OECD issues BEPS final reports
TAX ALERT |
On Oct. 5, 2015, the G20 and Organisation for Economic Co-operation and Development (OECD) released a package of final reports from the base erosion and profit shifting (BEPS) project. Two years ago, the G20 commissioned the OECD to propose a plan to combat perceived abuses of the international tax system. The OECD identified 15 action items and over the past two years has worked on compiling recommendations to address each. In September 2014, the OECD released seven preliminary reports as discussion drafts. Throughout the BEPS project, the OECD has been transparent in its process‒as a result of this open dialogue many of the concepts presented in the final reports have previously been vetted. If enacted by governments, the proposals will likely impact the operational structure and compliance obligations of multinational businesses. Below is a discussion of some of the key BEPS proposals.
Reinforced transfer pricing rules
The OECD’s transfer pricing proposals will likely have the most significant impact on the compliance burdens of multinational companies. Under these proposals, taxpayers must complete and maintain three new files:
- Master file that contains high-level information about their global operations
- Local file that contains pertinent information regarding related party transactions
- Country-by-country report that provides internal data in every country in which they do business
Strengthened tax treaty provisions
Perhaps the most significant development presented with the final report relate to proposed revisions to current bilateral tax treaties’ thresholds for nexus, permanent establishment (PE) status. Specifically, the OECD proposals would curtail the effectiveness of commissionaire arrangements to avoid PE status. In addition, the OECD would limit the scope of various exemptions to PE status, including the preparatory and auxiliary and construction project exemptions.
The goal of BEPS in the area of tax treaties is to ensure the elimination of double taxation and avoid double non-taxation of income. To this end, the OECD has also proposed that countries adopt a limitations on benefits provision and an anti-abuse rule both of which are designed to limit benefits to taxpayers for whom benefits were intended.
Addressing preferential tax regimes and special rulings
Through the BEPS project, the OECD evaluated numerous preferential tax regimes and found 16 of those to be inconsistent with the BEPS objectives. The final report adopts a nexus approach to establishing valid tax regimes, which all OECD and G20 member countries have endorsed. Under this approach, countries may extend benefits to taxpayers that engage in significant economic activity in the local jurisdiction. In addition, the OECD has proposed that countries exchange information regarding the granting of certain preferential tax rulings. Countries subject to treaties with appropriate exchange of information articles are to begin exchanging information beginning on April 1, 2016, regarding rulings issued on or after that date and they must exchange information regarding existing rulings by Dec. 31, 2016. Taxpayers that have received preferential rulings should assess whether these rulings may be scrutinized or even revoked under the standards set forth in this latest OECD guidance.
Limiting benefits from hybrid entities and instruments
The final report includes model provisions to tackle hybrid mismatch arrangements that take advantage of the differences between two countries laws to create non-taxable income or double deductions. In general, the OECD proposes that countries deny deduction for a payment that is not includible in the income of a counterparty in another country, or alternatively, that the recipient’s country tax a payment that is deductible to the payor.
While the OECD did not propose that countries adopt controlled foreign company (CFC) rules, it provided recommended principles that countries may use should they decide to adopt new legislation or modify existing law. Furthermore, the final reports propose that countries limit interest deductions based on either an individual fixed ratio or in conjunction with a group-wide ratio that would limit interest based on the overall debt of the worldwide group.
Addressing the digital economy
One of the overarching goals of the BEPS project was to address changes in business practices brought about by the growth of the digital economy and challenges to the value-added tax (VAT) system. To ensure the proper taxation of the value-added activities, the final report recommends the implementation of VAT rules to ensure tax revenue is collected in the country where the consumer resides. Given the complexities raised by numerous VAT systems, the report also highlights the positive experiences of the several countries that have implemented simplified registration and reporting systems for VAT. Given the complexities of addressing the impact of the digital economy on BEPS, the final report generally identifies technical options available to address the challenges related to the allocation of taxing rights among countries.
The next challenge for the BEPS project will be ensuring consistent implementation. One method for ensuring consistent implementation is the final report’s mandate to develop a multilateral instrument that implements BEPS recommendations and supersedes existing bilateral tax treaties. Such an instrument has not yet been created as it would require a special OECD drafting conference. To date, about 90 countries have agreed to pursue such a multilateral agreement and it is expected that a multilateral conference may convene as early as the first quarter of 2016.
The OECD proposals are broad and will have a significant impact on taxpayers with international business operations. Some or all of these proposals could be adopted quickly if governments adopt them through a multilateral instrument. Taxpayers should carefully review their operations and international tax positions to assess the continued viability of their planning structures and position if the BEPS proposals are adopted.