UK: BEPS and tax structuring – how does it affect the shipping industry?

There has been much recent focus on tax structures employed by multi-national corporations. This has led to an initiative, spearheaded by the OECD, to combat "base erosion and profit shifting", or BEPS. The shipping industry is likely to be affected both directly and indirectly by the BEPS initiative - directly, by the new laws and policies that are likely to be introduced in various countries in order to tackle "aggressive tax planning", and indirectly, by the negative change in public opinion towards businesses that do not pay their "fair share" of taxes.

This article explores in a little more detail what the BEPS project is and what the impact could be on typical arrangements that exist in the shipping sector.

What is BEPS?

Base Erosion and Profit Shifting refers to the exploitation of gaps and mismatches in tax rules, mainly cross-border, to reduce taxable profits in one jurisdiction (i.e. erode the tax base) or to shift profits to locations where the taxes are low, resulting in little or no overall corporate tax being paid. In this context, BEPS strategies are generally not illegal and have historically been regarded as acceptable tax planning that directors would be bound to consider in order to maximise shareholder value. In particular, corporations have tended to exploit differences between (i) those jurisdictions where the current tax rules are still grounded in a bricks and mortar economic environment, and (ii) those jurisdictions that have adapted their rules to make them "good" jurisdictions in which to establish holding or owning vehicles (whether holding or owning shares, IP or ships).

The world has changed to incorporate more and more multi-national businesses. Advances in technology mean that those businesses can do business in jurisdictions without having to locate staff or infrastructure there. These changes also mean that governments have come to the view that existing tax frameworks are not sufficiently well advanced to allocate taxing rights appropriately between jurisdictions in these circumstances.

The G20 asked the OECD to investigate international tax systems in order to provide an internationally coordinated approach to respond to the issue. The 2014 BEPS Action Plan provides a consensus-based plan to address these issues and is part of the OECD's ongoing efforts to ensure that the global tax architecture is equitable and fair. It deals with a wide range of mechanisms to tackle BEPS and we look at some of the key measures for the shipping industry below.

The most advanced action points are those on the prevention of double tax treaty abuse and the prevention of the artificial avoidance of permanent establishment status, and both of these are likely to be relevant to the shipping industry. Other action points are still being developed by the OECD, with an overall package being expected by the end of 2015. Some of the changes will be introduced on an international level; others will require domestic legislation.

Impact on shipping

A number of the measures being considered under BEPS are likely to affect the shipping industry. In particular, the measures aimed at avoidance of permanent establishments and abuse of double taxation treaties may lead to shipping enterprises re-evaluating some of their existing structures.

Some relevant action points include:

  • Artificial avoidance of permanent establishments (Action 7): This action point breaks down into a number of sections. The key elements are as follows:
    • There is a move to reduce the ability of a company in one jurisdiction to negotiate contracts on behalf of an affiliate in another jurisdiction (usually a jurisdiction with a lower rate of tax) without creating a permanent establishment of the second company. In a shipping context, this could affect the way businesses split the ownership of ships and the entities that arrange charters and employment for the ship. This could lead to more of the profit from the chartering or shipowning activity being taxed in the onshore jurisdiction.
    • There are specific actions aimed at structures that seek to avoid a permanent establishment by splitting contracts between various associated entities, so that they do not trigger the 12 month period generally required for a permanent establishment. This type of structure is typically seen in the offshore oil and gas sector and is likely to be subject to scrutiny in the future.
    • Whilst the shipping industry generally benefits from a separate shipping profits article of double tax treaties, it does not necessarily mean that these measures would not impact on some structures set up within groups where some activities are carried on in high-tax jurisdictions and others in low-tax jurisdictions.
  • Prevention of treaty abuse (Action 6): This action plan aims to restrict the availability of double taxation treaty benefits in circumstances where the entity claiming the benefit of the treaty has limited connection with, or limited substance in, the jurisdiction claiming the benefit of the treaty. The rule is likely to restrict benefits where the ultimate beneficiary of the payment received is not a person resident in the appropriate jurisdiction and this may affect all kinds of holding structures, whether the holding of equity or the holding of ships themselves.
  • Transfer pricing to align with value creation (Action 8): Most jurisdictions already have transfer pricing rules that seek to tax transactions between associates on an arm's length basis. The BEPS action plan can broadly be said to go further than this in trying to allocate taxable profits in line with the chain of value creation within the group. This could potentially lead to an approach that re-characterises transactions rather than re-prices them. This is likely to give rise to disputes as to whether value is created by the risk capital invested in a shipowning entity or by the human capital involved in the marketing, ship management or contracting arm.

The BEPS project will be implemented through a mixture of domestic legislation and amendments to international treaty obligations (and their interpretation). We have set out some examples of how the UK and the Netherlands have begun their approach to the issues raised by the BEPS project.

The Netherlands

The Netherlands has stated its desire to be one of the forerunners in the international cooperation against tax avoidance. While it has not announced any domestic law changes yet, it has been focussing on renewing its extensive tax treaty network.

In a publication dated 19 September 2014, the Dutch State Secretary for Finance Mr Wiebes stated, "We are currently revising more than a quarter of our treaty network, together with our treaty partners. We will take advantage of the opportunity of countering the abuse of treaties. (...) The Netherlands has one of the best tax treaty networks in the world. These efforts will ensure that the treaty network is future-proof. And the treaty network will remain a mainstay of the fiscal investment climate, and citizens and businesses alike will be able to reap the benefits".

The United Kingdom

The United Kingdom introduced a new tax, the "diverted profits tax", in April 2015, which is aimed at taxing avoided permanent establishments in the UK and arrangements lacking substance. Although this was primarily aimed at taxing arrangements that have been seen in the digital economy, it is no surprise to see that arrangements seen in the shipping industry could also be caught by the new tax. For further details, please see our briefing on the diverted profits tax and shipping.

Conclusion

It is difficult at this stage to draw a concrete conclusion. It has to be said that the shipping industry is not an industry that is the primary target of the BEPS project and it will still be appropriate to take advice to ensure that group and holding structures are tax efficient. However, as the outcomes of the BEPS project develop, it will be important to ensure that existing arrangements are not caught by measures that are implemented either on a domestic or at a treaty level.

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