In this edition: The IRS and the Treasury Department issued proposed regulations on the Base Erosion and Anti-Abuse Tax under section 59A of the Internal Revenue code; the U.S. Department of the Treasury and the IRS released the proposed regulations that provide guidance related to foreign tax credits; the European Commission has been engaged in the investigation of tax rulings agreed between Member States and Multinational Enterprises; HMRC disclosed a new voluntary facility named the Profit Diversion Compliance Facility; the Italian government adopted unilateral action against technology behemoths through the approval of a new digital revenue tax; and Japan's ruling party released their 2019 tax reform proposal for Cabinet's approval.
- U.S. Issues Regulations on BEAT
- Release of Proposed Foreign Tax Credit Rules
- European Commission Opens Investigation into Nike's Tax Dealings in the Netherlands
- HMRC Announces Voluntary Disclosure Facility in Respect of Diverted Profits
- Italy Adopts New Web Tax
- Japan's 2019 Tax Reform Proposal Updates Transfer Pricing Rules for Intangibles
- Australia Publishes Assessment Framework for Inbound Distributors
U.S. Issues Regulations on BEAT
On December 13, 2018, the Internal Revenue Service (the
"IRS") and the Treasury Department issued proposed
regulations (the "Proposed Regulations") on the
Base Erosion and Anti-Abuse Tax ("BEAT") under
section 59A of the Internal Revenue code. Any comments and requests
for hearings related to the proposed regulations need to be filed
within 60 days their issuance.
As background, BEAT was enacted in 2017 as part of the Tax Cuts and Jobs Act (TCJA). In order for BEAT to be applicable, U.S. taxpayers must meet two requirements. First, they must have a three-year average of gross receipts greater than $500 million dollars. Second, the U.S. taxpayer's deductions for intercompany payments for services, interest, certain property / assets and royalties must be greater than three percent of its total deductions allowed. Certain alternative thresholds are named for banks and special entities. Additionally, the BEAT provisions do not apply to regulated investment companies, REITs or S-Corps.
If a U.S. taxpayer meets the two thresholds provided, they will
be assessed an additional tax to the extent that otherwise
applicable income tax is less than 10 percent of modified taxable
income (which is taxable income excluding deductions for BEAT
payments). The tax under the BEAT provision is equal to 10 percent
of the taxpayer's "modified taxable income" (5
percent for 2018; 12.5 percent after 2025), less applicable tax
Based on the Proposed Regulations issued in December 2018, some key clarifications from a transfer pricing perspective include:
- The amount of any base erosion payment is generally determined on a gross basis and would not permit the netting of amounts owed between the taxpayer and foreign related party.
- If a taxpayer's payments would have qualified for the service cost method exception but actual charges were made with a mark-up, only the amount paid in excess of the total cost of services (i.e., the mark-up component) would be disqualified from the exception and would therefore give rise to base erosion payments.
- Intercompany transactions are excluded for purposes of the base erosion percentage and gross receipts test.
- Payment or accrual by the taxpayer to a foreign related party may be a base erosion payment, regardless of whether the payment is in cash or non-cash consideration (e.g., property, stock or the assumption of a liability).
Companies seeking to better identify and classify intercompany expenses in order to minimize the potential effects of BEAT can find the article by Duff & Phelps, "Unbundling Your Way out of BEAT – Can Cost Allocations Make a Difference?" from Bloomberg BNA's Transfer Pricing Report here. The Proposed Regulations can be found here.
Release of Proposed Foreign Tax Credit Rules
On November 28, 2018, the U.S. Department of the Treasury and the IRS released the proposed regulations that provide guidance related to foreign tax credits including guidance implementing changes made by the Tax Cuts and Jobs Act ("TCJA") enacted on December 22, 2017. The TCJA modified the foreign tax credit rules, which allow U.S. taxpayers to offset their taxes by the amount of foreign income taxes paid or accrued, to reflect new international tax provisions. The changes include the addition of categories for foreign tax credit limitation under Section 904. This article focuses on the foreign tax credit limitation particularly with respect to global intangible low-taxed income ("GILTI") under Section 951A.
In general, GILTI generally impacts U.S. shareholders of controlled foreign companies ("CFCs") that have a large amount of intangible assets outside of the United States. GILTI is calculated as aggregate net CFC income less net deemed tangible income less interest expense, with net deemed tangible income calculated as a 10.0 percent return on the aggregate CFC tangible assets for the taxable year. GILTI is subject to a minimum tax rate of 10.5 percent through 2025 as a deduction equal to 50 percent of GILTI is allowed. Under Section 951A, credits equal to 80.0 percent of foreign taxes attributable to GILTI are permitted.
However, the foreign tax credit limitation rules under Section 904 reduce a taxpayer's ability to use foreign tax credits against GILTI due to the allocation and apportionment of expenses at the U.S. shareholder level to foreign income. The interaction between GILTI and the foreign tax credit limitation rules may yield a case where a U.S. shareholder's foreign taxes paid may exceed the U.S. tax on GILTI category income, but only a portion of the foreign taxes paid may be credited, which would result in additional U.S. taxes.
The proposed regulations also provide partial relief by
providing exempt income and exempt asset treatment with respect to
GILTI income. A portion of the GILTI income is treated as exempt
income and a portion of the CFC stock that generates the GILTI
income is treated as an exempt asset when computing the foreign tax
Because the rules are proposed to be retroactively applied for tax years beginning after December 22, 2017, taxpayers should assess the potential tax impact of the proposed regulations. Parties that wish to provide comments to Treasury and the IRS, should provide them within 60 days of the publication of the proposed regulations. The proposed rel="noopener noreferrer" regulations can be found here.
European Commission Opens Investigation into Nike's Tax Dealings in the Netherlands
Since 2013, the European Commission has been engaged in the investigation of tax rulings agreed between Member States and Multinational Enterprises ("MNEs"), aiming to identify instances where MNEs received illegal state aid. To date, the Commission has identified several cases that they believe involved illegal state aid, all through which the Commission found that well-known MNEs, including Apple, Fiat, Starbucks, Amazon and IKEA, had received inappropriate competitive advantages through favourable tax deals with revenue authorities in certain countries.
On rel="noopener noreferrer" January 10, 2019, the European Commission announced that it had opened an in-depth investigation into tax treatment of Nike in the Netherlands. At issue are two Nike group companies based in the Netherlands, Nike European Operations Netherlands BV ("NEO BV") and Converse Netherlands BV ("Converse BV"). These two operating companies develop, market and sell Nike and Converse products in the EMEA region. To conduct these activities, the companies obtained licenses to use intellectual property rights relating to Nike and Converse products respectively.
The two companies obtained the licenses from two Nike group
entities located also in the Netherlands, but which were not
taxable in the Netherlands. At the same time, the royalties paid by
NEO BV and Converse BV were deductible for tax purposes.
The European Commission is now investigating five tax rulings between Nike and the Netherlands in order to examine whether such rulings, two of which are still in force, are considered illegal state aid. According to the Commission, the tax-deductible royalties paid by NEO BV and Converse BV appear not to be in line with the arm's length principle. Moreover, the Commission argues that the intercompany license transactions do not reflect the economic reality, since the "transparent entities" (i.e. the entities not taxable in the Netherlands) that receive the royalty payments have no employees, nor do they carry out any economic activity.
HMRC Announces Voluntary Disclosure Facility in Respect of Diverted Profits
In the latest evidence that the UK tax administration ("HMRC") is devoting significant attention to the Diverted Profits Tax ("DPT"), rel="noopener noreferrer" HMRC has disclosed a new voluntary facility this month, named the Profit Diversion Compliance Facility ("PDCF"), to enable multinational groups using arrangements targeted by the DPT to bring their UK tax affairs up to date. Multinationals whose transfer pricing is problematic in a way that yields high DPT risk may wish to participate in this program in hopes that it will enable quick, efficient resolution on these matters with HMRC. This allows for greater certainty with respect not only to the past, but also for reduced risk around DPT in the future, as well as potentially reduced penalties.
HMRC has identified two main reasons for the adoption by multinational groups of cross-border pricing arrangements that are based on an incorrect fact pattern and/or inconsistent with the OECD's Transfer Pricing Guidelines ("TPG"): the making of incorrect assumptions or the failure to implement the transfer pricing arrangements as intended. These failures result in a divergence between the accurately delineated transaction and the transaction as described and analysed by the taxpayer, leading to transfer pricing policies that are not in accordance with the TPG.
DPT was introduced in 2015, to discourage multinational groups from using such arrangements, which HMRC states often result in a reduction of UK profits through under-rewarding UK activity and over-rewarding overseas entities in low- or no-tax jurisdictions, and to encourage payment of corporation tax on profits in line with economic activity. Typical risk indicators for HMRC, where contractual allocation of key risks may not be consistent with control of the risks, include commissionaire structures, limited risk distributors, toll or contract manufacturing arrangements and contract R&D arrangements. Investigations by HMRC into profit diversion are usually resolved by agreeing to transfer pricing adjustments. If DPT applies based on those adjustments, the group may face a DPT charge.
If a multinational group is not already under investigation by HMRC in relation to DPT, the PDCF is aimed at giving such a group the opportunity to bring its UK tax affairs up to date through:
- Reconsideration of its transfer pricing policies or restructuring, as appropriate;
- The making of a full and accurate disclosure of the facts for all relevant accounting periods and the use of reasonable endeavours to determine the correct amount of tax payable, based on an application of the arm's length principle to those facts;
- Payment of what is owed.
All prior accounting periods for the disclosed arrangements were applicable must be covered, to the extent that HMRC is within the relevant time limits to assess those periods. Take-up for HMRC's disclosure facilities has not always been as high as HMRC would hope – one thinks of the offshore disclosure facilities that ran from 2013 to 2015 – and it will be interesting to see how many groups are tempted to avail themselves of the PDCF, given the level of disclosure necessary to secure the certainty promised.
Italy Adopts New Web Tax
In a further sign of the widespread dissatisfaction among EU countries over their difficulties in taxing digital giants such as Google and Facebook locally through conventional transfer pricing principles, the Italian government has become the latest to adopt unilateral action against the technology behemoths, through the approval of a new digital revenue tax (or "web tax") on December 30, 2018.
The measures adopted mirror the proposals of the European Commission for an EU-wide digital services tax ("DST"), which foundered at the end of 2018 on strong opposition from Ireland and the Nordic countries. Italy has decided to proceed alone with its own tax, even as the EU considers revised proposals for a reduced-scope DST from Germany and France which would limit the scope of the tax to revenues from online advertising. Italy is not alone in this approach, France and Austria have also separately announced their own unilateral plans to introduce a digital services tax as part of tax reform in 2019.
The new Italian tax is applicable to groups with global annual revenue of €750 million or more, with minimum revenues of €5.5 million from specific digital services (identified as online advertising, online sales and data processing) provided to Italian users. The tax is set at 3% of revenues arising from such digital services, the details of which remain to be clarified.
The web tax forms part of Italy's 2019 budget package and is likely to come into effect by the summer, provided the legislation to implement it is adopted by April 2019.
Japan's 2019 Tax Reform Proposal Updates Transfer Pricing Rules for Intangibles
On December 14, 2018, Japan's ruling party (i.e. Liberal Democratic Party) released their 2019 tax reform proposal ("2019 Proposal") for Cabinet's approval. Among the changes in various corporate tax measures, the 2019 Proposal amends certain transfer pricing rules in relation to intangibles in order to be consistent with the recommendations of the OECD Base Erosion and Profit Shifting ("BEPS") Action 8. The Cabinet approved the 2019 Proposal on December 21, 2018, and the amendments in relation to transfer pricing rules will be applied from taxable years beginning on or after April 1, 2020.
The 2019 Proposal amends the definition of intangibles and includes the discounted cash flow valuation approach as a transfer pricing method. In this regard, the definition of intangibles would include "something which is not a physical asset or a financial asset whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances."
The 2019 Proposal also addresses issues with hard-to-value intangibles ("HTVI") by allowing tax authorities to use hindsight and make tax assessments for transactions involving HTVI if the ex post valuation is different by 20% or more from the actual transaction value (based on the ex ante valuation). However, this tax assessment will not be made if a taxpayer submits satisfactory documentation showing that unforeseeable events were responsible for the difference between projections and actual results (consistent with the treatment of the issue in the OECD TPG).
Further measures in the 2019 Proposal include an extension of the statute of limitation period for transfer pricing matters for both taxpayers and the tax authorities from 6 years to 7 years, and approval of the inter-quartile range as a statistical measure for transfer pricing analyses.
Australia Publishes Assessment Framework for rel="noopener noreferrer" Inbound Distributors
On November 23, 2018, the Australian Taxation Office ("ATO") released its Draft Practical Compliance Guideline PCG 2018/D8 (the "PCG"), outlining its intended compliance approach to the transfer pricing outcomes of local distributors. The PCG covers the distribution of both tangible goods purchased from foreign related parties and digital products or services where the intellectual property in those products or services is owned by foreign related parties ("inbound distributors").
The draft PCG provides a range of risk-ratings for various
categories of inbound distributors. The risk-ratings are based on
operating margin results from applying the Transactional Net Margin
Method. In assessing an inbound taxpayer's risk-rating, the PCG
states that this should be calculated on a five-year weighted
average basis. The PCG provides risk-rating ranges for general
distribution activities as well as specific risk-rating ranges for
life sciences companies, information and communication technology
companies ("ICT"), and motor vehicle
Significantly, the PCG provides different risk-rating ranges for various levels of activity and intensity in the local life sciences and ICT companies operations. The definitions of these various categories of inbound distributors are very loosely defined and will no doubt be contentious.
The PCG applies to all inbound distributors, except: (i) small distributors eligible for application of the Simplified Transfer Pricing Record Keeping Rules (as provided in PCG 2017/2); or (ii) companies which have their transfer pricing arrangements covered under Advanced Pricing Agreements ("APAs"), decided upon via an ATO settlement, a court or Administrative Appeals Tribunal decision, or where the ATO has previously reviewed and considered the arrangement as low risk.
The PCG applies the ATO's 'traffic light' risk rating approach, which is similar to the approaches provided in previous risk-assessment PCGs on marketing hubs (PCG 2017/1) and cross border financing arrangements (PCG 2017/4).
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.