Client Alert:
OECD Action Plan on BasE Erosion and Profit Shifting Executive Summary On 19 July 2013, the Organisation for Economic Cooperation and Development (OECD) published its “Action Plan on Base Erosion and Profit Shifting” (the Action Plan). The OECD’s Action Plan aims at effectively preventing no or low taxation by Base Erosion and Profit Shifting (BEPS). BEPS relates to instances where the interaction of different tax rules results in the double non-taxation or less than single taxation by shifting profits away from the jurisdictions where the activities generate those profits. BEPS issues may arise directly from the existence of loopholes, as well as gaps, frictions or mismatches in the interaction of countries’ domestic tax laws. Loopholes resulting from the use of intangibles, risks, capital and other high-risk transactions shall be closed by the OECD’s Action Plan. In detail, the OECD (1) identifies in its Action Plan 15 actions needed, (2) sets deadlines until September 2014, December 2014 and December 2015 for the implementation of these actions and (3) figures out the resources and the methodology which are appropriate to implement these actions sufficiently. The digital industry is of specific interest of the Action Plan due to the difficulty of determining the jurisdiction in which value creation occurs and the question how it relates to the concepts of source and residence or the characterization of income for tax purposes. The proposed actions of the OECD concern (1) BEPS in general, (2) treaty-related actions, (3) permanent establishments (PE) and transfer prices and (4) disclosure. Concluding, the overall impact on German tax laws can be estimated as low to moderate. However, the impact might be substantial on other jurisdictions. Therefore, the Action Plan could affect the operating businesses either of foreign subsidiaries of German parents or of foreign parents of German subsidiaries (see table below).
Deadline Impact on Overall OECDAction Action Plan on Base Erosion and ProfitExpected ShiftingOutput German Tax Law
Impact
1
Address the tax challenges of the digital economy
09/2014
Report identifying taxation problems raised by the digital economy
low
low
2
Neutralise the effects of hybrid mismatch arrangements
09/2014
Changes in model treaty provisions and recommendations to domestic rules
low
moderate to high
3
Strengthen CFC rules
09/2015
Recommendations to revise domestic rules
low
moderate to high
4
Limit base erosion via interest deductions and other financial payments
9/2015 and 12/2015
Recommendations to revise domestic rules and changes to the Transfer Pricing Guidelines
low
moderate to high
5
Counter harmful tax practices more effectively, taking into account transparency and substance
9/2014, 12/2014 and 12/2015
Revision of the existing framework and expansion to non-OECD members
low
high
6
Prevent treaty abuse
09/2014
Changes in model treaty provisions and recommendations to revise domestic rules
low
high
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Client Alert: OECD Action Plan on BasE Erosion and Profit Shifting
Action
Deadline
Expected Output
Impact on German Tax Law
Overall Impact
7
Prevent the artificial avoidance of PE status
09/2015
Changes in model treaty provisions
high
high
8– 10
Assure that transfer pricing outcomes are in-line with value creation
9/2014 and 9/2015
Changes in model treaty provisions and transfer pricing guidelines
moderate to high
moderate to high
11
Establish methodologies to collect and analyse data on BEPS and the actions to address it
09/2015
Recommendations regarding data to be collected and analysing tools
depending on output
depending on output
12
Require taxpayers to disclose their aggressive tax planning arrangements
09/2015
Recommendations to revise domestic rules
depending on output
depending on output
13
Re-examine transfer pricing documentation
09/2014
Recommendations to revise domestic rules and changes to the Transfer Pricing Guidelines
low
moderate to high
14
Make dispute resolution mechanisms more effective
09/2015
Changes in model treaty provisions
depending on output
depending on output
15
Develop a multilateral instrument
9/2014 and 12/2015
Analysis of the tax and public international law issues related to a multilateral instrument
low
low
This client alert intends to provide some background information, summarizes the 15 actions recognized by the OECD and comments on the expected impact for tax payers in general and especially on German tax laws. Background The objective of international tax law to set clear and predictable rules eliminating double taxation can be traced back many decades ago. Today, the shifting of manufacturing bases from high-cost to low-cost locations, technological developments and the possibility to deliver digital products over the internet despite of the residence of the customer in another country facilitate attempts of multi-national enterprises (MNEs) to shift their income away from jurisdictions where income producing activities are conducted. Different tax rules of sovereign jurisdictions create gaps, in cases where corporate income is not taxed at all, either by the country of source or the country of residence, or is only taxed at nominal rates, leaving plenty of room for arbitrage exploitation by taxpayers. These developments have opened up opportunities for MNEs to minimize their tax burden by identifying and exploiting legal arbitrage opportunities.
Actions Action 1: Address the tax challenges of the digital economy (deadline: 9/2014) The OECD suggests examining (1) international tax rules allowing a company to dispose of a significant digital presence in the economy of another country without being liable to taxation due to the lack of tax nexus according to current international rules, (2) the attribution of value created from the generation of marketable location-relevant data through the use of digital products and services, (3) the characterization of income derived from new business models, (4) the application of related source rules, and (5) how to ensure the effective collection of VAT/GST with respect to the cross-border supply of digital goods and services. RBS-Comment: This action addresses the taxation issue triggered by the digital economy in double taxation treaties. As long as this action is restricted to identifying taxation issues of the digital economy, the direct impact on German and other jurisdictions’ tax laws might be low. At the same time, it is quite possible that after the identification of tax issues (expected for 9/2014) the OECD will promote further measures preventing tax challenges. The impact on the tax laws of Germany and other countries triggered by those measures could be substantial in the medium run.
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Client Alert: OECD Action Plan on BasE Erosion and Profit Shifting
Action 2: Neutralise the effects of hybrid mismatch arrangements (deadline: 9/2014) The OECD Model Tax Convention may be changed to (1) prevent the effects of a misuse of hybrid instruments and dual resident entities. In addition, recommendations to domestic rules are to be developed (2) to prevent exemption or non-recognition for payments deductible at the level of the payer, (3) non-deduction for a payment that is not considered in the determination of the income by the recipient, (4) prohibit deduction for a payment deductible in another jurisdiction and (5) provide guidance on co-ordination or tie-breaker rules where necessary. RBS-Comment: This action is implemented by the development of model treaty provisions and recommendations to domestic rules. Considering the existing provisions regarding the qualification of foreign companies and structures under German tax laws, the expected impact from this action might be low. However, other jurisdictions only provide for rare tax legislation on qualification of foreign companies. Consequently, in these jurisdictions the impact might be much more relevant. Furthermore, the aforementioned development of model treaty provisions could also affect the tax payers. Hence, the overall impact could be estimated as moderate to high. Action 3: Strengthen Controlled Foreign Corporations (CFC) rules (deadline: 9/2015) The OECD targets the shifting of income from a resident entity to a non-resident affiliated entity (located in a low tax jurisdiction) by strengthening CFC rules which discourage this kind of tax planning developments. RBS-Comment: This action shall be implemented by domestic rules. Therefore, the impact depends on whether or not the jurisdiction already implemented CFC rules. This is the case for Germany, see sec. 7–14 Foreign Tax Act. In contrast other jurisdictions, e.g. Ireland and Luxembourg, still do not have CFC rules in force. Therefore the overall impact could be estimated as moderate to high. Action 4: Limit base erosion via interest deductions and other financial payments (deadline: 9/2015 and 12/2015) The OECD attempts to develop recommendations and changes to the Transfer Pricing Guidelines regarding the best practice in the design of rules to prevent base erosion through the use of interest expenses, for instance, through the use of related-party and third-party debt to achieve excessive interest deductions. RBS-Comment: This action shall be implemented by domestic rules and changes to the Transfer Pricing Guidelines. German tax laws already limit the deductibility of interest payments (“thin capitalization rules”), see sec. 4h Income Tax Act and sec. 8a Corporate Tax Act. As far as German tax laws are applicable, the impact of this action might be low. Besides this, many other – especially EU Member States – countries provide interest barrier rules which restrict the deductibility of expenses on interest. On the other hand, several jurisdictions currently have not introduced any thin capitalization rules. It is quite possible that those jurisdictions use Action 4 as an opportunity to implement thin capitalization rules. In these cases the impact might be high. So the overall impact might be moderate to high. Action 5: Counter harmful tax practices more effectively, taking into account transparency and substance (deadline: 9/2014, 9/2015 and 12/2015) The Action Plan states that the possibility of BEPS resulting from the interactions among more than two countries has to be prevented by revisions to the existing framework. For any preferential regime a substantial activity is required. RBS-Comment: This action is implemented by double taxation treaties. Rules ensuring transparency as well as substantial activity for any preferential regime already exist in Germany, see sec. 90 para. 3 and sec. 42 General Tax Code. From a German perspective the expected impact might be low. However, in other jurisdictions the impact might be substantial.
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Client Alert: OECD Action Plan on BasE Erosion and Profit Shifting
Action 6: Prevent treaty abuse (deadline: 9/2014) The Action Plan states that in many countries, the interpretation of the model treaty provisions on agency-permanent establishments (PE) allows contracts for the sale of goods belonging to a foreign enterprise to be negotiated and concluded in a country by the sales force of a local subsidiary of that foreign enterprise without the creation of a respective tax nexus for the profits generated by these sales. Domestic rules shall be modified based on model treaty provisions and recommendations to prevent the granting of treaty benefits in inappropriate circumstances. RBS-Comment: The development of model treaty provisions and recommendations will be implemented by both domestic rules and double taxation treaties. Germany has already introduced several treaty override provisions with the aim to prevent treaty abuse. Hence, the expected impact for Germany might by low. In contrast the impact might be high in jurisdictions which do not have corresponding treaty override provisions in force. Action 7: Prevent the artificial avoidance of PE status (deadline: 9/2015) The OECD proposes amending the PE definition to prevent the artificial avoidance of a PE status in relation to BEPS by using commissionaire arrangements and specific activity exemptions. RBS-Comment: The definition of PE should be implemented by changes to model tax provisions. Depending on the criteria for the definition of PE, this action could eventually have significant impacts on taxpayers in Germany as well as in other countries. Actions 8–10: Assure that transfer pricing outcomes are in line with value creation (deadline: 9/2014 and 9/2015) The OECD plans to develop rules for prevention of BEPS. The focus is put on transfers of intangibles and other movable assets for less than their full value (action 8), the transfer of risks among, or allocation of excessive capital to group members to accrue inappropriate returns (action 9) and BEPS by engaging in transactions that would not, or only very rarely, occur between third parties (action 10). RBS-Comment: These actions will be implemented by the Transfer Pricing Guidelines and possibly the Model Tax Convention. Similar rules exist in Germany. The transfer of intangibles is regulated to some extent in sec. 3 FVerlV. Other high-risk transactions are regulated in sec. 1 Foreign Tax Act and sec. 42 General Tax Code. However, especially the transfer of intangibles may currently not be covered sufficiently according to German tax laws. Thus, the expected impact might be moderate to high. Although the vast majority of jurisdictions have implemented transfer pricing rules and arm‘s length principles for transactions, only a few of them will meet the expected requirements of the OECD provided by Action 8 to 10. Hence, the expected impact might by moderate to high. Action 11: Establish methodologies to collect and analyse data on BEPS and the actions to address it (deadline: 9/2015) The Action Plan suggests implementing tools to estimate the economic impact of BEPS as well as ensuring the availability of tools which monitor and evaluate the effectiveness and economic impact by actions taken to prevent BEPS. The OECD will foster this measure by developing recommendations. RBS-Comment: The future recommendations will be implemented by double taxation treaties and domestic rules. Several data sources already exist in Germany and other jurisdictions. The impact depends on the extent to which specific measures will be taken. Thus, the impact on Germany and other countries depends on the specific outcome of Action 11. Action 12: Require taxpayers to disclose their aggressive tax planning arrangements (deadline: 9/2015) The Action Plan suggests the development of recommendations regarding mandatory disclosure rules for aggressive or abusive transactions, arrangements or structures by expanding the definition of “tax benefit”.
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Client Alert: OECD Action Plan on BasE Erosion and Profit Shifting
RBS-Comment: The disclosure rules shall be implemented by domestic rules. Under German tax laws sec. 90 para. 3 General Tax Code taxpayers are obligated to provide tax authorities with relevant information regarding cross-border transactions and arrangements. The consequences for Germany and other jurisdictions depend on how to define aggressive but legal transactions and arrangements in contrast to abusive and illegal structures. Hence, the overall impact depends on the outcome of Action 12. Action 13: Re-examine transfer pricing documentation (deadline: 9/2014) The OECD attempts to develop rules regarding transfer pricing documentation, taking into consideration the compliance costs for businesses. The aim is to increase transparency for tax administration. All relevant governments shall be provided with the information on the global allocation of the income, economic activity and taxes paid among the countries. RBS-Comment: The action shall be implemented by domestic rules and changes to the Transfer Pricing Guidelines. Provisions dealing with the documentation of transfer prices exist in Germany. Consequently, the expected impact might be low according to German tax laws. However, some other jurisdictions do not provide sufficient rules on transfer prices documentation. It is very likely that businesses paying taxes in those jurisdictions face a strong impact by Action 13. So the overall effect might be moderate to high. Action 14: Make dispute resolution mechanisms more effective (deadline: 9/2015) The Action Plan attempts to develop solutions to address obstacles that prevent countries from solving treaty-related disputes under the mutual agreement procedure (MAP). The OECD states that most treaties lack of arbitration provisions and that access to MAP and arbitration may be denied in certain cases. RBS-Comment: The action will be implemented by double taxation treaties; say by negotiations of contracting countries. Therefore it is quite difficult to assess the impact in advance. For EU-Member States the Arbitration Convention provides rules for dispute resolutions. Action 15: Develop a multilateral instrument (deadline: 9/2014 and 12/2015) The OECD suggests to analyze the tax and public international law issues related to the development of a multilateral instrument to enable jurisdictions to implement the aforementioned actions and amend bilateral treaties. RBS-Comment: The action will be implemented by a multilateral instrument. The probability of sovereign jurisdictions agreeing upon multilateral rules might be not very high. This thesis can be proved by the unsuccessful attempts of the European Union to implement multilateral double tax treaties. The only multilateral double tax treaty which is set in force by now exists between Denmark, Finland, Sweden, Iceland and Norway. Accordingly, the impact might be low.
Contact
Marcus von Goldacker
Reinhard Ewert
Tax Advisor
Attorney, Tax Advisor
Partner
Senior Manager
T +49 89 350 00-2324
T +49 89 350 00-2344
E m.vongoldacker@rbs-partner.de
E r.ewert@rbs-partner.de
Dr. Tobias Heerdt Manager T +49 89 350 00-2328 E t.heerdt@rbs-partner.de 5
Client Alert: OECD Action Plan on BasE Erosion and Profit Shifting
Note to this Client Alert: Neither the RBS RoeverBroennerSusat GmbH & Co. KG, nor other related entities of the RBS Group (i. e. RBS RoeverBroennerSusat Geschäftsführungs-GmbH, RBS RoeverBroennerSusat Rechtsanwaltsgesellschaft mbH, SUSAT Gesellschaft für Beratung und Revision mbH, SUSAT GmbH, RBS RoeverBroennerSusat Consulting GmbH, RBS RoeverBroennerSusat Advisors GmbH & Co. KG hereinafter only and collectively called RBS Group) renders, by means of this client alert, professional advice, service or recommendation for a certain entrepreneurial or personal decision. The sole purpose of this client alert is to outline general thoughts regarding some aspects of the OECD Action Plan on Base Erosion and Profit Shifting. This Client Alert contains general information only. Decisions have to be made independently and autonomously by the client. Before making any decision or taking any action related to the content of this Client Alert both for yourself and on behalf of another person, you should consult a qualified professional advisor. No entity of the above defined RBS Group shall be responsible for any loss whatsoever sustained by any person who relies on this client alert. Editorial: Marcus von Goldacker Herzog-Heinrich-Strasse 22 D-80336 München T +49 89 350 00-2324 E m.vongoldacker@rbs-partner.de Publisher: RBS RoeverBroennerSusat GmbH & Co. KG Wirtschaftsprüfungsgesellschaft Steuerberatungsgesellschaft D-Domstrasse 15 20095 Hamburg