OECD issues Action Plan on Base Erosion and Profit Shifting (BEPS)
On 19 July 2013, the Organisation for Economic Cooperation and Development (OECD) issued its much-anticipated Action Plan on Base Erosion and Profit Shifting (the Plan). The Plan can be viewed at “Action Plan”.
The Plan reiterates the themes of the initial report on BEPS, Addressing Base Erosion and Profit Shifting (the Report): that, in the OECD’s view, gaps in the interaction of domestic tax rules of various countries, the application of bilateral tax treaties to multijurisdictional arrangements, and the rise of the digital economy with the resulting relocation of core business functions have led to weaknesses in the international tax system. The Plan acknowledges that in many circumstances existing domestic law and treaties yield the correct result, but states that without coordinated action in the areas that give rise to policy concerns, countries that wish to protect their tax base may resort to unilateral action that could result in a resurgence of double taxation as well as global tax uncertainty. Thus, the Plan concludes, fundamental, consensus-based changes are needed to address double non-taxation and cases of no or low taxation where taxable income is artificially separated from the activities that generate it.
The Plan contains 15 Actions, each of which is linked to specific outputs that are to be completed in 2014 or 2015:
- Address the challenges of the digital economy
- Neutralize the effects of hybrid mismatch arrangements
- Strengthen CFC rules
- Limit base erosion via interest deductions and other financial payments
- Counter harmful tax practices more effectively, taking into account transparency and substance
- Prevent treaty abuse
- Prevent the artificial avoidance of permanent establishment status
- Assure that transfer pricing outcomes are in line with value creation (three action items)
- Risks and capital, and
- Other high-risk transactions
- Establish methodologies to collect and analyze data on BEPS and actions to address it
- Require taxpayers to disclose aggressive tax planning arrangements
- Re-examine transfer pricing documentation
- Make dispute resolution mechanisms more effective
- Develop a multilateral instrument for amending bilateral treaties
The Plan recognizes the tremendous benefits of globalization for domestic economies, but expresses concern that the increasing globalization of the economy and of multinational corporations (MNCs), coupled with the growing digital economy, has made it easier for MNCs to locate many productive activities in geographic locations that are distant from the physical location of their customers. The Plan asserts that these developments have created opportunities for BEPS, which occurs through the interaction of different tax rules that leads to double non-taxation or less than single taxation and through “arrangements that achieve no or low taxation by shifting profits away from the jurisdictions where the activities creating those profits take place.” The Plan states that this has resulted in reduced revenue for governments and higher costs of enforcement, a shifting of the tax burden to other taxpayers, and competitive disadvantages for businesses that do not engage in BEPS. It also has caused some interest groups to question the fairness of tax systems.
The Plan states that no or low taxation alone is not per se a cause of concern; the concern arises in situations involving artificial separation of income from activities. The Plan also states that the relocation of core business functions resulting in a different distribution of taxing rights that may lead to low taxation is not per se evidence of defects in the existing system; rather, an examination of how value is added and profits are made is necessary. The Plan states that although certain of the Actions will restore both source and residence taxation where cross border income would otherwise be subject to zero or very low tax, the actions are not directly aimed at changing the current standards on allocation of taxing rights on cross border income.
The Plan calls for fundamental changes to the current mechanisms and the adoption of new consensus-based approaches, including anti-abuse provisions, designed to prevent and counter BEPS. The Plan outlines 15 separate Actions that will be the focus of OECD work going forward. The expected outputs of the work, and the target dates for completion, are set forth in an Annex.
Action aimed at addressing concerns with respect to the digital economy
The Plan states that in order to effectively address BEPS concerns with respect to the digital economy, a thorough analysis is required of the different business models and how value is generated. The Plan indicates that a dedicated task force on the digital economy will be established.
Action 1 – Address the tax challenges of the digital economy
Action 1 proposes to identify the main difficulties in applying the current international tax rules to the digital economy and to develop detailed options to address these difficulties, taking a holistic approach and considering both direct and indirect taxation. The Plan calls for the examination of (i) the potential for a digital presence in a country without creation of taxable nexus; (ii) the attribution of value that is created from marketable location-relevant data generated through the use of digital products and services; (iii) the characterization and sourcing of income from new business models; and (iv) how to ensure the effective collection of VAT/GST with respect to cross-border digital delivery.
The expected output of this Action is a report identifying issues and possible actions. The target date is September 2014.
Actions aimed at establishing international coherence of corporate income taxation
The Plan states that there is a need to complement the current rules on preventing double taxation with a new set of standards “designed to establish international coherence in corporate income taxation.”
Action 2 – Neutralize the effects of hybrid mismatch arrangements
The Plan states that hybrid mismatch arrangements can be used to achieve unintended double non-taxation or long-term tax deferral. The Plan states that rules that allow taxpayers to choose the tax treatment of certain domestic and foreign entities could facilitate hybrid mismatches.
Action 2 proposes to develop model treaty provisions and recommendations regarding the design of domestic rules to neutralize the effect of hybrid instruments and entities. These may include: (i) changes to the OECD Model Tax Convention to prevent granting treaty benefits in inappropriate circumstances; (ii) domestic law provisions to prevent exemption or non-recognition for payments that are deductible by the payor; (iii) domestic law provisions denying a deduction for a payment that is not includible in income by the recipient or under controlled foreign corporation (CFC) rules; (iv) domestic law provisions denying a deduction for a payment that is also deductible in another jurisdiction; and (v) guidance on coordination or tiebreaker rules, where necessary, if more than one country seeks to apply such rules to a transaction or structure.
The Plan states that this work will be coordinated with the work on the Actions on interest expense deduction limitations, CFC rules, and treaty shopping. The expected output of this Action is changes to the OECD Model Tax Convention and recommendations on domestic rules. The target date is September 2014.
Action 3 – Strengthen CFC Rules
The Plan states that CFC rules address BEPS by discouraging the shifting of income from a resident enterprise to a non-resident affiliate. The Plan states that although CFC rules in principle lead to income inclusions in the residence country of the ultimate parent, they also affect the source country positively by lessening any incentive to shift profits into a third, low-tax jurisdiction.
Action 3 proposes to develop recommendations regarding the design of CFC rules. The expected output of this Action is recommendations regarding domestic law provisions. The target date is September 2015.
Action 4 – Limit base erosion via interest deductions and other financial payments
The Plan states that deductible interest payments may give rise to double non-taxation in both inbound and outbound scenarios. The Plan also states that deductions for other financial payments raise similar concerns, particularly in the context of transfer pricing.
Action 4 proposes to evaluate the effectiveness of different types of limitations and develop recommendations regarding best practices in the design of rules to prevent BEPS through the use of interest expense and other economically-equivalent financial payments. Transfer pricing guidance will also be developed regarding the pricing of related party financial transactions, including financial and performance guarantees, derivatives, and captive and other insurance arrangements.
The Plan states that this work will be coordinated with the work on the Actions on hybrids and CFC rules. The expected output of this Action is recommendations on domestic provisions and changes to the OECD Transfer Pricing Guidelines. The target dates are September and December 2015.
Action 5 - Counter harmful tax practices more effectively, taking into account transparency and substance
The Plan references the OECD’s 1998 report on harmful tax practices and states that concerns about a “race to the bottom” with respect to corporate tax rates on mobile income continue to be relevant.
Action 5 proposes to refocus the work of the OECD’s Forum on Harmful Tax Practices to develop more effective solutions to harmful tax practices, with a priority on improving transparency and on requiring substantial activity for any preferential regime. This will include a focus on compulsory spontaneous exchange of information on rulings related to preferential regimes. It also proposes engagement with non-OECD members.
The expected output of this Action is a report on the review of member country regimes, a report on strategy to expand participation to non-OECD member countries, and revision of existing criteria with respect to harmful tax practices. The target dates range from September 2014 to December 2015.
Actions aimed at restoring full effects and benefits of international standards
The Plan states that while current rules work well in many cases, the rules must be modified to address the use of multiple layers of entities inserted between a residence country entity and a source country entity.
Action 6 – Prevent treaty abuse
The Plan states that abuse of tax treaties is one of the most important sources of BEPS concerns.
Action 6 proposes to develop model treaty provisions and recommendations on the design of domestic rules that would prevent the granting of treaty benefits in inappropriate circumstances, clarify that tax treaties are not intended to be used to generate double non-taxation, and identify tax policy considerations that countries should take into account when determining whether to enter into a tax treaty with another country.
The Plan states that this work will be coordinated with the work on the Action on hybrids. The expected output of this Action is changes to the OECD Model Tax Convention and recommendations on domestic rules. The target date is September 2014.
Action 7 – Prevent the artificial avoidance of permanent establishment (PE) status
The Plan states that the PE definition must be updated to prevent abuses, citing in particular the agency-PE rules, the treatment of commissionaire arrangements, and the PE exceptions for preparatory and ancillary activities.
Action 7 proposes to develop changes to the definition of PE to prevent the artificial avoidance of PE status in relation to BEPS, including through the use of commissionaire arrangements, and the specific activity exemptions. This Action also will address related profit attribution issues.
The expected output of this Action is changes to the OECD Model Tax Convention. The target date is September 2015.
Actions aimed at assuring that transfer pricing outcomes are in line with value creation
The Plan states that while existing transfer pricing rules based on the arm’s length principle are an effective and efficient means of allocating income among taxing jurisdictions in many cases, there are other cases where transfer pricing rules have been mis-used to separate income from activity. The Plan specifically rejects suggestions regarding adoption of an alternative allocation system like formulary apportionment. There are three Actions in the transfer pricing category.
Action 8 – Intangibles
Action 8 proposes to develop rules to prevent BEPS involving the move of intangibles among group members, which will involve adopting a broad, clear definition of intangibles; ensuring that profits associated with the transfer and use of intangibles are appropriately allocated in line with value creation; developing rules for transfers of hard-to-value intangibles; and updating guidance on cost contribution arrangements.
The expected output of this Action is changes to the OECD Transfer Pricing Guidelines and possibly to the OECD Model Treaty. The target dates are September 2014 and September 2015.
Action 9 – Risks and capital
Action 9 proposes to develop rules to prevent BEPS involving the transfer of risks among, or allocation of excessive capital to, group members, which will involve developing rules to ensure that “inappropriate returns” will not accrue to an entity solely because it has contractually assumed risks or has provided capital. The rules to be developed also will require the alignment of returns with value creation. The Plan states that this work will be coordinated with the work on the Action on interest deductions and other payments. The expected output of this Action is changes to the OECD Transfer Pricing Guidelines and possibly to the OECD Model Treaty. The target date is September 2015.
Action 10 – Other high risk transactions
Action 10 proposes to develop rules to prevent BEPS involving transactions which would not (or would only very rarely) occur between third parties, which will involve adopting rules to clarify the circumstances in which transactions can be recharacterized, clarifying the application of transfer pricing methods (profit splits in particular) in the global value chain context, and providing protection against common types of base-eroding payments such as management fees and head office expenses.
The expected output of this Action is changes to the OECD Transfer Pricing Guidelines and possibly to the OECD Model Treaty. The target date is September 2015.
Actions aimed at ensuring transparency while promoting increased certainty and predictability
The Plan states further work is needed on evaluating the scale and economic impact of BEPS-related activity and monitoring the impact of measures taken to address BEPS. It also states that disclosure by taxpayers of tax planning strategies is needed and that transfer pricing documentation requirements should be less burdensome and more targeted.
Action 11 – Establish methodologies to collect and analyze data on BEPS and the actions to address it
Action 11 proposes to develop recommendations on indicators of the scale and economic impact of BEPS and to ensure that tools are available to evaluate the effectiveness and economic impact of actions taken to address BEPS on an ongoing basis, which will involve developing an appropriate economic analysis, assessing existing data sources, identifying new data that should be collected, and developing methodologies based on aggregate data (such as foreign direct investment and balance of payments) and micro-level data (such as data from financial statements and tax returns). The Plan notes that this work will take into consideration the need to respect taxpayer confidentiality and the cost for both tax administrations and businesses.
The expected output of this Action is recommendations on what data to collect and methodologies for analyzing such data. The target date is September 2015.
Action 12 – Require taxpayers to disclose their aggressive tax planning arrangements
Action 12 proposes to develop recommendations on the design of mandatory disclosure rules for aggressive or abusive transactions, arrangements, or structures, taking into consideration the costs for tax administrations and businesses and drawing on the experiences of countries that have such rules in place. The Plan indicates that this work will use a “modular design” that aims at consistency, but that allows for country-specific tailoring. An identified area of focus is international tax schemes, and the work will explore how a broad definition of “tax benefit” can be used to capture such transactions. The Plan states that this work will be coordinated with OECD work on cooperative compliance, and will thus involve designing enhanced information sharing models for tax administrations to use.
The expected output of this Action is recommendations on domestic rules. The target date is September 2015.
Action 13 – Re-examine transfer pricing documentation
The Plan states that tax administrations have little capability of developing a complete understanding of a taxpayer’s global value chain. This potentially undermines the administration of the arm’s length principle and enhances opportunities for BEPS. In addition, the Plan states that the divergences of countries’ transfer pricing documentation requirements lead to significant administrative costs for businesses.
Action 13 proposes to develop rules on transfer pricing documentation to enhance transparency for tax administrations, taking into consideration the compliance costs for business. Such rules may include a requirement that MNCs provide “all relevant governments with needed information on the global allocation of income, economic activity and taxes paid among countries according to a common template.”
The expected output of this Action is changes to the OECD Transfer Pricing Guidelines and recommendations on domestic rules. The target date is September 2014.
Action 14 – Make dispute resolution mechanisms more effective
The Plan states that there likely will be uncertainties related to the interpretation and application of the new rules resulting from this Plan. It states that the uncertainties could be resolved by improving the effectiveness of the mutual agreement procedure (MAP).
Action 14 proposes to develop solutions to address obstacles that prevent countries from solving treaty-related disputes under the MAP, including the lack of arbitration provisions and the fact that access to MAP and arbitration may be denied in certain cases.
The expected output of this Action is changes to the OECD Model Tax Convention. The target date is September 2015.
Action aimed at addressing the need for swift implementation
The Plan notes that any changes in the OECD Model Tax Convention arising from the identified Actions will have no direct effect on bilateral treaties and that amending such agreements on a country-by-country basis would take a considerable amount of time. The Plan suggests that developing a multilateral instrument to amend bilateral treaties could be a promising approach for moving these changes forward.
Action 15 – Develop a multilateral instrument for amending bilateral treaties
Action 15 proposes to analyze the tax and public international law issues related to the development of a multilateral instrument that would enable jurisdictions to implement measures developed in the OECD’s work on BEPS, and amend bilateral tax treaties. The Action further proposes that interested parties will develop a “multilateral instrument designed to provide an innovative approach to international tax matters” that will reflect the “rapidly evolving nature of the global economy and the need to adapt quickly to this evolution.”
The expected output of this Action is a report on international law and tax issues and a multilateral instrument. The target dates are September 2014 and December 2015.
The Plan is an ambitious document that reflects the high-level political concern about BEPS issues in many OECD member countries. The Plan proposes an extraordinary amount of work to be undertaken over the next two and a half years. The expected outputs of the fifteen separate Actions include changes to OECD Transfer Pricing Guidelines, changes to the OECD Model Treaty, recommendations for domestic law rules, and the development of novel approaches such as multilateral tax instruments. Most of the expected outputs of the Plan then will require significant work at the individual country level in terms of determining whether, when and how to implement the OECD’s recommendations. The opportunity for the global business community to engage formally with the OECD on the BEPS project has been limited to date. However, the Plan indicates that the OECD’s work on the Actions will “include a transparent and inclusive consultation process” (although specifics on that process are not provided). Companies should evaluate which aspects of the Plan could have the greatest impact on their businesses, stay informed about ongoing developments in the OECD and in individual countries, and determine how to participate most effectively in discussions regarding this project, and regarding the underlying international tax policy issues, with the OECD and with tax policymakers in their home countries and the countries where they invest.