Strategizing International Tax Best Practices – by Keith Brockman

Posts tagged ‘tax avoidance’

European Commission: Full speed ahead

The European Commission has clearly announced it’s intent to be the global leader in advancing OECD’s BEPS initiatives, with some proposals exceeding the scope / intent of the OECD.

Copies of the following documents are provided for reference, with subsequent posts addressing highlights of significant initiatives.  It is important to distinguish the documents between Proposals for a Council Directive, Communications, Studies and Recommendations.  

  1. Anti Tax Avoidance Package
  2. Proposal for a Council Directive re: tax avoidance practices
  3. Proposal for a Council Directive re: automatic exchange of information
  4. Annex to automatic exchange of information proposal
  5. Communication on an External Strategy for Effective Taxation
  6. Annexes to the external strategy communication
  7. Communication re: Tax Avoidance Package
  8. Study on Structures of Aggressive Tax Planning & Indicators
  9. Recommendation on implementation of measures against tax treaty abuse

The documents are required reading for all international tax practitioners, as they highlight the complex post-BEPS world and the trend indicators for the near future.  We can assume that some of these developments will proceed for action very quickly, thereby imputing a doctrine that “time is of the essence.”

http://ec.europa.eu/taxation_customs/taxation/company_tax/anti_tax_avoidance/index_en.htm

http://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=COM:2016:26:FIN&from=EN

http://eur-lex.europa.eu/resource.html?uri=cellar:89937d6d-c5a8-11e5-a4b5-01aa75ed71a1.0014.03/DOC_1&format=HTML&lang=EN&parentUrn=COM:2016:25:FIN

http://eur-lex.europa.eu/resource.html?uri=cellar:89937d6d-c5a8-11e5-a4b5-01aa75ed71a1.0014.03/DOC_3&format=HTML&lang=EN&parentUrn=COM:2016:25:FIN

http://eur-lex.europa.eu/resource.html?uri=cellar:b5aef3db-c5a7-11e5-a4b5-01aa75ed71a1.0018.03/DOC_1&format=HTML&lang=EN&parentUrn=COM:2016:24:FIN

http://eur-lex.europa.eu/resource.html?uri=cellar:b5aef3db-c5a7-11e5-a4b5-01aa75ed71a1.0018.03/DOC_3&format=HTML&lang=EN&parentUrn=COM:2016:24:FIN

Click to access swd_2016_6_en.pdf

Click to access taxation_paper_61.pdf

Click to access c_2016_271_en.pdf

UK Autumn Statement: 2015

UK’s Autumn Statement 2015 has been announced, with several measures aimed at changing corporate tax behavior and promoting transparency with the objective to achieve a modern and fairer tax system.  A link to the Statement is provided for reference:

https://www.gov.uk/government/publications/spending-review-and-autumn-statement-2015-documents/spending-review-and-autumn-statement-2015

Key points:

  • A 60% penalty of tax due for successful general anti-abuse rule (GAAR) cases, to be implemented in 2016.  The revenue impact of this measure is highly uncertain, as it is also meant to be an incentive to change corporate tax behavior.
  • A desire to be to the most digitally advanced tax administration in the world.
  • New criminal offense for corporates failing to prevent tax evasion; failure to prevent their agents from criminally facilitating tax evasion by an individual or entity.
  • Hybrid mismatch rules to be effective 1/1/2017, following the OECD’s BEPS Guidelines.
  • Corporates to publish tax strategies as they relate to, or affect, UK taxation.
  • Cooperative compliance framework.
  • “Special measures” regime to tackle businesses that persistently engage in aggressive tax planning.

A carrot, stick and transparency approach is contained within the Statement, and thus important to follow as other countries will surely review UK’s leading initiatives to gauge impact on their respective economy.  The GAAR related penalty, which is inherently subjective, will be dictated in some fashion by HMRC’s aggressiveness to assess GAAR and a willingness to pursue it through the respective appeal avenues or court.  The tax strategy initiative will also be interesting to monitor as to its breadth and potential impact upon a company’s risk rating.

ATO interim report: Corporate tax avoidance

The Senate Economics References Committee has published its interim report entitled “Corporate tax avoidance.”  Part I, “You cannot tax what you cannot see” provides an excellent frame of reference for the discussions therein.

It is worthwhile noting that there is a section “Government Senators’ Dissenting Report” expressing concerns about some recommendations therein; this should be a additional warning sign of the recommendations put forth.  Conversely, there are “Additional Comments from the Australian Greens” fully supporting the report in its entirety.

The final report is due in November 2015, although this interim release provides an indication of the thought trends currently in process by the Australian Tax Office (AT0).  A link to the report is provided for reference:

http://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/Corporate_Tax_Avoidance/Report_part_1

Key observations:

  • 17 recommendations provided addressing (1) evidence of, and multilateral efforts to combat, tax avoidance and aggressive minimization, (2) multilateral actions to protect Australia’s revenue base, and (3) capacity of Australian government agencies to collect corporate taxes.
  • Australian government to work with other countries having significant marketing hubs to improve the transparency of information
  • Australian government continues to take the load re: OECD BEPS initiatives; international collaboration should not prevent the Australian Government from taking unilateral action
  • Mandatory tax reporting (transparency) code
  • Existing transparency laws to be identical for private and public companies
  • Public register of tax avoidance settlements reached with the ATO
  • Public excerpts from the Country-by-Country OECD reports, based on the EU’s standards
  • Annual public report on aggressive tax minimization and avoidance activities
  • Section 3.95 discusses a novel concept: “Effective tax borne” effective tax rate formula, a metric that seeks to reflect all of the channel profit derived from business activities involving Australia and the Australian and global tax paid on that channel profit.  Appendix 3 provides additional rules for application of this formula, noting that there has not yet been a consultation with taxpayers or other stakeholders.  The metric envisions that the entire supply chain profit is a profit of the economic group arising from Australian business activities (i.e. intercompany purchases of goods and services from offshore related parties).  Numerator is either the Australian tax paid on business activities by the economic group, or the global tax paid by such group.  Denominator is the total economic profit from business activities which are linked to Australia.  Withholding taxes of economic group profit are includable, whereas royalties and excises are not.  Numerous rules apply for intercompany adjustments.

Australia is still recognized as a leader in the pursuit of the BEPS objectives, using transparency as a weapon to fight ensuing battles.

This report not only extends the strong cry for public disclosure of tax information, it suggests a new concept to examine the effective tax rate of jurisdictions having activities with an Australian related party.  However, it is hopeful the envisaged complexity, cost/benefit and technical nuances of the “effective tax borne” concept are presented to stakeholders with enough time to review, plan and adjust/eliminate the final recommendation accordingly.

As Australia leads, many others follow.  This report is required reading for all interested parties, as the ideas presented have a high probability of appearing in other jurisdictions in a similar form and formulating the same intent for transparency.

ATO Practice Statement: Tax benefits/avoidance & GAAR

The Australian Tax Office (ATO) has issued a very interesting Practice Statement Law Administration.  It is an informal policy document for which interested parties should submit comments by 25 September.  The Statement is a lengthy document, citing case law, that is very worthwhile reading, as Australia continues its proactive efforts driving change in the international tax arena.

Although informal, taxpayers can rely on such guidance for protection from interest and penalties.  A copy of the Statement is provided for reference:

http://law.ato.gov.au/atolaw/view.htm?docid=%22DPS%2FPSD200524%2FNAT%2FATO%2F00001%22

Key observations:

  • A general anti-avoidance rule (GAAR) cannot be applied before a determination by the Tax Counsel Network (TCN).
  • A GAAR decision is generally referred to a GAAR Panel (an independent advisory body) before a final decision is made.
  • The taxpayer may be invited to attend a Panel meeting to assist the deliberative process.
  • Concepts of a tax scheme and a tax benefit are discussed.  A tax benefit inclusive in Part IVA, the GAAR provision relates to: an amount not included in income, an allowable deduction, a capital loss, a tax loss carry back, a foreign income tax offset or withholding tax.
  • An alternative hypothesis” or “alternative postulate” identification is discussed; what would have happened or might reasonably be expected to have happened if the particular scheme had not been entered into or carried out.
  • It is for the court to determine objectively what alternative would have occurred if the scheme had not been carried out.
  • Arguably, there is no longer a test of reasonable exception, based on Parliament’s intention in enacting the Amendments.
  • Warning signs that GAAR may apply (which ATO must consider) are established:
    • Arrangement is out of step ordinarily used to achieve the commercial objective,
    • Arrangement seems more complex than necessary,
    • Tax result does not conform to the commercial or economic result,
    • Arrangement is low risk where significant risks  would normally apply,
    • Parties are operating in a non-arm’s length manner, or
    • Gap between substance and legal form.
  • Penalties are applicable.
  • Division 165 (a GST GAAR rule) is discussed, including permanent and timing differences.
  • A “dominant purpose” test is applicable for the GAAR and the GST provisions, with different factors includable in each.

The above provisions attempt to conceptualize objective factors for an inherently subjective GAAR determination.  As additional GAAR’s are introduced around the world, each applying a different level of subjectivity, the Statement is helpful in understanding the rationale and intent of the ATO.

Tax planning post-BEPS will require additional GAAR documentation for significant transactions, thereby requiring tax to be involved early in the discussions to understand the business intent and alternatives considered.

UK risk proposals: Public tax strategy, Voluntary Code of Practice and Special Measures

HMRC has issued consultation documents proposing requirements to publish a “tax strategy,”, voluntary Code of Practice corporate tax processes and creation of a “special measures” regime.  Comments are due by 14 October 2015 for each Consultation document.

These proposals follow closely upon the heels of the ATO issuance of Best Practice methodologies addressing a taxpayer’s tax risk.

Three documents are provided for reference: (1) A Clifford Chance Briefing note, (ii) HMRC’s Consultation document for Improving Large Business Tax Compliance and (iii) HMRC’s Consultation document on Strengthening Sanctions  for Tax Avoidance.

http://www.cliffordchance.com/briefings/2015/07/mandatory_tax_strategiesacodeofpracticean.html

Click to access Improving_Large_Business_Tax_Compliance.pdf

Click to access Strengthening_Sanctions_for_Tax_Avoidance_-_A_Consultation_on_Detailed_Proposals.pdf

Executive brief:

  • Public availability of a company’s tax strategy (financial penalty for non-disclosure) including:
    • Tax internal governance arrangements
    • Risk management approach
    • Tax planning attitude and tax risk appetite, including affirmation that it aims to satisfy the spirit, as well as the letter of the law
    • Attitude to relationship with HMRC
    • Target UK effective tax rate (if applicable), and what measures are being taken to achieve it
  • Voluntary Code of Practice, including affirmations that:
    • Tax planning is consistent with the economic consequences
    • Transactions provide a tax result that is in accordance with the intentions of Parliament: “HMRC will consider a purposive construction of the legislation, and will also consider whether Parliament can realistically have intended to give the proposed result in circumstances that are very different from those that prevailed at the time”
    • Transparent relationship is maintained with HMRC
    • Tax obligations are met
    • Early dialogues for engagement with HMRC to discuss tax planning, strategy, risk, significant transactions and full disclosure of areas providing significant uncertainty
    • Objective evidence is provided to HMRC that decisions with tax implications have been approved by a senior decision maker
  • Special Measures for companies entering into aggressive tax planning / failing to transparently engage withHMRC, including:
    • Providing all documentation (including third party tax advice) related to tax
    • Refusal to provide non-statutory clearances
    • Public naming
    • Automatic 100% tax penalties

Observations in the Documents:

  • Attitudes to tax avoidance and aggressive tax planning have altered significantly, including political interest
  • Intention is to create Best Practices
  • The Government is awaiting the EU Tax Transparency Package consultation, and will consider its findings carefully
  • Proposal is separate from the current SAO regime, as well as the OECD’s country-by-country reporting guidelines
  • A company could be required to state in their tax strategy whether they are a signatory to the Voluntary Code of Practice
  • Non-publication of a tax strategy will be a consideration of HMRC’s tax risk reviews
  • Evidence of “governance in action” to be provided
  • Voluntary Code of Practice is aimed at tax planning that crosses over into tax avoidance
  • The company should reasonably believe that transactions give a tax result which is not contrary to Parliament’s intentions
  • Special measures will remain for a minimum of 2 years

A higher standard of tax excellence is being demanded by public pressures and tax administrations in the form of an objective tax risk framework overseen at the Board level and subject to internal control testing.  HMRC’s proposals are being followed by other countries worldwide, and similar measures would not be unexpected in other jurisdictions.  Accordingly, all interested parties should review the documents, and provide comments thereto.

 

European Parliament 24-0 vote for public disclosure: CbC & Beneficial Ownership

The European Parliament recently voted unanimously for public disclosure rules to fight tax evasion, tax avoidance and establishing fair, well-balanced, efficient and transparent tax systems.  A copy of the press release is provided for reference:

http://www.europarl.europa.eu/news/en/news-room/content/20150601IPR61336/html/Development-MEPs-call-for-action-to-target-tax-evasion-in-developing-countries

Summary:

  • All countries to adopt country-by-country (CbC) reporting, with all information available to the public
  • Beneficial ownership information to be made publicly available
  • Call for coordination to combat tax evasion and avoidance by the European Investment Bank, European Bank for Reconstruction and Development and EU financial institutions.
  • Request to the Commission for an ambitious action plan, without delay

The outcry for public reporting, currently underway by the OECD, European Parliament and European Commission is increasing exponentially within Europe.  Other countries will obviously follow the EU approach, with perceptions of complicated international tax rules increasing disparity between application of the transfer pricing arm’s length principle.

The CbC reporting, and beneficial ownership detail, should be expected to be in the public domain if this trend continues.  Currently, it is a sign of an incoming tsunami that cannot be completely avoided.

 

European Commission’s Tax Transparency Package: new era

The European Commission published a package of tax transparency measures on 18 March 2015.  The press release and other documents, linked herein for reference, include a tax transparency communication, Council Directive re: automatic exchange of information and Q and A’s of the comprehensive package. Significant initiatives are included in this package addressing corporate tax avoidance and harmful tax competition in the EU, key components of which are highlighted. http://europa.eu/rapid/press-release_IP-15-4610_en.htm http://ec.europa.eu/taxation_customs/resources/documents/taxation/company_tax/transparency/com_2015_136_en.pdf http://ec.europa.eu/taxation_customs/resources/documents/taxation/company_tax/transparency/com_2015_135_en.pdf http://europa.eu/rapid/press-release_MEMO-15-4609_en.htm Press release:

  • The concepts of tax evasion, corporate tax avoidance, “pay their fair share,” aggressive tax planning and abusive tax practices are summarily stated, although corollary concepts for avoidance of double taxation and effective dispute resolution are noticeably absent.
  • Tax rulings will be automatically exchanged every 3 months.
  • Feasibility of public disclosure of certain tax information of MNE’s will be examined.
  • The EU Code of Conduct on Business Taxation will be reviewed to ensure fair and transparent tax competition within the EU.
  • The Savings Tax Directive is proposed to be repealed to provide efficiencies and eliminate redundant legislation in the Administration Cooperation Directive.
  • Next steps: The tax rulings proposal  will be submitted to the European Parliament for consultation and to the Council for adoption, noting that Member States should agree on this proposal by the end of 2015, to enter into force 1/1/2016.
  • Common Consolidated Corporate Tax Base (CCCTB) proposal will be re-launched later this year.

Tax Transparency proposal:

  • Existing legislative framework for information exchange will be used to exchange cross-border tax rulings between EU tax authorities.
  • The Commission will develop a cost/benefit analysis for additional public disclosure of certain tax information.
  • The tax gap quantification will be explored to derive more accuracy.
  • The global automatic exchange of information for tax rulings will be promoted by the EU.

Council Directive (amending Directive 2011/16/EU) re: automatic exchange of information:

  • Mandatory automatic exchange of basic information about advance cross-border rulings and advance pricing agreements (APAs).
  • Article I definition of “advance cross-border ruling:
    • any agreement, communication, or any other instrument or action with similar effects, including one issued in the context of a tax audit, which:
      • is given by, or on behalf of, the government or the tax authority of a Member State, or any territorial or administrative subdivisions thereof, to any person;
      • concerns the interpretation or application of a legal or administrative provision concerning the administration or enforcement of national laws relating to taxes of the Member State, or its territorial or administrative subdivisions;
      • relates to a cross-border transaction or to the question of whether or not activities carried on by a legal person int he other Member Sate create a permanent establishment, and;
      • is made in advance of the transactions or of the activities in the other Member State potentially creating a permanent establishment or of the filing of a tax return covering the period in which the transaction or series of transactions or activities took place.
  • Automatic exchange proposal is extended to valid rulings issued in the 10 years prior to the effective date of the proposed Directive (Article 8a(2)).
  • In addition to basic information exchanged, Article 5 of the Directive should provide relevant authority for the full text of rulings, upon request.
  • EU central repository to be established for submission of information by Member States.
  • Confidentiality provisions should be amended to reflect the exchange of advance cross-border rulings and APAs.

Q and A’s:

  • Corporate tax avoidance, as explained, undermines the principle that taxation should reflect where the economic activity occurs.
  • Standard/template information for the quarterly exchange of information includes:
    • Name of taxpayer and group
    • Issues addressed 
    • Criteria used to determine an APA
    • Identification of Member States most likely to be affected
    • Identification of any other taxpayer likely to be affected
  • Commission could open an infringement procedure for Member States not following the disclosure obligations.
  • Domestic tax rulings are exempt.
  • The EU could be a global standard setter of tax transparency.
  • The EU Code of Conduct criteria are no longer adequate, and it lacks a strong enough mandate to act against harmful tax regimes.

The EU Tax Transparency Package is required reading for all MNE’s and other interested parties, as it is an ambitious effort to provide globally consistent procedures for the exchange of tax rulings/APAs. Additionally, it is interesting to note the EU’s aggressive actions and timing in its efforts to align, as well as expand, the OECD’s efforts to address BEPS Action Items.  These actions are also intended to be a standard for global setting in the new era of international tax transparency.     As a Best Practice, the 10-year look-back provision for rulings implies that MNE’s should have a similar central database for prior, and future, cross-border rulings.  Additionally, this automatic exchange is another element of consideration prior to formally requesting a tax ruling.    

UK: Name and shame scheme of promoters

HMRC has published new guidance providing for publication of names re: high risk promoters.  To the extent a promoter has not complied with the terms of a Conduct Notice previously communicated to them, the promoter will be publicly named and they will need to inform their clients of this monitoring action.

The first Conduct Notice has already been issued, as part of HMRC’s ambitious intent to address “tax avoidance.”

A link to the news story is provided:

https://www.gov.uk/government/news/high-risk-promoters-of-tax-avoidance-face-government-clampdown

The timing is also noteworthy, as it precedes final drafting of the Diverted Profits Tax proposal which will soon be followed by elections.

Advisors, as well as MNE’s, should monitor this trend of “name and shame,” as it is generally considered too late for damage control after one’s name and reputation are subject to public perception in this new age of addressing “tax avoidance.”

UK Consultation document: Tax Avoidance sanctions

HMRC has released a Consultation document entitled: Strengthening Sanctions for Tax Avoidance.  The document was provided on 30 January 2015, with comments due by 12 March 2015.  The document targets repeat offenders of tax avoidance schemes, and also proposes GAAR penalties and processes.

A link is included for reference:

Click to access Strengthening_sanctions_for_tax_avoidance_-_consultation_document.pdf

Key provisions:

  • It is focused on “tax avoidance” arrangements, specifically targeting “serial avoiders.”
  • A tax surcharge and special measures are suggested for repeated use of tax avoidance schemes.
  • A “name and shame” approach is also suggested, although being wary of reputational damage.
  • GAAR: It is now the right time to reconsider imposition of a GAAR-specific penalty and surcharge.  The document addresses maintenance of the current GAAR Independent Advisory Panel and related guidance, for which a flowchart is provided in Annex B for reference.
  • A series of questions re: Serial Avoiders and GAAR Penalties are provided for comment.

It is interesting to note the surcharge and accelerated payment concepts, also introduced in the controversial Diverted Profits Tax proposal.  Additionally, retaining the GAAR independent panel is a welcome statement that is not proposed for comment.

The inherent subjectivity of “tax avoidance” proposals potentially subject taxpayers and tax administrations to further complexity, additional costs and potential double taxation.  Therefore, all interested individuals and organisations should review this document and prepare comments to address this initiative, as other countries will be following these developments for possible application in their respective jurisdictions.

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 Strategy for Developing Countries

The OECD has released its plans for developing countries to play a greater role in its BEPS initiatives.  A link to the OECD release is attached:

http://www.oecd.org/newsroom/developing-countries-toplay-greater-role-in-oecdg20-efforts-to-curb-corporate-tax-avoidance.htm

Summary:

  • Three-part strategy
    • Attendance at meetings by 10 developing countries, including Albania, Jamaica, Kenya, Peru, Philippines, Senegal and Tunisia.
    • Five regional networks of tax policy and administration officials will be established for coordination and dialogue on BEPS issues.  The regional focus includes developing countries located in Asia, Africa, Central Europe, Middle East, Latin America / Caribbean and Francophone regions.  The regional network will also be a forum for developing countries to discuss negotiation and implementation of the multilateral instrument under Action 15 of the BEPS Project.
    • BEPS toolkits to be developed for practical implementation and capacity building.
  • A two-day workshop is scheduled in December 2014 that will allow developing countries to discuss practical aspects and their priority issues.

Developing countries generally have less resources, experience and training to implement BEPS effectively, therefore this initiative should be monitored to determine ultimate success of the BEPS initiatives around the world.

Substance vs. Form: “Directive Shopping”

Today’s tax climate, OECD Base Erosion & Profit Shifting (BEPS) Action Plans, 2014 changes to the OECD Model Tax Convention re: “Beneficial Ownership” (refer to 22 July 2014 post), and General Anti-Abuse Rules (GAAR) all focus on increased substance of activities in an entity, versus pure legal form, to derive relevant treaty benefits.

A recent Austrian Administrative High Court decision (VwGH 26/6/2014, 2011/15/0080-13) focused on the EU Parent-Subsidiary Directive (PSD) re: “directive shopping.”  There were dividend distributions from an Austrian company to a pure holding company in Cyprus with no people or physical assets. Withholding tax was paid by the Austrian company, with a refund claimed by the Cypriot company in accordance with the EU PSD.  (Note the Cypriot company had a Russian shareholder, for which direct distributions from Austria to Russia would not have the benefit of the EU PSD.)

The High Court, confirming the tax authority’s view, stated the Cypriot company structure was abusive.  Accordingly, the withholding tax refund application of the Cypriot company was denied.

The substance vs. form application of the case highlights the potential withholding tax issues for a pure holding company located in a tax favorable jurisdiction.  Thus, all holding company structures should be reviewed under current law, and most importantly with respect to future international tax changes focusing on the proper substance to receive treaty benefits.

2014 Update to the OECD Model Tax Convention

The 2014 Update, as adopted by the OECD Council on 15 July 2014, includes changes that were previously released for comments, including the meaning of “beneficial owner.”  Numerous additions and deletions to Commentaries on various Articles, including positions of non-member countries, are also included.  A link to the Update is provided for reference:

http://www.oecd.org/tax/treaties/2014-update-model-tax-concention.pdf

Interesting changes:

  • Article 5 Commentary: new views by Germany, Estonia, and Israel.
  • Article 9 Commentary: Hungary (newly added) and Slovenia reserve the right to specify that a correlative (i.e., offsetting) adjustment will be made only if they consider that the primary adjustment is satisfied.
  • The term “beneficial owner” does not have reference to any technical meaning under domestic law, thus it should not be used in a narrow technical sense, rather, it should be understood in its context and in light of the object and purposes of the Convention including avoiding double taxation and the prevention of fiscal evasion and avoidance.
  • The term “beneficial owner” does not deal with other cases of treaty shopping, which can be addressed in specific anti-abuse treaty provisions, general anti-abuse rules (GAAR), substance-over-form or economic substance approaches.
  • Article 13 Commentary: With respect to paragraph 3.1, Austria and Germany hold the view that when a new tax treaty enters into force, these countries cannot be deprived of the right to tax the capital appreciation which was generated in these countries before the date when the new treaty became applicable.
  • Article 26 Commentary: The Commentary was expanded to develop the interpretation of the standard of “foreseeable relevance” and the term “fishing expeditions,” i.e. speculative requests that have no apparent nexus to an open inquiry or investigation.  The Commentary further provides for an optional default standard of time limits within which the information is required to be provided unless a different agreement has been made by the competent authorities.  The examples provided are to demonstrate the overarching purpose of Article 26 not to restrict the scope of exchange of information but to allow information exchange “to the widest possible extent.”

The Update requires a comprehensive review to determine potential implications, including beneficial ownership restrictions and ways of working by competent authorities.  Such review should distinguish changes to the Articles versus additions or deletions to the Commentary interpreting such Articles.  Note that the OECD BEPS changes will be an addition to this Update.

Parent Sub Directive: EU Anti abuse proposals

European Commission tackles tax avoidance: tightening key EU corporate tax legislation

http://europa.eu/rapid/press-release_AGENDA-13-40_en.htm

On 25 November, the European Commission will adopt a proposal to amend the Parent Subsidiary Directive (2011/96/EU) in order to close off opportunities for corporate tax avoidance. The Parent Subsidiary Directive was originally conceived to prevent the double taxation of same-group companies based in different Member States. However, loopholes in the Directive have been exploited by some companies to avoid paying any taxes at all. The proposal aims to close these loopholes. First, it will introduce a common anti-abuse rule into the Directive. This will allow Member States to ignore artificial arrangements used for tax avoidance purposes and to tax on the basis of real economic substance. Second, it will ensure that the Directive is tightened up so that specific tax planning arrangements are no longer eligible for the tax exemptions provided under the Directive.

The background:

The issue of corporate tax avoidance is very high in the political agenda of many EU and non-EU countries, and the need for action to combat it has been highlighted at recent G20 and G8 meetings.

One of the key problems to be addressed is that of double non-taxation i.e. where loopholes in national tax systems are exploited by companies to pay no tax at all. Double non-taxation deprives Member States of significant revenues and creates unfair competition between businesses in the Single Market. Tackling this problem requires urgent and coordinated action at EU level.

On 6 December 2012 the Commission presented an Action Plan for a more effective EU response to tax evasion and avoidance. This action set out a comprehensive set of measures, to help Member States protect their tax bases and recapture billions of euros legitimately due (IP/12/1325). The revision of the Parent Subsidiary Directive is one of the measures announced in the action plan.

The event:

Algirdas Šemeta, the European Commissioner for Taxation, Customs, Anti-Fraud, Statistics and Audit will present the proposal at the midday briefing in the Commission’s press room. Press materials will be available on the day.

  1.  Available on EbS

The sources:

Information on fight against tax fraud and evasion:

http://ec.europa.eu/taxation_customs/taxation/tax_fraud_evasion/index_en.htm

Information on Commissioner Šemeta:

http://ec.europa.eu/commission_2010-2014/semeta/index_en.htm

This important proposal should be monitored by all multinationals re: potential impacts upon current or future planning and relevant documentation.

Indian GAAR: 10 important features to watch out for

This excellent article was contributed by Ajay Kumar and Richa Sawhney.

The article elaborates on the following observations, which should be considered for General Anti-Avoidance Rules (GAAR) worldwide:

  • Broad subjectivity of provisions
  • GAAR applies in addition to prior Specific Anti-Abuse Rules (SAAR)
  • GAAR provisions override the respective tax treaties
  • A binding ruling is issued by a GAAR panel
  • GAAR may apply, notwithstanding meeting the respective Limitation of Benefits (LOB) clause in the treaty
  • There are no provisions addressing compensating transfer pricing adjustments

From a Best Practices perspective, the observations and prior postings should be reviewed to develop Best Practices for future challenges.

Structuring Transactions – Watch out for 10 important features of Indian GAAR
Ajay Kumar and Richa Sawhney
Danta Transaction Services
October 2013

With the release of GAAR Rules (Rules) in September 2013 by the Central Board of Direct Taxes (CBDT), India looks set to implement its statutory General Anti Avoidance Rule (GAAR). GAAR provisions were inserted in the Income-tax Act, 1961 (IT Act) by Finance Act, 2012 and would be effective in relation to incomes arising on or after April 1, 2015. Earlier this year, several changes were made in the GAAR provisions by Finance Act 2013. These changes were made based on the recommendations of the Committee set up under the chairmanship of Dr. Parthasarthi Shome (Shome Committee). While it looks as if GAAR implementation is some time away, MNCs in particular need to consider the impact, as the GAAR Rules provide for limited grandfathering.

This Article covers 10 major features of how the Indian GAAR is expected to work and the areas foreign investors need to focus on.

1.    Main Purpose

GAAR would be invoked in case of “impermissible avoidance arrangements”. An impermissible avoidance arrangement refers to an arrangement whose main purpose is to obtain a tax benefit. Further in addition to the main purpose one of the four supplementary tests[i] is also required to be met.However where the main purpose is established to be non tax then one is not required to prove that none of four supplementary tests are met.

The term “main purpose”, the touchstone of GAAR, is not defined. So how does one compare “non tax purpose” with “tax benefit purpose”. There could be several purposes/objectives in an arrangement some may be amenable to quantification and it may not be possible to do so in case of others.

Given that GAAR by definition cannot be completely objective, it is extremely important for the taxpayer to document all the factors that were considered to conclude the main purpose. In our view one should document the all objectives behind any arrangement, options evaluated and the basis of selection or rejection of the options considered. The minutes of Board or Committee meetings, profitability projections and feasibility studies could help substantiate the taxpayers claim. Given that guidance will evolve overtime, one should start documenting business advantages alongside the tax advantage of the options considered, particularly in those situations where the tax benefit will accrue over several years.

In our view unless it is a case of pure sham transaction, in most of the cases, it should be possible for the tax-payer to establish that business and commercial reasons outweigh the tax reasons. This could in effect be the potent weapon to counter GAAR.

2.    Tainted Elements

The secondary or the supplementary tests, often called the tainted elements are the next important aspect one must be familiar with. Once the main purpose is found to be tax benefit, GAAR provisions will apply only and only if any one of the following tests are met:

(a)  The dealings between parties is not at arm’s length,

(b)  There is lack of bonafide purpose,

(c)  There is misuse or abuse of the provisions of the IT Act,

(d)  There is lack of commercial substance.

Except in case of commercial substance where some sort of guidance is provided under the law, there is no guidance available on the parameters for fulfilment/non fulfilment of these tests. The matter is entirely left to the discretion of the tax authorities. To make matters a bit simpler Shome Committee had recommended that at least arm’s length test should be examined only in cases not covered by Transfer Pricing. However it has not been included in the Rules so far.

A plain reading of the GAAR provisions suggests that lack of bonafide purpose test is considered met if an arrangement is entered into, or carried out, by means or in a manner, which are not ordinarily employed for bona fide purposesAs the language suggests, it is more of a manner test rather than a purpose test. So one can only anticipate trouble if the tax officer feels that the arrangement appears to be too complicated and what is sought to be achieved could have been accomplished in a simpler manner. The taxpayer may also have to explain if there is any reason apart from tax reason to justify what might appear to the tax officer as superfluous steps.

As far as the misuse and abuse test is concerned, the question is does it mean the contextual or purposive interpretation of provisions of the IT Act i.e. what was the backdrop in which a particular provision was introduced, what mischief it wanted to remedy, what loophole in law was intended to be covered or the purpose and spirit behind the enactment. In some cases the government does come up with clarificatory Circulars and Memorandum explaining provisions inserted in the law from which this intent can be gathered, but they are not exhaustive. In light of the above, it can be very difficult to analyse and apply misuse/abuse test where the rationale of provisions are not outlined by the government.

3.    SAAR v. GAAR – Simultaneous applicability

The IT Act contains several Specific Anti Avoidance Rules (SAARs)[ii]. They target specific areas of tax avoidance. In case of conflict between general provisions and specific provisions courts in India have laid down than specific provisions overrule general provisions. Departing from this maxim the GAAR provisions state that GAAR would to apply” in addition to, or in lieu of, any other basis of determination of tax liability”.

The Shome Committee had recommended that for the sake of clarity and certainty, in case SAAR is applicable in any particular situation then GAAR should not be invoked in that case. The government had a different view. It was indicated that if in situation both GAAR and SAAR are applicable, guidelines would be made to clarify that only one of them will apply. The existing Rules do not deal with this issue.

4.    GAAR override on Treaty

The provisions lay down that in situations where GAAR is invoked any Tax treaty benefits claimed by the taxpayer would be denied.

Consider a case where in GAAR is invoked and the undesirable tax advantage being claimed by the taxpayer is denied.  Now post this treatment by the tax authorities, the impermissible avoidance agreement can no longer be considered impermissible. One would want to know if Tax treaty benefit is still not available for this “treated” arrangement. Say in case GAAR is invoked and part of the equipment price paid to the foreign parent gets re-characterised as Royalty. Now in such situations after the tax consequences have  been determined under GAAR, would the beneficial withholding tax of 10% provided in the Tax treaty apply to such Royalty or withholding @ 25% specified under the IT Act would have to be carried out.

Another related issue arises in case of Tax treaties which have anti- avoidance provisions in form of Limitation of Benefits (LoB) clause, say the India- Singapore Tax treaty. The Shome Committee was of the view that GAAR should not be invoked to deny Tax treaty benefit in case the Tax treaty itself has a LoB clause. Cases of avoidance in such cases, should be left to be dealt by the LoB clause. If need be, i.e. the LoB clause fails to deliver, the Government should look at re-negotiating the Tax treaty.  However the GAAR Rules and law are silent on this point. Hence MNCs should be ready to subject themselves to additional GAAR tests even though they may otherwise fulfil LoB tests given under the relevant Tax treaty.

5.    Applicability to existing investments/structures

Immunity has been provided only to income from transfer of investments made before August 30, 2010, i.e. date of introduction of Direct Taxes Code Bill 2010. Hence even if the same structure or arrangement is used by the taxpayer to route further investments post August 31, 2010 that would be subject to GAAR tests.

All the other existing and proposed arrangements will be subject to GAAR tests. In the context of investments from Mauritius, Singapore, Cyprus etc. made before August, 30 2010, income from transfer of such investments will continue to enjoy Tax treaty benefits without having to go through the rigours of GAAR.  But where there is other income accruing on such investments e.g. interest income earned on Compulsory Convertible Debentures it will be subject to GAAR test even though such investments were made before August 30, 2010.

6.    When can one apply for Advance Rulings

Under the GAAR regime, the taxpayer can obtain Rulings in advance, as regards applicability of GAAR on the specifics of their case. The Authority for Advance Ruling (AAR) could be approached for such Rulings. Further,though the GAAR provisions do not provide any immunity to arrangements proposed to entered into before April 1, 2015, one can approach the AAR for a Ruling only after March 31, 2014. Given the current backlog of applications pending at AAR, one can only expect to see such Rulings coming out around December 2014. In essence, the point is that the MNCs will have limited time to make their arrangements GAAR compliant, before GAAR provisions kick off in April 2015.

7.    Safe harbors

The current provisions do not contain any other safe harbors except the monetary threshold.

The Rules stipulate that GAAR will apply if the tax benefit is more than INR 3 crore (equivalent of US$ 500000) in a financial year after taking into account all parties to an arrangement. The other way to look at it is that given the corporate tax rate is 30% and capital gains rate is 10%, or 0% in case of listed securities, it is only small value transactions which will be out of the purview of GAAR. In case of tax deferral ShomeCommittee had suggested that the tax benefit amount should be worked out on the basis of present value of money, taking the interest rate as that applicable for shortfall of taxes. The Rules are silent on this aspect.

Though from the legislative intent of GAAR provisions[iii] it appears that GAAR would target only aggressive tax planning through use of sophisticated structures, clarity on use of fiscal incentives provided under the IT Act would have been really appreciated. In fact the Shome Committee, taking into account the concerns of stakeholders had recommended that cases of selection of one of the options provided under law such as purchase v. lease, dividend v buyback, funding through debt or equity, timing of a transaction in case of capital gains, mergers and amalgamation approved by Court should be clearly out of the purview of GAAR. It was felt that considering India does not have Thin Cap Rules yet, choice of funding either through debt or equity should be left to the taxpayer and tax officer should not question it. However the Rules are silent on this aspect.

8.    Wide powers conferred on Tax Authorities

Wide powers have been conferred on the tax authorities to nullify the tax benefit being sought by the taxpayer. This includes lifting of corporate veil, clubbing or disregarding entities, treating capital receipts as revenue, debt as equity etc. Here again it can be seen that the power of re-characterization of debt into equity has been given, despite the absence of any formal Thin Cap Rules in India. However, the tax officer who issues a notice alleging that GAAR should apply to an arrangement has to provide detailed reasoning behind his belief.

The other major safeguard is that a GAAR Panel which would comprise a High Court Judge, Chief Commissioner of Income-tax and a Scholar of repute would review the cases. The directions issued by this Panel would be binding on taxpayer and tax authorities. Time lines have also been laid down for each step in this process.

9.     Compensatory Adjustment

If GAAR gets invoked in case of one party to an arrangement; there is no provision to effectuate any compensatory adjustment in respect of other parties to the arrangement.

Let us consider a situation where Company A makes interest payment to Company B. Let us now assume that GAAR gets invoked in this case and the payment gets re-characterised as dividend. Company A would now be required to pay dividend distribution tax (DDT) on the same. Now the question is, should this be treated as dividend in the hands of Company B and be taken to be tax exempt or should it be continued to be taxed as interest. Under the current GAAR provisions it would continue to be taxed as interest. The intent is to ensure that GAAR does not lose its deterrent value. The government has however indicated that the same income would not be taxed twice in the hands of one taxpayer because of GAAR adjustments.

10.   GAAR on FIIs

As per the Rules, GAAR provisions would not be applicable in case of FIIs registered with Securities Exchange Board of India (SEBI) which are not availing any Tax treaty benefit. Further, investment made by non-resident investors in FIIs, whether by way of offshore derivate instruments or otherwise, either directly or indirectly also do not get covered under the provisions of the GAAR.

Coming to the point

Coming to the point, changes made by Budget 2013 and the recently released GAAR Rules have ironed out a number of issues that stakeholders were really concerned about, but clarity is still required on several key aspects. It s not clear as to whether the open issues will be addressed anytime before GAAR provisions become effective which is April 1, 2015. MNCs would be well advised to have a GAAR test applied to current structures. They should clearly analyse and assess whether their arrangements fulfil the main purpose test being tax benefit or are the other business purposes predominant. Though the Rules do not provide guidance and are unlikely to provide any guidance before these provisions become effective, one should apply a common business sense test to analyse non-tax advantages of the current arrangements. Documentation of all facts and other business purposes will help MNCs defend any GAAR related enquiry. In case the assessments reveal that arrangements fail on account of main purpose test and one of the supplementary tests, MNCs should plan to restructure entities or restructure business dealing to ensure that the structures are GAAR compliant.  As MNCs will be able to apply for Advance Rulings after March 31, 2014, one can expect to get some guidance on how the judiciary interprets these new not so legal but economic concepts.



[i]
As per section 96 of the IT Act – An impermissible avoidance arrangement means an arrangement, the main purpose of which is to obtain a tax benefit, and it:

(a)   creates rights, or obligations, which are not ordinarily created between persons dealing at arm’s length;

(b)   results, directly or indirectly, in the misuse, or abuse, of the provisions of this Act;

(c)   lacks commercial substance or is deemed to lack commercial substance in whole or in part; or

(d)  is entered into, or carried out, by means, or in a manner, which are not ordinarily employed for bona fide purposes.

[ii]E.g. the transfer pricing provisions which ensure that international transactions between related parties or certain specified domestic transactions are at arm’s length, Income clubbing provisions in case of certain transfers, deemed dividend provisions etc

[iii]Memorandum explaining provisions of Finance Bill, 2012

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