As a result of the global financial crisis, the necessity for growth has become paramount and fiscal consolidation non-negotiable. Private sector growth is fundamental for economic recovery and to reduce deficits.
There is a general belief, even in developing countries, that governments are losing substantial tax revenues as a result of aggressive tax schemes which result in the eroding of the tax base or the shifting of profits into more favourable tax jurisdictions.
It seems that the effective tax rates of multi-national companies are much lower than the statutory tax rates and it appears that the gap is growing, largely as a result of aggressive tax planning and particularly in developing countries where tax revenue is critical for long-term development.
As far back as 1961 President Kennedy said that: "Recently more and more enterprises organised abroad by American firms have arranged their corporate structures aided by artificial arrangements between parent and subsidiary regarding intercompany pricing, the transfer of patent licensing rights, the shifting of management fees and similar practices [...] in order to reduce sharply or eliminate completely their tax liabilities both at home and abroad."
The former United Nations Secretary-General, Kofi Annan, has blamed transfer pricing for causing an out flow of taxes from Africa.
The name of the game has changed! Although tax avoidance is not illegal it is seen as unethical. Transparency is the new buzz word and various stakeholders are involved with very different interests. Non-governmental organisations drive corporate social responsibility while civil society demands a fair and balanced tax system, both sometimes blaming the arm's length principle as the cause for all these problems. Taxpayers require stable and commercially acceptable tax legislation to avoid double taxation and to manage their effective tax rates as they still has an obligation to shareholders to maximise their profits by managing all expenses, including their tax expense.
In light of these factors, the Organisation for Economic Co-operation and Development ("OECD") is looking to address these issues concerning base erosion and profit shifting (BEPS), and implement country-by-country reporting that will require taxpayers to set out exhaustive details on how income taxes and business activities are allocated. The focus of the OECD is no longer only the avoidance of double taxation but it also wants to prevent double non-taxation.
The key objectives of the BEPS action plan are:
- Enhancing transparency to governments;
- Using economic substance to determine taxation;
- Broadening the taxable base;
- Eliminating tax leakages through anti-avoidance measures and co-operation between tax jurisdictions; and
- Drafting a new multi-lateral instrument to give effect to all these changes.
Looking at the discussion document already released by the OECD it is clear that transfer pricing is one of the key areas that will be used to address the BEPS issue.
The transfer pricing of intangibles (Step 8 of the BEPS action plan) will no longer only depend on legal ownership but where other parties within the group perform, function, uses or contributes assets, or assume risks or cost related to the enhancement, development, maintenance and protection of the intangible, the returns on the intangible must also accrue to these other parties through arm's length compensation which reflects the contribution of each party.
One needs to determine which transfer pricing structures will be acceptable under the BEPS action plan and which will no longer be acceptable. A profit centre which actively participates in the enhancement, development, maintenance and protection of the intellectual property may still be acceptable while a profit centre with limited functions, risks and assets and very little significant people functions may no longer be acceptable.
The white paper on transfer pricing documentation (Step 13 of the BEPS action plan) sets out a possible coordinated approach to transfer pricing documentation through the use of a master file and a local file. The content of the transfer pricing documentation should offer a more balanced trade-off between greater transparency and more streamlined country transfer pricing documentation requirements. Transfer pricing documentation rules should be modified to make transfer pricing compliance simpler, while providing tax authorities with more useful information to consider during transfer pricing audits. To comply with the BEPS action plan Step 13, the transfer pricing documentation rules, will include a requirement that multi-national enterprises provide all relevant governments with needed information on their global allocation of income, economic activity and taxes paid amongst countries according to a common template, that is country-by-country reporting.
The BEPS action plan sets out 15 action steps aimed to address tax planning strategies that exploit gaps and mismatches in tax rules or shift profits to locations where there is little or no activity. These actions will result in fundamental changes to the international standards.
Multi-national groups need to urgently evaluate whether they are ready to comply with any BEPS triggered regulations such as those on intangibles and transfer pricing documentation. Multi-national groups need to decide whether they will just do nothing, choose a cause of action only once BEPS activities materialise in local legislation or immediately undertake a comprehensive BEPS proof assessment to:
- identify risk areas taking into account the 15 areas identified under BEPS; and
- minimise tax and transfer pricing risks.
A multi-national group needs to determine whether:
- it is dependent on digital products and royalties from intangibles;
- it uses techniques to save tax leakages;
- it uses certain financial instruments or entities that qualify as hybrids;
- a large portion of the group's income is subject to CFC legislation;
- it is dependent on inter-company transactions;
- it has a tax and transfer pricing management framework; and
- its transfer pricing documentation is acceptable for all the jurisdictions in which the group operates.
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.