The EU Anti-Tax Avoidance Package included a Commission recommendation on the implementation of measures against tax treaty abuse. Specifically, this statement was issued to address artificial avoidance of permanent establishment status as stated in BEPS Action 7 Action Plan.
Re: tax treaties of Member States that include a “principal purpose test” (PPT) based general anti-avoidance rule, the following modification is encouraged to be inserted:
“Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capita l if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that it reflects a genuine economic activity or that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention.”
This subjective phrase, that applies notwithstanding other provisions of the Convention, has already been used in new treaties and will proliferate as new treaties are drafted by a Member State, not necessarily with another Member State. Thereby, it is important to draft supporting documentation that will provide support for transactions against which it is aimed. This phrase will elicit additional appeals and court cases as to its meaning and / or intent for which non-consistent answers will be provided.
Questions that may be asked re: this statement:
- Who is concluding on the reasonableness? What facts are used for such determination?
- Which facts and circumstances are relevant?
- What are all of the principal purposes of the arrangement or transaction?
- How is a benefit measured, directly or indirectly?
- What is a genuine, vs. non-genuine, economic activity?
- How do you determine if such arrangement is in accordance with the object and purpose of the “relevant provisions” of the Convention?
The phrase is purposefully vague, and thereby subject to inconsistent interpretation.
It is hopeful that tax administrations will use this statement wisely to address egregious transactions rather than ordinary business transactions for which the clear intent was not an evasion of tax. This subjectivity will be important to monitor going forward to further understand subjective enforcement interpretations around the world.
The EU Council has provided a Directive that would introduce legislation ensuring the EU maintains its leadership role in anti-BEPS recommendations, as well as providing good tax governance for the rest of the world. EY’s summary of the Directive is provided for reference:
- Automatic exchange of tax rulings would be effective 1/1/2017.
- Changes would be introduced for the EU Code of Conduct.
- EU anti-BEPS proposal to include the following BEPS Actions:
- 2: Hybrid mismatches
- 3: CFC rules
- 4: Interest limitations
- 6: General anti-abuse rule (noting its inclusion for the Royalty & Interest Directive, similar to the Parent-Subsidiary Directive)
- 7: PE status
- 13: Country-by-Country (CbC) reporting
- Common Corp. Tax Base (absent later consolidation phase) proposal to be introduced in 2016
The EU continues its pace to maintain its global lead in addressing anti-BEPS concerns, which will impact non-EU countries around the world. Thereby, it provides another set of rules that would be mandated to achieve EU conformity.
The OECD has released its second draft, following its initial draft on 31 October 2014, on BEPS Action 7: Preventing the Artificial Avoidance of PE Status. Comments, which should be kept as short as possible, on this latest draft should be sent by 12 June 2015. The discussion draft, and related comments, will be discussed at the Working Party 1 meeting of 22-26 June 2015.
A link to the latest discussion draft is provided for reference:
- Objective is to address commissionnaire arrangements and fragmentation of operations to meet the “preparatory and auxiliary” exception.
- Alternative PE options from the first draft have been reduced to 1 proposal re: each PE avoidance strategy, concluding that Option B re: commissionnaire arrangements, Option E re: specific activity exemptions and Option J re: fragmentation are the best models.
- Follow-up work on attribution of profits issues re: Action 7 would result in additional guidance by the end of 2016, the deadline for negotiation of the multilateral instrument.
- Low-risk distributor arrangements are to be addressed in Action 9, Risks and Capital.
- Par. 5 alternative test: Independent agent exception is disregarded if it meets a control (50 % or more interest) test. Persons (acting on behalf of an enterprise) habitually concluding contracts or habitually negotiating the material elements of contracts can lead to a PE, disregarding the act of formal conclusion/approval/review in another jurisdiction. “Contracts” refers to the business proper of the enterprise.
- Each specific activity exemption would be restricted to activities that are otherwise of a “preparatory or auxiliary” character. Additional Commentary guidance and examples are provided re: the phrase “preparatory or auxiliary.”
- Re: splitting up of contracts for the 12-month threshold, the concept of “connected enterprises” replaces “associated enterprises” along with anti-abuse rules for determination.
The above captions provide only a snapshot of the detailed proposals and changes included in this latest draft; accordingly all interested parties should review this draft carefully and consider providing succinct comments for consideration in the final guidelines.
As PE is a strong pillar in the foundation of transfer pricing, this draft will chart the course for future PE determinations that may impact current organization structures and where profits from certain activities are taxed.
The OECD has updates available with respect to Action 5 (Intangibles), Action 15 (Multilateral instrument) and Action 13 (Country-by-Country reporting – refer to prior post of 6 Feb. 2015). Links are provided for the OECD’s statement of intent addressing these three actions in particular.
Summary – Action 5 (Intangibles):
- The Modified Nexus Approach is generally accepted.
- 30% uplift of qualifying expenses re: outsourcing and acquisition costs in addition to significant R&D activities of taxpayer.
- Existing regimes will be closed by 30 June 2016 to new entrants; legislation to be effected in 2015.
- Grandfather rules for existing regimes may extend 5 years (i.e. 30 June 2021).
- Methodology of tracking / tracing R&D expenditures will be developed.
- Guidance to be issued re: definitions; patents qualify, whereas trademarks do not qualify.
Summary – Action 15 (Multilateral Instrument):
- The intent to develop a multilateral instrument to implement specific BEPS Actions is still desirable and feasible.
- The instrument will be designed to implement treaty-related measures of the BEPS Project.
- Several BEPS Action items that are known to be inclusive are Action 2 (Hybrid entities), Action 6 (Treaty abuse), Action 7 (PE) and Action 14 (Dispute resolution). Other Action items may be included after final guidance is developed, including a mechanism to exchange information for country-by-country reporting.
- Each Action item may be optional, or there may be a minimum number of Actions that a country will have to execute.
- The instrument is not compulsory and is open to all jurisdictions.
- Development of the instrument will be accomplished by an ad-hoc group that is under the aegis of the OECD and G20.
- Outputs are expected Sept. 2015, with final development of the instrument concluded by 31 Dec. 2016.
The timing of 31 Dec. 2016 will be critical to monitor, as many countries may decide to develop unilateral legislation prior to this date. It is hopeful that tax administrations will not try to (informally) implement BEPS guidelines prior to the time that effective legislation is executed.