral convention probably just changed them. Then check for new laws, regulations, tax circulars and tax interpretations.
It may be necessary to adapt the international corporate structure, the management structure, the business model, the supply chain and financial arrangements.
It won’t be plain sailing. To achieve a consensus of sorts, the BEPS multilateral convention contains many alternatives for countries to choose. Therefore, the uptake of the multilateral convention may prove to be uneven, and it will be necessary to check out what each country adopted. For example, Israel and the UK are each amending their tax treaties with the US, but the US isn’t! Stand by for surprises.
Example: Your company sells products over the Internet to clients in the United States. The products are made in China and drop-shipped into a fulfillment house in the US, which packages and stores the products. When a US customer orders a product, they are delivered rapidly by the fulfillment house.
In this case, you should check, among other things: (1) whether the IRS regards the fulfillment house as a taxable permanent establishment or effectively connected trade or business; (2) whether any tax treaty with the US is consistently applied in each country; (3) how much profit will the US tax at the federal level; (4) what will be the state and local tax treatment; (5) what reporting and forms are needed; (6) which taxes apply to the repatriation of profits from the US, as the US has a complex branch remittance tax; (7) avoidance of double/ multiple taxation; (8) and so forth.
Next steps: If you have international activity, check what action is needed.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
[email protected] Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.