Strategizing International Tax Best Practices – by Keith Brockman

Tax Executives Institute, Inc. (TEI) has submitted comments in response to OECD’s discussion draft on BEPS Action 1: Address the Tax Challenges of the Digital Economy.  The link for the submission is provided for reference:

http://www.tei.org/Documents/TEI%20Comments%20-%20OECD%20Action%20Item%201%20-%20Digital%20Economy%20-%20FINAL%20to%20OECD%2013%20April%202014.pdf

Some of the key comments include:

  • TEI agrees that ring-fencing the digital economy as a separate sector with unique tax rules would be neither appropriate nor feasible.
  • Technology companies face similar challenges as other businesses in moving assets and people, a view not assumed in the Discussion Draft.
  • TEI opposes options set forth in Section VII, including modifications to the PE exemptions, a new nexus standard based on significant digital presence, a virtual PE, and creation of a withholding tax regime on digital transactions.  These options are all generally unworkable.
  • The options set forth above are not aligned with G20′s statement that profits should be taxed where they are located.
  • Other measures noted in the Discussion Draft would aim to restore taxation in both the market country and the country of the ultimate multinational parent.  TEI notes that many of the issues that  these measures are designed to address are the result of deliberate tax policy of the OECD’s Member States.  It is these policies that create the low effective tax rates.

The comments provide thoughtful and practical business considerations that should be considered when formulating principles for international tax policy.  The digital economy issue is very complex, challenging and should be monitored to address proposals by the OECD, Member States and other countries for transformation.

 

 

The PwC News Alert, issued today, highlights statements of India’s High Court re: treaty override situations in a recent decision of Vodafone South Ltd.  These statements are significant in determining whether retrospective amendments can override treaty benefits.  The link to the Alert is attached for reference:

http://www.pwc.in/assets/pdfs/news-alert-tax/2014/pwc_news_alert_14_april_2014__vodafone_south_ltd.pdf

Important observations noted in the Alert:

  • Sovereign power extends to “breaking” a tax treaty.
  • Unilateral cancellation of a tax treaty through an amendment to domestic law, subsequent to conclusion of a tax treaty, is a recognized sovereign power.
  • If , after the tax treaty came into force, an Act of Parliament was passed which contained a provision contrary to the tax treaty, the scope and effect of the legislation could not be curtailed by the tax treaty.
  • India is not a signatory to the Vienna Convention on the Law of Treaties (Vienna Convention), although such principles have previously been relied on by several Indian courts as such concepts have been accepted as a source of international law.

The concept of treaty override is becoming a very significant issue, evidenced by various GAAR provisions that have been enacted in domestic law that override general tax treaty provisions.  Additionally, recently released OECD draft on BEPS Action Plan 2 (22 March 2014 post) highlights the complex interplay of GAAR provisions with primary and linking mechanism proposals set forth to ensure consistency and uniformity.

In summary, the concepts of the Vienna Convention, combined with current events and complexities re: tax treaty override, merit special attention as tax audits become more complex leading to costly and lengthy appeals, while legislated issues become more subjective all leading to additional cases of double taxation and controversies based on uncertainties of international tax law.

 

The OECD has provided further observations on its country-by-country information template, based on the premise such information is a useful guide in the risk assessment of transfer pricing for relevant jurisdictions.  KPMG has provided a summary of the latest notes by OECD on this topic:

http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/taxnewsflash/Pages/2014-1/oecd-update-on-transfer-pricing-documentation-country-by-country-reporting.aspx

As this important initiative develops into final form, additional questions that may be asked include:

  • Will this information only be provided to tax authorities both currently and in the future, versus subject to public disclosure?  Will the OECD and/or separate countries’ provide for such legal assurance?
  • Should tax authorities be requested to share results of a risk assessment, based on this data, with the taxpayer prior to any assessments to ensure facts are aligned  to promote efficiencies upon assessment, and potentially in domestic or treaty based appeals?  A possible Best Practice for adoption?
  • How will relevance of the global information impact discussions and determinations in the relevant jurisdiction upon audit?
  • Is a post-adoption survey planned to compare expectations with actual results, providing flexibility for ongoing changes as a risk assessment tool?
  • To the extent that a country has adopted, or will adopt, different rules for global reporting, will the rules prescribed by OECD override, or supplement, domestic law?  What (legal) mechanisms will be put in place to align expectations for domestic and international rules?
  • What alignment is planned for countries utilizing the UN Model Convention?
  • Will this tool be used differently for co-operative compliance engagements and/or joint audits?

Many other questions should be carefully considered, looking at both immediate issues for implementation and long-term effects for taxpayers and tax administrations.

 

 

International Tax Review has published, in association with KPMG, an informative summary of transfer pricing (TP) landscapes in the following countries:

Australia, China, Hong Kong, India, Indonesia, Japan, Korea, Malaysia, New Zealand, Philippines, Singapore, Taiwan, Thailand and Vietnam.  I will summarize key highlights from each country, with the following link provided for a complete reference:

http://www.kpmg.com/VN/en/IssuesAndInsights/ArticlesPublications/Documents/2014/Asia%20Transfer%20Pricing%202014.pdf

  • Australia: New TP legislation is aligned with a policy intent of self-assessment; market support strategies classified as a capital or revenue nature
  • China: Location savings; Focus on domestic contributions as a part of the global value chain; value-add analysis of intra-group services; domestic GAAR; expert panel at the SAT level providing TP opinions
  • Hong Kong: Bilateral/multilateral APA focus; TP documentation to mitigate risk
  • India: Valuation of share investments; advertising expenditures resulting in marketing intangibles; intra-group services; “significant people function” approach to intangibles
  • Indonesia: Automatic tax audits; ITO tax revenue focus; MAP/APA trend; unpredictability
  • Japan: Combined TP and income tax audits; bilateral APA’s; documentation of related party profits in intercompany transactions
  • Korea: Intercompany royalties; intra-group service fees; local benchmarking focus; TP audit process diagram; TP Review Committee
  • Malaysia: Local company comparable supplement to TP documentation; Intercompany transaction disclosure to assess TP risk; proof that intercompany services have been rendered and are not duplicative
  • New Zealand: Inter-group financing / credit assessment tools; OECD alignment; TP questionnaires to taxpayers re: risk assessment; collaboration
  • Philippines: Internal database for risk assessment; year-end adjustments; withholding taxes
  • Singapore: Intra-group service fees; APA / MAP procedures
  • Taiwan: Specialized TP teams; inspection forms to re-complete economic analysis on a transaction-by-transaction basis; intra-group funding; cross-border licensing; China-Taiwan OECD model based cross-strait taxation agreement
  • Thailand: Forthcoming reforms in TP, thin capitalization, CFC rules and GAAR; inter-company services re: benefits received; FX documentation; local comparables; APA and MAP process
  • Vietnam: MAP and APA regulations; annual disclosure of related party transactions effective 1/1/2014; targeted sectors for TP audits

 

There are many common themes highlighted in this region, and it is evident that transfer pricing processes and reporting obligations have increased significantly.  Accordingly, this region may merit a special TP review re: contemporaneous documentation and the particular risk areas for each country.

 

 

Portugal has introduced new transfer pricing rules, including the ability to request a unilateral APA, absent a tax treaty between Portugal and the other jurisdiction.  KPMG has provided a concise summary for these changes:

http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/taxnewsflash/Pages/2014-1/portugal-transfer-pricing-law-changes-allow-more-unilateral-apa.aspx

Multinationals should consider this new provision to obtain additional certainty re: Portugal’s application of transfer pricing rules.  Recognizing that a unilateral APA does not eliminate the risk of double taxation, this opportunity should be reviewed within the context of the global tax risk framework.

 

TEI has published comments addressing the UN Practical Manual on Transfer Pricing for Developing Countries, in addition to US IRS Notices for revisions to Revenue Procedures setting forth new policies to implement the Competent Authority (CA) and Advance Pricing Agreement (APA) procedures.  References to TEI’s submissions are included for reference:

UN TP Manual key comments:

http://www.tei.org/Documents/TEI%20Comments%20on%20UN%20Transfer%20Pricing%20Manual%20March%202014.pdf

  • Harmonize UN and OECD Transfer Pricing (TP) guidelines to reduce cross-border disputes
  • Risk assessment should be the primary focus, with most multinationals (MNE’s) “low-risk” status due to global and consistent TP policies and documentation
  • First step of tax authorities should be to address overall business, group TP policy and risk control framework
  • Domestic legislation defeats the purpose of a standard international TP guideline
  • Recharacterization by tax authorities should only be permitted in clear cases of abuse
  • TP documentation flexibility must be preserved
  • Burden of proof should reside with tax authorities, with penalty protection granted to taxpayer upon providing sufficient TP documentation
  • Intangible discussion precedes work of the OECD on revision of its Chapter VI Guidelines, reducing likelihood of harmonization
  • Intra-group services and management fees: Consistency of UN and OECD approaches for clarity, in addition to uniform safe harbors
  • TP documentation: “Less is more” approach to assess risk, materiality consideration on a group and country level, global and regional comparables, English language
  • Chapter 10 policy objectives are not aligned with the UN TP Manual and the arm’s-length principle

US Competent Authority key comments to Notice 2013-78 re: revisions to Revenue Procedure:

http://www.tei.org/Documents/TEI%20Comments%20on%20Notice%202013-78%20Revised%20CA%20Revenue%20Procedure%20-%20FINAL%20to%20IRS%20Mar%2010%202014.pdf

  • Opening the CA process to taxpayer initiated adjustments is welcome
  • A new procedure whereby an informal consultation is arranged with taxpayers to discuss its exhaustion of remedies to reduce its foreign tax before claiming a US Foreign Tax Credit (FTC) should not be compulsory.  The timeliness of such advice is also of concern.
  • CA initiated MAP cases and required inclusion of MAP issues that are not a part of the taxpayer’s request for assistance raises many questions.
  • Provision of all information to both CA’s is over broad and may not be mutually relevant.
  • US CA assistance may be denied if a foreign initiated adjustment is agreed to without consulting the US CA: this raises resource and timeliness issues and should also have no impact upon  the merits for claiming a US FTC.

US APA key comments to Notice 2013-79 re: revisions to Revenue Procedure

http://www.tei.org/Documents/TEI%20Comments%20on%20Notice%202013-79%20Revised%20APA%20Revenue%20Procedure%20-%20FINAL%20to%20IRS%20Mar%2010%202014.pdf

  • The Notice reflects prior creation of the Advance Pricing and Mutual Agreement (APMA) program
  • Details are set forth regarding the “pre-filing” process
  • Appendix is included stating the required materials to be submitted for inclusion
  • Rules are provided for when the IRS may cancel or revoke a completed APA
  • Inapplicable information should not be submitted, but a “suitable explanation” why the information is not relevant must be provided
  • The suggested changes will increase information required for application, and time required for APA completion, thereby reducing the likelihood that taxpayers will proceed with an APA request

 

In alignment with the OECD’s BEPS proposals, unilateral country legislation including General Anti-Avoidance Rules (GAAR), and the UN TP Manual principles for developing countries, tax controversies are expected to increase significantly.  Tremendous pressure will be placed on CA assistance around the world, and possibilities for new APA ‘s will be reviewed to reduce inherent uncertainty.

Accordingly, all multinationals and interested parties should read TEI’s excellent comments to better understand the issues to be confronted, with suggestions for thoughtful and practical ideas to achieve mutual objectives for taxpayers and tax authorities around the world.

 

The OECD released discussion drafts on Action 2, re: hybrid mismatch arrangements, of its BEPS Action Plan.  A copy of the press release, therein referencing the documents, is attached for reference:
Numerous comments should  be received in response to the discussion proposals, however I do want to also draw attention to the statements and purpose of the Vienna Convention on the Laws of Treaties, also referenced herein:
OECD Press release excerpt:

19/03/2014 – Public comments are invited on two discussion drafts on Action Item 2 of the BEPS Action Plan.

In July 2013, the OECD published its Action Plan on Base Erosion and Profit Shifting. The Action Plan identifies 15 actions to address BEPS in a comprehensive manner and sets deadlines to implement these actions.

Action 2 of the BEPS Action Plan calls for the development of model treaty provisions and recommendations for the design of domestic rules to neutralise the effect of hybrid mismatch arrangements:

ACTION 2

Neutralise the effects of hybrid mismatch arrangements

Develop model treaty provisions and recommendations regarding the design of domestic rules to neutralise the effect (e.g. double non-taxation, double deduction, long-term deferral) of hybrid instruments and entities. This may include: (i) changes to the OECD Model Tax Convention to ensure that hybrid instruments and entities (as well as dual resident entities) are not used to obtain the benefits of treaties unduly; (ii) domestic law provisions that prevent exemption or non-recognition for payments that are deductible by the payor; (iii) domestic law provisions that deny a deduction for a payment that is not includible in income by the recipient (and is not subject to taxation under controlled foreign company (CFC) or similar rules); (iv) domestic law provisions that deny a deduction for a payment that is also deductible in another jurisdiction; and (v) where necessary, guidance on co-ordination or tie-breaker rules if more than one country seeks to apply such rules to a transaction or structure. Special attention should be given to the interaction between possible changes to domestic law and the provisions of the OECD Model Tax Convention. This work will be co-ordinated with the work on interest expense deduction limitations, the work on CFC rules, and the work on treaty shopping.

The Action Plan calls for this work to be concluded by September 2014. In connection with this work the Committee on Fiscal Affairs (CFA) has now released two consultation documents on Action Item 2 as a single proposal for public consultation.

The first discussion draft (Neutralise the effects of Hybrid Mismatch Arrangements – Recommendations for Domestic Laws) sets out recommendations for domestic rules to neutralise the effect of hybrid mismatch arrangements and the second discussion draft (Neutralise the effects of Hybrid Mismatch Arrangements – Treaty Aspects of the Work on Action 2 of the BEPS Action Plan) discusses the impact of the OECD Model Convention on those rules and sets out recommendations for further changes to the Convention to clarify the treatment of hybrid entities. The recommendations set out in these discussion drafts do not represent the consensus views of the CFA or its subsidiary bodies but rather are intended to provide stakeholders with substantive proposals for analysis and comment.

Comments on these documents should be submitted electronically (in word format) before 5.00 pm on 2 May 2014 (no extension will be granted).  It is the policy of the OECD to publish all responses (including the names of responders) on the OECD website.

Observations:

The Vienna Convention on the Laws of Treaties has been attached as a timely reference to the role of treaties and the interplay of domestic law and treaty provisions.  It is worthy to readdress these historic provisions as contrasted to the OECD’s BEPS proposals, especially with respect to domestic law override provisions of tax treaties.

The subject of General Anti-Avoidance Rules (GAAR) are also of paramount significance, due to the layers of anti-avoidance and anti-abuse rules proposed from a domestic law and / or a tax treaty perspective.  The GAAR provisions are in addition to specific anti-avoidance rules (SAAR) and targeted anti-avoidance rules (TAAR) rules that are already effected into local legislation.  The OECD documents prescribe primary and linking mechanisms between domestic GAAR and Treaty GAAR provisions to ensure consistency and uniformity.  However, such rules should consider the additional uncertainty that the “automatic” rules may generate.

The interplay, and priority, of domestic law and treaty provisions are converging quickly.  As a result, there will be additional controversies as to whether a taxpayer can utilize a treaty to avoid double taxation, and the different interpretations that tax authorities may have interpreting the complex rules.

The OECD proposals are significant in international tax policy and the application of tax treaties vs. domestic law, thereby all interested parties should submit thoughtful and practical comments to the OECD within the prescribed timeline for comment.

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