Strategizing International Tax Best Practices – by Keith Brockman

EU ruling request: 2010-2013

In the context of State Aid, aggressive tax planning, tax avoidance and competition for a country’s fair share of tax, the European Commission has broadened its earlier request for taxpayer rulings to include all tax rulings of all Member States from 2010 to 2013.  This initiative introduces additional transparency into the ruling practice of Member States.

Most importantly, the tax cost for denial of tax benefits for previously issued rulings is incurred by the respective companies, not the Member States.  MNE’s can participate, directly and/or indirectly, into the process if such rulings are formally investigated.  A link to the press release is attached for reference:

http://europa.eu/rapid/press-release_IP-14-2742_bg.htm?locale=FR

This initiative should be monitored by all MNE’s, supplemented by coordinating a list of all such rulings that would be requested for additional review and reference.

OECD BEPS recent releases

The OECD has, in the past week, published several consultation drafts, with relevant links provided for reference.

The documents include:

Action 8,9,10: Risk, recharacterization

Action 14: Dispute resolution

Action 4: Interest deductions

Action 10: Profit splits

Action 10: Transfer pricing aspects of cross-border commodity transactions

http://www.oecd.org/ctp/transfer-pricing/discussion-draft-action-10-commodity-transactions.pdf

http://www.oecd.org/ctp/transfer-pricing/discussion-draft-action-10-profit-splits-global-value-chains.pdf

http://www.oecd.org/ctp/aggressive/discussion-draft-action-4-interest-deductions.pdf

http://www.oecd.org/ctp/dispute/discussion-draft-action-14-make-dispute-resolution-mechanisms-more-effective.pdf

http://www.oecd.org/ctp/transfer-pricing/discussion-draft-actions-8-9-10-chapter-1-TP-Guidelines-risk-recharacterisation-special-measures.pdf

The discussion drafts have deadlines for comment in January or February 2015, and all interested parties should review the relevant drafts to submit comments accordingly.  Additionally, the documents should be reviewed by all international tax practitioners to understand the trend of these topics, thereby affecting how all countries may be affected, directly or indirectly, by these actions.

Chiina GAAR: New rules

China’s State Administration of Taxation (SAT) has established rules for implementing its General Anti-Avoidance Rule (GAAR), effective 1 February 2015.  A PwC summary and details of the rule, as translated into English, are attached for reference:

http://www.pwchk.com/webmedia/doc/635539923624544645_chinatax_news_dec2014_33.pdf

http://www.pwchk.com/webmedia/doc/635540044774352869_chinatax_news_dec2014_33_article.pdf

Note, as in most GAAR provisions, the definition is subjective in nature.  Additionally, these rules would be applied after the Specific Anti-Avoidance Rules (SAAR) are applied, resulting in a tiering of potential disallowance avenues.  However, the MAP rules could be employed to minimize double taxation consequences.

As the GAAR provisions are being enacted into domestic law, as well as treaties, in addition to existing rules for SAAR, these rules are critical for new arrangements / transactions, as well as preparing relevant documentation for future reference and defense.

 

 

With the increasing complexity of audits, OECD BEPS incentivized unilateral legislation, General Anti-Avoidance Rules (GAAR), and cases proceeding to arbitration, appeals and Mutual Agreement Procedure (MAP), a comprehensive tax audit diary will prove to be of valuable reference during the audit, from commencement to final determination and thereafter.

Ideally, this diary could be signed/initialed contemporaneously by the company and tax authorities signifying agreement of the summary.

A tax audit diary may include the following components:

  • Summary of discussions at each audit meeting, including attendees, conclusions, future actions and promised timelines.
  • Paper/electronic copies of all written audit inquiries received, including a date stamp upon receipt.
  • Paper/electronic copies of all written audit inquiries provided, including the date provided to tax authorities.
  • Copies of all reports, including transfer pricing studies, provided.
  • Agreement as to what documents are not to be provided, with mutual consent of the company and tax authorities.
  • Documentation of BEPS related discussions / assessments not yet legislated into domestic law.
  • Summary of discussions re: jeopardy assessments / threats of additional assessments re: Competent Authority filings.
  • References to adequate / inadequate transfer pricing documentation, as a finding of “inadequate documentation” may provide a basis for additional interest, penalties and possible disallowance of treaty benefits, such as MAP.

The diary should be included in corporate governance documentation that will provide consistency upon changes in personnel during the course of an audit, including relevant appeals.

Additionally, this diary will be instrumental in providing information to Competent Authority personnel and advisors for clarity of the audit negotiations and discussions, as well as serving as one source of valuable reference for the audit, including similar audits of other legal entities in that jurisdiction, joint audits, etc.

A discussion of a joint audit discussion as a component of the Tax Risk Framework is included in an earlier post dated 25 October 2014 for related reference.

HMRC is taking a unilateral proactive lead in devising measures based on OECD BEPS initiatives that introduce a diverted profits tax, as well as country by country (CbC) reporting for UK headquartered MNE’s.  A Tax Journal summary provides a summary of the diverted profits tax, which is linked herein, in addition to the HMRC source articles for application of the diverted profits tax and CbC reporting.

http://www.taxjournal.com/tj/articles/google-tax-sends-clear-message-multinationals-divert-profits-10122014

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/385741/Diverted_Profits_Tax.pdf

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/385161/TIIN_2150.pdf

Diverted Profits Tax:

This measure will introduce a new 25% tax (regular tax rate plus a punitive component) on diverted profits. The diverted profits tax will operate through two basic rules. The first rule counteracts arrangements by which foreign companies exploit the permanent establishment rules. The second rule prevents companies from creating tax advantages by using transactions or entities that lack economic substance.  The proposal will be effective as of 01 April 2015.

The main objective of the diverted profits tax is to counteract contrived arrangements used by large groups (typically multinational enterprises) that result in the erosion of the UK tax base.

CbC reporting:

The publication allows regulations to be issued re: CbC reporting for UK-based companies after the OECD publishes guidance on how the reports should be filed and how the information in them may be shared between relevant countries, and after a period of consultation in the UK.

After issuance of the hybrid mismatch rules (post of 7 December 2014) that patiently await the final OECD guidelines for consensus in its guidelines, the diverted profits tax mechanism will be in effect next year prior to final OECD guidelines and subject to other countries following a similar early unilateral lead as incentivized by the BEPS initiatives.

The CbC reporting is addressed at UK-based MNE’s, while presumably non-UK based MNE guidance for such reporting will be also be issued in the near future.

These initiatives may target legal mechanisms that the taxpayer will need to defend aggressively, while advancing preparation for timely compliance for CbC reporting.  Additionally, other countries may use this information via automatic exchange of information to assist in transfer pricing risk assessment.  The initiatives should be reviewed in detail to better understand the rules, and trends, for these proposals.

A anti-abuse rule has been proposed by the EU Economic and Financial Affairs Council for inclusion in the EU Parent-Subsidiary Directive (PSD), following implementation of hybrid mismatch rules as summarized in my post of 24 June 2014.  The proposal would be required to legislated into law by 31 December 2015, in addition to the earlier hybrid loan rules.

A copy of the communique is attached for reference:

http://register.consilium.europa.eu/doc/srv?l=EN&f=ST%2016435%202014%20INIT

Key observations:
Annex I contains the following language (highlights added for emphasis) for the proposed anti-abuse rule:

Member States shall not grant the benefits of this Directive to an arrangement or a series of arrangements that, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage which defeats the object or purpose of this Directive, are not genuine having regard to all relevant facts and circumstances. An arrangement may comprise more than one step or part. 3. For the purposes of paragraph 2, an arrangement or a series of arrangements shall be regarded as not genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality. 4. This Directive shall not preclude the application of domestic or agreement-based provisions required for the prevention of tax evasion, tax fraud or abuse.”

Annex II provides further reference stating that EU Member States  will endeavor to inform each other, and additionally that an anti-abuse provision will be considered in future work addressing the EU Interest and Royalties Directive 2003/49/EC.

This proposal should be closely followed, as it will directly affect transactions between EU Member States.  Additionally, this initiative will be followed by other countries in drafting domestic and/or treaty anti-abuse/anti-avoidance rules, possibly resulting in a multi-pronged approach of anti-avoidance / anti-abuse rules in Directives, treaties and domestic legislation.

The subjectivity of this rule will increase complexity, reduce clarity and certainty while being subject to further appeals contesting implementation and/or interpretation of the guidelines, including the “main purpose” test.

OECD BEPS: EY update

EY’s recent tax alert highlights the recent developments and trends of the OECD BEPS initiatives:

OECD
The OECD has announced another in its series of webcasts providing updates on developments with respect to the BEPS project. The webcast is scheduled for 15 December 2014 and will feature senior members of the OECD secretariat.

Asia-Pacific region
On 24-27 November 2014, the creation of a new task force was announced at a meeting of the Study Group on Asian Tax Administration and Research (SGATAR) in Sydney. The task force is to be made up of SGATAR members and be designed to, among other things, enable the Asia-Pacific region to discuss and to keep abreast of international developments and issues including base erosion, profit shifting, and tax transparency. According to the announcement, there is already unprecedented and powerful global collaboration on these issues and the creation of the task force will give all SGATAR members a platform to play a role, including relaying their views to international forums. The task force also is intended to enable cooperation and support for the development of robust, cohesive tax systems in each jurisdiction. According to the announcement, SGATAR members will be able to use the task force to coordinate sharing of best practices and experience and to seek assistance on implementing initiatives such as exchange of information. Current SGATAR members include Australia, People’s Republic of China, Hong Kong SAR, Indonesia, Japan, Republic of Korea, Macao SAR, Malaysia, Mongolia, New Zealand, Papua New Guinea, The Philippines, Singapore, Chinese Taipei, Thailand and Vietnam.

See EY Global Tax Alert, Asia Pacific tax administrations create task force as next step in greater regional cooperation, dated 2 December 2014.

European Union
On 1 December 2014, according to several media outlets, the Finance Ministers of Germany, France and Italy sent a joint letter to Pierre Moscovici, European Union (EU) Commissioner for Economic and Financial Affairs, Taxation and Customs. According to the reports, the letter calls upon the EU to rapidly develop a new EU Directive on anti-base erosion and profit-shifting measures, which should be presented for consideration before the end of 2014, with a view to EU Member States adopting the measures therein by the end of 2015. According to the reports, the ministers noted that the G20 and the OECD are already one year through a two year long comprehensive BEPS initiative, but further noted that it is important that the EU should also adopt a common set of binding rules that go beyond greater transparency and company registries, to a “general principle of effective taxation” to compensate for the EU’s lack of “tax harmonization.” According to the letter, these rules should include mandatory and automatic exchange of information on cross-border tax rulings (including Advance Pricing Agreements in the field of transfer pricing), a register identifying beneficiaries of trusts, shell companies and other non-transparent entities, and measures against tax havens.

See EY Global Tax Alert, Finance Ministers of France, Germany and Italy ask European Commission to rapidly develop a new Directive addressing tax avoidance and tax evasion issues, dated 2 December 2014.

France
On 5 December 2014, during the debates on the Draft Amended Finance Bill for 2014, the French Assemblée Nationale incorporated a provision addressing inbound hybrid payments. The rule would deny the participation exemption on income from shares (i) if the income was tax deductible for the distributing entity (in implementation of the EU Parent-Subsidiary Directive as amended on 8 July 2014) or (ii) if such income was paid out of profits from a non-taxable activity. The rule would apply to fiscal years that begin on or after 1 January 2015. The Bill is still in draft form, and final enactment is expected by the end of December.

See EY Global Tax Alert, French Parliament to implement recent EU rule on hybrid mismatches, dated 8 December 2014.

Netherlands
On 1 December 2014, the Dutch State Secretary of Finance provided input on previously raised parliamentary questions regarding the future of the innovation box regime. Generally, the Dutch State Secretary supports the discussions around substance requirements, but also wants to safeguard the position of innovative small and medium sized entities. The Dutch State Secretary has stated that the Netherlands plans to continue to promote innovation through tax and other incentives and expressed the view that, in light of the strong substance requirements that are in place for the Dutch innovation box, the regime should not be vulnerable for abuse. Based on this, it is not expected that the Dutch government will propose major changes to the Dutch innovation regime at this time.

See EY Global Tax Alert, Dutch State Secretary of Finance provides input on innovation box regime, dated 5 December 2014.

New Zealand
On 27 November 2014, New Zealand’s Minister of Revenue released two officials’ reports regarding BEPS. They outline officials’ current views on the BEPS project and the timetable for action. They show strong support for the OECD’s approach to BEPS and commit to no unilateral measures in advance of final OECD recommendations, which should reduce risks of incoherence and double taxation. They also show that tax authorities are using BEPS concerns to justify certain measures with respect to foreign trusts, non-resident withholding taxes, and tax compliance for large corporations. The reports provide a detailed timetable, which should give business some measure of short-term certainty.

South Africa
On 19 November 2014, National Treasury and the South African Revenue Service (SARS) made presentations on transfer pricing during a meeting of Parliament’s Mineral Resources and Finance Committees. SARS informed the committees that specific legislation is being considered for transfer pricing documentation and for country-by-country reporting and that a legislative framework for Advance Pricing Agreements is also being considered. While tighter legislation may be needed, SARS recognizes the importance of a balanced approach in line with domestic and international law, which does not pose a deterrent to foreign direct investment. The date when such legislation will be drafted (or implemented) is unclear. SARS also informed Parliament of the results of transfer pricing audits performed over the last three years. The SARS Transfer Pricing Unit has audited more than 30 cases and made transfer pricing adjustments of over R 20billion (at a conservative estimate) with an income tax impact of R 5billion. A similar number of cases are currently in progress and other cases are in the process of risk assessment. This underscores the importance for South African taxpayers of making sure that their transfer pricing policies are compliant with the arm’s length principle and South African transfer pricing regulations.

See EY Global Tax Alert, South African authorities address transfer pricing and OECD’s BEPS Action Plan, dated 8 December 2014.

Spain
On 28 November 2014, Laws enacting a Spanish tax reform were published in the Spanish Official Gazette. Most rules will enter into force as of 1 January 2015 (subject to specific transition rules). Among many other measures, the new Laws address matters that are focus areas in the OECD BEPS project. Anti-hybrid arrangement rules are introduced under which: (i) expenses corresponding to related party transactions will no longer be tax deductible if, as a result of a different tax characterization, no income is generated or, if generated, the income is tax exempt or subject to a nominal tax rate lower than 10%; and (ii) the participation exemption will no longer apply to dividend or profits distributions that are derived from a tax deductible expense in the source country. Intra-group profit sharing loans, currently characterized as debt instruments for Spanish tax purposes, are treated as equity instruments. An additional limitation is introduced that caps deductible interest on loans financing the purchase of purchase of shares at 30% of the operating profit of the acquiring entity (including where the acquired and acquiring entities are merged or join the same tax unity), subject to an escape clause. The Spanish controlled foreign company (CFC) rules are strengthened, including additional substance requirements for the CFC in order to avoid imputation of foreign low-taxed income. Anti-abuse rules regarding EU dividend and royalty payments are amended.

See EY Global Tax Alert, Spain enacts tax reform, dated 5 December 2014.

United Kingdom
On 2 December 2014, the UK Government issued an update on likely changes required to the UK patent box following the work being done on preferential, intellectual-property (IP) tax regimes as part of the OECD BEPS project. The UK announcement indicates that the joint UK and German proposal on a new modified nexus approach was welcomed by both the G20 and the OECD Forum on Harmful Tax Practices as well as the EU’s Code of Conduct Group in recent meetings. The proposal will now form the basis of continuing work by the Forum on Harmful Tax Practices to determine how the approach will work in practice. As part of this work, the OECD will carry out an informal consultation with countries and other stakeholders. Under the proposal, countries with existing preferential IP regimes would be required to agree to close these to new IP by 30 June 2016 and to eliminate them by 30 June 2021, after which all countries would be required to operate only regimes that are compliant with the modified nexus approach. The UK has confirmed its commitment to retaining a patent box. It will consult on changes to the existing patent box once the Forum on Harmful Tax Practices has completed work on the detail of the new rules.

See EY Global Tax Alert, Update on UK Patent Box and other preferential IP regimes, dated 3 December 2014.

On 3 December 2014, the UK Chancellor of the Exchequer delivered his Autumn Statement. Key announcements from a BEPS perspective include the introduction of a “diverted profits tax” on profits earned as a result of substantial UK activity (e.g., sales) where those profits are considered to be diverted abroad. The tax charge will be 25% of the diverted profits and will come into effect from 1 April 2015. At present there is no further information on the rules but draft legislation and a technical note are expected to be available on 10 December. Also, a consultation document was released on the implementation of the OECD’s recommendations to prevent hybrid mismatches under BEPS Action 2. The new rules are proposed to apply to payments made after 1 January 2017. The rules proposed in the consultation document are directionally similar to the existing UK anti-arbitrage rules, but the motive test would be removed. This would mean that, from 2017, any structure involving hybrid mismatches would potentially be subject to higher UK taxation, regardless of whether the mismatch was for the purposes of avoiding UK tax. The consultation document largely mirrors the latest Action 2 report issued by the OECD in September.

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