Board Matters Quarterly, September 2014
Global focus on tax base erosion and profit shifting
What boards should know about the OECD initiative
The tax landscape is clearly changing. As governments search for additional revenue streams, the focus on transparency is increasing and tax policies are being modified.
Boards and audit committees need to be well informed about tax policy developments and trends worldwide — in the markets they currently serve and those they may be considering.
A key project to monitor is an effort by the heads of state of the G20 countries. This initiative is driven largely by concern about the potential for multinational corporations (MNCs) to shift income to low- or no-tax jurisdictions.
The Organisation for Economic Co-operation and Development’s (OECD) base erosion and profit shifting (BEPS) project is meant to better coordinate how countries address tax strategies perceived as eroding countries’ tax bases. The project is intended to spur governments to change their tax laws and treaties in order to reduce opportunities to shift profits to lower-taxed jurisdictions.
Based on a 15-point action plan issued in July 2013, the BEPS initiative focuses on several areas, including:
- Reporting and transparency
- Transfer pricing
- Deductibility of financing costs
- Entitlement to tax treaty benefits
- Tax treatment of companies operating in the digital economy
- Preferential tax regimes
The OECD plans to issue a series of reports, analyses and recommendations between September 2014 and the end of 2015.
Why are the OECD’s recommendations important?
While not a governmental organization, the OECD is influential in setting global tax policy. Moreover, the BEPS project involves all of the G20 countries, including China and India, which are not OECD members.
Effects of the ongoing BEPS effort are already evident as individual countries have started implementing anti-BEPS policies through both legislation and enforcement activity, without waiting for the OECD’s final recommendations.
For example, new tax laws in France and Mexico have included several BEPS-related changes, including fresh restrictions on the deduction of financing costs. Many other countries are also taking action.
The US Treasury has taken a lead role and has strongly supported some OECD BEPS action items and been more cautious or even critical in other areas. Anti-BEPS measures are also featured in some recent US international tax reform proposals, as well as in the Obama Administration’s budget proposal.
Individual country responses to the OECD recommendations will vary, as will the timing of any legislative actions.
For this reason, companies and their boards need to carefully track BEPS-related developments, both at the OECD level and within the countries where the company has current or future operations, investment or activity.
By doing so, they can understand the trends and anticipate changes.
What is the expected outcome?
Ultimately, the OECD’s recommendations are expected to play a role in reshaping country tax laws. The likely long-term result for MNCs will be more aggressive tax enforcement, heightened tax scrutiny, greater transparency requirements, increased compliance costs and, potentially, more taxes paid.
The OECD expects to release a number of items in the last months of 2014, including:
- A template for country-by-country reporting
- Guidelines on transfer pricing for intangibles
- Recommendations on hybrid mismatch arrangements (i.e., certain instruments or entities that are treated differently under the tax laws of two countries)
- Recommendations on options to address treaty abuse
- Report on the tax challenges of the digital economy
- Report on OECD member country preferential tax regimes
- Report on the feasibility of a multilateral instrument for amending bilateral tax treaties
In most of these areas, the OECD will work on implementation and other details into 2015. The OECD will also begin work on the action items with 2015 target dates, including treatment of interest expense, allocation of risk and capital, and controlled foreign corporation rules.
How should boards prepare?
A significant number of OECD recommendations are now in place, and countries are now assessing how to develop their local implementation. The timing is right for companies to review their business models and structures against each recommendation to identify possible pressure points.
Current reporting and compliance processes should be reviewed in light of the likelihood of expanded requirements in the future. Careful assessment includes preparing for the possibility of country-by-country reporting of financial and operating profiles for each country in which an MNC operates. Proactively managing global tax controversy is also important.
Other steps companies can take to respond to BEPS-related developments include:
- Consider advance pricing agreements (APAs) and other early engagement with tax authorities to gain greater certainty
- Consider proactively communicating information regarding your company’s total tax and economic contribution with key stakeholders, including regulators and shareholders
- Consider engaging with the OECD and country policymakers on these international tax issues
Given the many moving pieces of the BEPS initiative, relevant information that emerges from discussions with policymakers should be shared frequently with a company’s management, board and other relevant stakeholders.
Questions for the board and audit committee to consider
- Has management conducted a strategic review of the implications of potential cross-border tax
- changes for the company’s business models and structures? Has management shared this evaluation with the board?
- Has the board evaluated how the company can position itself for the evolving global tax landscape?
- Is the company ready for heightened scrutiny and tax audit risk, which can place increased pressure on cash tax and effective tax rate positions?
- Is the company prepared for the potentially substantial increase in global reporting requirements and the commensurate increase in compliance costs?