BEPS drives the most significant changes in international tax in decades
Understanding and planning for global tax evolution
INSIGHT ARTICLE |
The base erosion and profit shifting (BEPS) initiative undertaken by the Organisation for Economic Co-operation and Development (OECD) will lead to some of the most significant changes in international taxation in decades. Globally active companies, or those planning to be so, should track the OECD's progress and the current and proposed legislative changes that BEPS has already inspired and plan now to adapt their tax strategies and operations to what will likely be a significantly changed environment.
Why BEPS and why now?
Many multinational companies have utilized aggressive tax planning to take advantage of gaps in the tax laws of various countries, in many cases achieving double non-taxation. Companies also have used transfer pricing and other strategies to shift income to low- or no-tax countries even though those companies have little or no economic activity in those jurisdictions. As a result, many countries are missing out on significant tax revenue.
Given the environment of austerity in many affected countries, the public and media have taken a heightened interest in the tax planning schemes of multinational entities. The international tax activities of several major multinationals, including Starbucks, Amazon, Apple and Google, have been widely denounced in the press and have been targeted by various jurisdictions for examination. In most cases, multinationals have not broken any tax laws but have only exploited the planning opportunities available to them. However, the growing sense that these entities do not pay their fair share of taxes has resulted in considerable worldwide political pressure for international tax reform.
As a result, the G-20, nations have asked the OECD to develop potential solutions, which gave rise to the BEPS initiative.
What is BEPS?
BEPS is a coordinated international effort to develop better coherence among, and more rigorous standards in, taxing regimes along with heightened transparency into the operating results and taxes paid by multinational companies. BEPS will result in model legislation and help facilitate an internationally coordinated approach to international taxation that will facilitate and reinforce domestic actions to protect a country's tax base. BEPS may be implemented quickly through a multilateral instrument that countries can use to enact the BEPS proposals into law. BEPS has four central goals:
- To eliminate the current mismatches among various national tax programs that allow for double non-taxation
- To increase transparency into tax decisions and improve the exchange of information among national tax authorities
- To adjust transfer pricing rules to better ensure that profits are taxed in the jurisdiction where economic activity takes place and value is created
- To implement modern standards of taxation in treaties and domestic laws that reflect the realities of today's global economy
BEPS is focusing on 15 specific action points to achieve these goals:
- The digital economy
- Hybrid mismatch rules
- Controlled Foreign Corporations (CFC) rules
- Interest deductions and financial payments
- Harmful tax practices
- Treaty abuse
- Avoidance of permanent establishment (PE) status
- Transfer pricing and intangibles
- Transfer pricing and risk/capital
- Transfer pricing and other high-risk capital
- Data and methodologies
- Disclosure rules
- Transfer pricing documentation
- Dispute resolution mechanics
- Development of a multilateral instrument
The OECD intends to complete discussion drafts on all of these topics by December 2015.
What BEPS isn't
While the impact of BEPS will be substantial and likely will involve countries around the world, the BEPS project on its own changes nothing. It in no way restricts sovereign nations from the ability to enact or enforce their own laws. All nations will chose whether and how to implement the BEPS recommendations through legislation. Countries will continue to compete for business through varying tax rates and other incentives. As countries enact the BEPS provisions in varying degrees, new planning opportunities will likely emerge.
What is clear, however, is that countries around the world will be making changes to international tax law based on BEPS.
Why plan for BEPS now?
If companies think they can put off planning for BEPS, they should think again. Due to the BEPS initiative and the media and public attention that continues to be focused on international tax, companies are already facing a harsher enforcement environment in many jurisdictions, including more frequent, aggressive and sophisticated tax audits. Many countries already are enacting legislation to implement BEPS recommendations. For example:
- The U.K., Australia, Spain and France have already introduced draft legislation concerning transfer pricing based on the BEPS initiative
- The U.K. and Australia have enacted a "diverted profits tax" to address planning strategies designed to avoid PE status
- France is adopting the BEPS recommendations on interest limitations
- Spain is implementing new CFC rules
A key part of BEPS is the proposal to use a multilateral instrument to enact the BEPS rules into law. If this approach is taken, the BEPS proposals could become law in an accelerated time frame in every country that signs the instrument. If a multilateral instrument is used to enact the BEPS proposals, taxpayers could have a very short period of time to react before the rules become effective.
Two things are clear. As BEPS continues to be implemented by countries worldwide, international tax compliance costs will rise and many multinational companies will either have to accept higher overall global taxes or change their business models and structures. In many cases, they will need to do both. Shareholders and other stakeholders expect these companies to understand and manage international tax risks. External auditors, too, will expect taxpayers to define and accurately account for these risks.
A company's initial reaction may be to wait for all legislation that will affect it to be in place before making changes. However, the global legislative fallout from BEPS has already begun and is likely to continue for years. Companies need to begin planning now and will have to continue to adjust as the legislative picture evolves.
Remember, several key BEPS initiatives focus on issues of corporate structure, such as CFCs, permanent establishments and holding companies for intellectual property. Even though the legislative proposals aren't yet final, it is already clear that many companies will have to make structural changes in these and related areas. Considering the planning, budgetary approvals, legal entity changes and operational adjustments required to implement new multinational structures, companies will need significant lead time to make these adjustments. Companies may not have time to make changes after legislation that impacts their current structure is passed, which could expose them to penalties and other compliance risks. The time to plan is now.
BEPS and tax risk management
Planning on this scale requires a cohesive approach to tax risk management. As a company grows in complexity and geographic reach, the risks related to tax controversies increase exponentially. Even before BEPS, governments were increasingly focused on cross-border transactions and the movement of resources, assets and revenue within multinational companies. Governments were increasingly cooperative in exchanging information in order to protect their tax revenues. BEPS will significantly increase these trends.
It is vital, therefore, that a company understand and plan for its tax risks. This exercise should extend far beyond the tax department. From boards to senior management to business units to investors, everyone has a stake in a global tax risk approach. One only need consider the reputational and financial fallout from Starbuck's recent tax controversy in the U.K. to understand why. Companies that directly involve tax in financial and operational planning processes in order to proactively anticipate and respond to tax risks are already better positioned to control those risks than those that don't. As BEPS continues to be implemented, that integrated tax risk management approach will be increasingly important.
The following are some key tax risk questions your company should consider in light of BEPS:
- As BEPS requires increasing transparency into international tax plans, including state aid, companies face increased reputational risk, even in situations where they may not have violated tax laws. In the face of increased media and public scrutiny of some state aid arrangements, some companies have even chosen to voluntarily surrender legitimate tax benefits in order to control damage to their reputations. How will your company strike the balance between reputational risk and tax savings?
- Are your company's current methods of profit allocation in line with the emerging standards of economic substance in BEPS? If not, what changes will you need to make to bring them in line?
- BEPS targets a number of commonly used tax planning structures, such as commissionaire arrangements and hybrid entities. If your company is employing these structures, what changes should you make, and when?
- BEPS is redefining tax planning issues like PE and intangibles. How will these changes affect your tax plans and structure?
- Under BEPS, countries will be more aggressive about sharing information and coordinating their investigations of everything from corporate structures and transfer pricing to interest and other financing arrangements. Should you unwind any overly aggressive tax arrangements now to control this risk?
How to plan for BEPS
While your company's specific approach to BEPS will be driven by your structure, global footprint and current tax planning, there is a general planning approach that can help any multinational company better define and respond to the risks BEPS presents.
- Identification Through interviews and questionnaires with employees in all jurisdictions, develop a clear understanding of your company's organizational structure, business processes, and transaction flows worldwide. Interview your tax directors and other key personnel to identify key process stakeholders. Then hold a white boarding session to identify your key risks and concerns.
- Prioritization Match your current tax structure and planning against the 15 BEPS action items and prioritize those items by risk. Then, on a country-by-country basis, identify specific emerging risks and compliance obligations and determine their impact on your overall tax strategy. Based on that evaluation, develop a report outlining and prioritizing actions needed to control BEPS risks.
- Action Review your report with management and evaluate it according to your tax risk assessment, then develop a step-by-step action plan. In the near term, implement solutions to immediate material risks. Then, develop a BEPS review process to track ongoing changes and associated risks so that you can continue to have a proactive, prioritized response.
A brave new tax world
BEPS has already altered the international tax landscape and will continue to do so for years to come. The increase in new legislation by countries around the world, the requirement for enhanced transparency and the increase in global cooperation and information sharing among tax authorities will result in some of the most significant changes in international taxation in decades. Multinational companies need to start now to plan for near-term risks and to adjust their tax risk and planning approach to manage what will be a significant and evolving challenge.