Canadian banking outlook 2014

Increased scrutiny of cross-border transactions by taxation authorities

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The pace of global integration, not just of economies but also of culture, law, politics and business, led the Organisation for Economic Cooperation and Development (OECD) to release its report Addressing Base Erosion and Profit Shifting (BEPS) in February 2013. Current domestic and international tax laws are perceived to have become outdated and need to be updated for today’s dynamic and global business environment.

The focus of the OECD report was to describe studies and data available regarding the existence and magnitude of BEPS and to present issues faced by multinational enterprises (MNEs) related to global developments that have an impact on corporate tax. The key principles related to cross-border activities in which BEPS opportunities are created were discussed in the report, as were possible future changes and actions in respect of realigning international standards with the current global business environment. The report concluded that there is a need for increased transparency of the effective tax rates of MNEs.

The report identified six key pressure areas:

  1. International mismatches in entity and instrument characterization (hybrids and arbitrage)
  2. Application of tax treaty concepts to profits derived from the delivery of digital goods and services
  3. Tax treatment of related-party debt financing, captive insurance, and other intra-group financing
  4. Transfer pricing, particularly in relation to the shifting of risk and intangibles, the artificial splitting of ownership of assets between group legal entities, and group transactions that would rarely take place between independent entities
  5. Effectiveness of anti-avoidance measures such as the general anti-avoidance rule (GAAR), controlled foreign corporation (CFC) regimes, thin capitalization, and rules to prevent tax treaty abuse
  6. Availability of harmful preferential tax regimes.

Following this initial report, the OECD issued in July 2013 its Action Plan on BEPS, which outlined 15 separate focus areas of international tax law for the next phase of the ongoing BEPS project. These actions are expected to lead to changes to the OECD transfer pricing guidelines and model tax treaty, recommendations for domestic law, and the development of a multilateral treaty approach. This Action Plan has been fully endorsed by the G20 finance ministers and central bank governors.

The issue of BEPS has gained traction in international press given the growing perception that governments lose substantial corporate tax revenues because of tax planning aimed at shifting profits to lower-tax jurisdictions. As such, it is important that the business community become familiar with the ongoing BEPS project and review the OECD Action Plan to evaluate its potential implications on their future corporate taxation.