Canada: Tax Flash - BEPS: The Final Reports

5 October 2015, will be remembered as one of the most significant dates in the history of international taxation, for it was when the Organisation for Economic Co-operation and Development (OECD) concluded its two-year base erosion and profit shifting (BEPS) project with the publication of the final package of measures which, in the words of OECD Secretary-General Angel Gurría, represent "the most fundamental changes to international tax rules in almost a century".

This page contains links to articles which summarize these measures, and the steps that the OECD expects authorities around the world to take, in order to ensure they are implemented successfully.

Executive Summary 

After two and a half years of preparation and consultation, the Organisation for Economic Co-operation and Development (OECD) has released its final reports on how to bring global tax rules into the modern age and tackle base erosion and profit shifting (BEPS).

Immediately ahead of two webcasts that took place on 5 October, the OECD released recommendations for 'a comprehensive, coherent and co-ordinated reform of international tax rules', to close loopholes said to cost nations up to US$240bn in corporate tax revenues each year.

The OECD's work centres on the taxation of profits where economic activities take place, to close gaps in existing international tax rules that allow corporate profits to 'disappear' or to be artificially shifted to low or no tax territories.

According to Pascal Saint-Amans, speaking at the first of two webcasts on the matter, there is consensus among countries on the package as a whole and in particular on those Actions covering transfer pricing-related topics.

The BEPS package includes new minimum standards on: country-by-country reporting, to provide tax administrations with a global picture of the operations of multinationals; treaty shopping, to put an end to the use of conduit companies to channel investments; curbing harmful tax practices, in particular in the area of intellectual property and through the automatic exchange of information on tax rulings; and effective mutual agreement procedures, to ensure that the fight against double non-taxation does not result in double taxation.

In addition, guidance on the application of transfer pricing rules will be updated, including to prevent taxpayers from using so-called 'cash box' entities and to redefine the concept of permanent establishment. The OECD is also encouraging governments to adopt stronger rules covering Controlled Foreign Corporations (CFC), interest deductibility and hybrid mismatch arrangements (which enable double non-taxation).

Finally, the OECD is continuing to lead talks between nearly 90 countries on the development of a multilateral instrument capable of incorporating the tax treaty-related BEPS measures into the existing network of bilateral treaties. The instrument will be open for signature by all interested countries in 2016, and Saint-Amans has newly disclosed that it will likely take just over a year for the changes to be introduced, subject to an agreement between states.

The package will repaint the tax landscape globally and, according to Saint-Amans, such fundamental changes would have not been possible before the financial crisis and the advent of tax information exchange. He said recent international co-operation on tax matters has opened the door to extensive reforms previously thought impossible, such as during the work it attempted ten years ago to close the door on aggressive tax planning.

During the webcast, Saint-Amans was upbeat when asked whether the OECD is concerned countries will act unilaterally or reject some measures. He admitted countries are unlikely to move to implement the recommendations all at the same time, but said the OECD has developed a flexible package, containing minimum standards, with recommendations that have been drafted to specifically complement one another, such that a country that adopts them won't be disadvantaged or left unprotected should another territory decide not to adopt a particular recommendation. In particular, he noted the convergence between the OECD's recommendations in the area of transfer pricing and those recommendations concerning cash boxes, CFC rules and interest deductibility, among others.

Asked about the heightened risk of double taxation, Saint-Amans said there would 'unambigiously' be an increase in double taxation and therefore disputes. However, he said rules as they stand aren't fit for purpose. As a result, there have been numerous disputes concerning both double taxation and double non-taxation (statistics newly released by the OECD show the number of Mutual Agreement Procedure (MAP) cases increased from 1,341 in 2010 to 1,910 in 2013), but the OECD believes newfound international co-operation in tax matters will eventually lead to fewer disputes and more collaboration on tax administration and collection. Double tax issues will continue to be resolved through the MAP, and taxing rights determined and enforced through domestic legislation, he said.

Saint-Amans disclosed that the US$750m threshold for the new transfer pricing documentation standards is indeed arbitrary. It will be in place until 2020 to allow for a few years of testing, after the first automatic exchanges in 2018. These requirements currently cover 90% of multinational enterprises (MNEs) by activity and there is an expectation that the threshold will be revised downward, he said. It was agreed that groups should disclose eight pieces of information for each territory in which they have operations, to provide an appropriate amount of information as a risk assessment tool, without overburdening tax authorities.

Last, he discussed why the OECD had not pursued proposals for unitary taxation under the so-called the formulary apportionment approach. He said that while there are theoretical arguments as to why unitary taxation would be more effective than the existing arm's length principle (ALP), unitary taxation is untested and not without its own deficiencies. While not ruling out such a move in the future, he said upgrading transfer pricing rules under the ALP is the only feasible approach for now, highlighting that the EU has been discussing a common consolidated corporate tax base and unitary taxation with little progress for almost two decades.

He concluded that the adoption of the BEPS recommendations will usher in a return to a common-sense approach to taxing multinationals, where tax authorities will be newly equipped to tackle transfer mispricing under the ALP and he expressed hope that companies will recognize the tax risk involved – as well as the reduced benefits – with structuring their tax affairs without the underlying economic substance to back up their positions.

Background 

The BEPS project came into being at the behest of the G20 on 12 February 2013, when the OECD's first formal report on the subject, 'Addressing Base Erosion and Profit Shifting', was published. It was noted in that report that due to imperfect interaction between nations' tax regimes, MNEs have been permitted to legitimately structure their tax affairs using profit-shifting arrangements to pay minimal rates of tax, limiting their exposure to corporate tax rates as high as 30%, faced by fiscally immobile businesses in some OECD member states. What's more, the rapidly evolving world of international commerce has made national tax codes, many of which are more relevant to business in the middle of the 20th century rather than the 21st, increasingly outdated. Traditional tax concepts such as nexus and permanent establishment (PE) have become increasingly irrelevant in the fast-growing world of e-commerce and the 'digital economy', where companies can do substantial amounts of business in some of the world's largest markets without ever touching the ground, so to speak, thus enabling them to book profits in jurisdictions where taxation is lightest. Therefore, to all intents and purposes, the report was a clear call for the world's governments to come together and tackle the issue of aggressive corporate tax avoidance once and for all.

In July 2013, the OECD released the BEPS Action Plan consisting of 15 specific actions designed to give governments the domestic and international mechanisms to effectively close loopholes in the international tax system:

  • Action 1: Address the tax challenges of the digital economy
  • Action 2: Neutralize the effects of hybrid mismatch arrangements
  • Action 3: Strengthen CFC rules
  • Action 4: Limit base erosion via interest deductions and other financial payments
  • Action 5: Counter harmful tax practices more effectively, taking into account transparency and substance
  • Action 6: Prevent treaty abuse
  • Action 7: Prevent the artificial avoidance of PE status
  • Action 8: Assure that transfer pricing outcomes are in line with value creation: intangibles
  • Action 9: Assure that transfer pricing outcomes are in line with value creation: risks and capital
  • Action 10: Assure that transfer pricing outcomes are in line with value creation: other high-risk transactions
  • Action 11: Establish methodologies to collect and analyse data on BEPS and the actions to address it
  • Action 12: Require taxpayers to disclose their aggressive tax planning arrangements
  • Action 13: Re-examine transfer pricing documentation
  • Action 14: Make dispute resolution mechanisms more effective
  • Action 15: Develop a multilateral instrument.

The Action Plan called for the delivery of seven Actions by September 2014, and the remaining eight actions by September 2015.

The 2014 Outputs

The September 2014 BEPS 'outputs', as the OECD termed these series of reports, were delivered in an interim form and, while agreed, were not finalized as they would probably be impacted by some of the decisions to be taken with respect to the 2015 'deliverables', with which they interact. The 2014 outputs have been consolidated with the remaining 2015 deliverables to ensure a coherent package, which will be delivered to the G20 finance ministers on 8 October 2015, together with a plan for follow-up work and a timetable for their implementation.

The September 2014 deliverables included proposals to:

  • Address the tax challenges of the digital economy (Action 1)
  • Neutralize the effects of hybrid mismatch arrangements (Action 2)
  • Counter harmful tax practices more effectively, taking into account transparency and substance (Action 5)
  • Prevent treaty abuse (Action 6)
  • Assure that transfer pricing outcomes are in line with value creation/intangibles (Action 8)
  • Re-examine transfer pricing documentation (Action 13)
  • Develop a multilateral instrument (Action 15).

The 2015 Deliverables 

The 2015 deliverables include measures to:

  • Strengthen CFC rules (Action 3)
  • Limit base erosion via interest deductions and other financial payments (Action 4)
  • Prevent the artificial avoidance of PE status (Action 7)
  • Assure that transfer pricing outcomes are in line with value creation/risks and capital (Action 9)
  • Assure that transfer pricing outcomes are in line with value creation/other high-risk transactions (Action 10)
  • Establish methodologies to collect and analyze data on BEPS and the actions to address it (Action 11)
  • Require taxpayers to disclose their aggressive tax planning arrangements (Action 12)
  • Make dispute resolution mechanisms more effective (Action 14).
  • In February 2015, OECD and G20 countries agreed three key elements to enable implementation of the BEPS project, including:
  • A mandate to launch negotiations on a multilateral instrument to streamline implementation of tax treaty-related BEPS measures (Action 15)
  • An implementation package for CbC reporting in 2016 and a related government-to-government exchange mechanism to start in 2017 (Action 13)
  • Criteria to assess whether preferential treatment regimes for IP (patent boxes) are harmful or not (Action 5).

Overview of Final BEPS Package 

The OECD describes the level of interest and participation in its BEPS work as 'unprecedented', with 60 countries directly involved in the technical groups and others participating through regional structured dialogues. In addition, organizations such as the African Tax Administration Forum (ATAF), Centre de Rencontre Des Administrations Fiscales (CREDAF), and the Centro Interamericano de Administraciones Tributarias (CIAT) joined international organizations such as the International Monetary Fund (IMF), the World Bank (WB) and the United Nations (UN) in contributing to the work.

Importantly, businesses and non-government organizations contributed more than 12,000 pages of comments on the 23 discussion drafts published and engaged in discussions at 11 public consultations. This extensive consultation exercise with governments, plurilateral organizations and the private sector culminated in the final set of recommendations.

Summaries of the 15 reports are provided in the Explanatory Statement produced by the OECD is available on this link.

Implementation 

As was alluded to earlier in this article, formulating solutions to the problems posed by BEPS is one thing; implementing them is another challenge altogether, and a much larger one at that. Although aware of the scale of the changes that need to be made, the OECD is, nevertheless, bullish that its recommendations are achievable and can be acted upon in a relatively short space of time. Indeed, there are aspects of the package that can be implemented immediately, it says, such as revisions to the Transfer Pricing Guidelines.

Nevertheless, it is expected that more time will be required for governments, tax authorities, and national legislatures to implement many of the required measures, such as in the area of hybrid mismatches, CFC rules, interest deductibility, CbC reporting, and mandatory disclosure rules. In addition, domestic rules on preferential IP regimes may have to be aligned with the harmful tax practices criteria.

Just as important – if not more so – will be the consistent implementation of the required revisions at national level if the BEPS project is to lead to more coherent international taxation. Therefore, the OECD and the G20 have agreed to continue working together under the BEPS project framework to support, as the OECD puts it, 'effective and consistent implementation' of the new standards. Quite what this entails is unclear, but as an example the OECD cites the European Commission's 'Communication on a Fair and Efficient Corporate Tax System in the European Union', which aims to set out how the BEPS measures can be implemented within the EU.

The OECD states that it will continue to work 'on an equal footing' with G20 countries to complete the areas that require further work in 2016 and 2017. These include finalizing transfer pricing guidance on the application of transactional profit split methods and on financial transactions; discussing the rules for the attribution of profits to PEs in light of the changes to the permanent establishment definition; and finalizing the model provisions and detailed Commentary on the Limitation on Benefit (LOB) rule with a continued examination of the issues relating to the broader question of treaty entitlement of investment funds. Other work will include finalizing the details of a group ratio carve-out and special rules for insurance and banking sectors in the area of interest deductibility.

The OECD stresses the need for the implementation phase to be monitored effectively to ensure consistent application of the new rules, an area where it also intends to work closely with the G20. In a similar vein to the way the OECD monitors compliance with international tax transparency standards, the monitoring will involve a system of assessing compliance with the minimum standards in the form of reports on what countries have done to implement the BEPS recommendations. This will entail some form of peer review mechanism. Also, proposed improvements to data and analysis will help support ongoing evaluation of the quantitative impact of BEPS, and evaluating any 'countermeasures' developed under the BEPS project.

So far, in the envisaged implementation phase, the other 150 countries of the world that are not members of the G20 or the OECD are conspicuous by their absence. However, the OECD has not forgotten them. Noting the 'strong interest' shown by developing countries in the BEPS work, the OECD, in cooperation with the G20, will draw up an 'inclusive framework' early in 2016 to support and monitor the implementation of the BEPS package in other countries. This framework will draw on the mandate from the G20 Finance Ministers and Central Bank Governors as included in their communiqué issued in Ankara on 5 September 2015, which states:

"The effectiveness of the project will be determined by its widespread and consistent implementation. We will continue to work on an equal footing as we monitor the implementation of the BEPS project outcomes at the global level, in particular, the exchange of information on cross-border tax rulings. We call on the OECD to prepare a framework by early 2016 with the involvement of interested non-G20 countries and jurisdictions, particularly developing economies, on an equal footing".

In fact, the OECD and the G20 countries will extend their cooperation until 2020, meaning that the implementation phase is expected to last for at least five years.

So, all things considered, the hard work has only just begun.

Evaluating BEPS 

The OECD is to be admired for completing this ambitious project on time in just over two years. But why the rush to finish this hugely demanding task so soon? According to the OECD, the consultative phase needed concluding quickly "chiefly because there is an urgent need to restore the trust of ordinary people in the fairness of their tax systems, to level the playing field among businesses, and to provide governments with more efficient tools to ensure the effectiveness of their sovereign tax policies".

However, by fast-tracking the BEPS work, some sections of the global business community fear that the OECD has been unable to fully think through the potentially far-reaching consequences of its proposals. By and large, businesses have expressed support for the broad aims of the BEPS project. But some critics contend that the BEPS package will put too much power in the hands of revenue authorities, heightening the risk that taxpayers will be audited more frequently and perhaps more aggressively than has traditionally been the case, especially if taxpayers fall short of extensive new transfer pricing reporting and documentation requirements. Indeed, some suggest that this is already happening. What's more, national tax authorities might now feel more justified in taxing an MNE's income where previously they hadn't, leading to more instances of double taxation. So the unintended consequences of this could be reduced levels of global trade and investment, and lower level of economic growth.

What's more, as the old saying goes, you can lead a horse to water but you can't make it drink. And this is the fundamental problem that the OECD faces as it begins its attempt to steer through the proposed measures: While many governments have issued fulsome praise of the OECD's BEPS work and the reasons why it has undertaken the project, this doesn't necessarily mean that every country will be willing or able to implement each measure as the OECD wishes.

The US is one glaring example of a horse that won't be pushed to drink, for while the US Government is cooperating with the OECD on BEPS, the mood music emanating from a Republican-led Congress which is determined to protect US business interests from what it sees as a foreign-led tax grab, is hardly very soothing. Then there are dozens of developing nations, most of which lack the resources and technical expertise to implement this comprehensive set of proposed reforms.  And at the other end of the scale are countries that are a little over-eager to get stuck into the BEPS project, and have already implemented BEPS-inspired measures without waiting for the publication of the final recommendations. The UK, with its new Diverted Profits Tax, which is designed to prevent MNEs from artificially shifting profits from the UK to low- and no-tax jurisdictions, is one example that immediately springs to mind. In fact, about 20 countries have forged ahead with BEPS-like changes since the project commenced, which could put paid to the concept of a level international tax playing field.

Of course, it is impossible to say for sure how the project will pan out as it moves from the consultative to the implementation phase. But it is clear that it is entering perhaps its most critical phase. Given this represents the largest shake-up of international taxation in history, MNEs will therefore need to stay informed of developments at international level as never before.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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