A game changer - are you ready?

Debbie Payne, director in the tax department at PwC, takes a view on what paying your 'fair tax' could look like in the new, OECD way

Back in July 2013 the Organisation of Economic Cooperation and Development (“OECD”) published its Action Plan to address perceived flaws in the international tax rules.

What’s driving change?

Whilst the current international tax laws seek to remove the risk of double taxation, as we’re aware the view is that they are now being abused to allow double non taxation and shifting of profits to low/no tax jurisdictions: In the view of the OECD national tax laws have not kept pace with the globalisation of corporations and the digital economy, leaving gaps that can be exploited by multi-national corporations to artificially reduce their taxes. 

The Action Plan contains 15 separate action points or work streams, completion of which will take between one and two years. Whilst the timetable appears ambitious it would be unwise to underestimate the political momentum behind the Base Erosion and Profit Shifting (“BEPS”) agenda which is driven not only by a morality debate, but by a very real need to find tax revenues to fill national deficits. 

The issues which they are looking to address are complex and the OECD operates on the basis of consensus, so, if the political will evaporates some of the work streams will be abandoned. However, this does not mean that they will not be enacted in a different form.

What should you expect?

The actions planned can be grouped into four areas:

  • General actions on BEPS including limiting interest deductions and countering harmful tax practices, including private tax rulings.
  • Treaty actions to prevent inappropriate use of bilateral treaties to achieve double non taxation.
  • Permanent establishment and transfer pricing are the most widely publicised aspects of BEPS, aiming to ensure that tax authorities can see the global value chain and prevent the artificial avoidance of permanent establishment status.  Whilst the actions may not be enacted in their current form there will certainly be changes even if some of the other action points are abandoned. The challenge in the permanent establishment arena is to ensure that in lowering the threshold for creating a taxable presence in a particular country you do not create a regime which is unsustainable in practice. For example, private equity deal teams regularly travel to undertake due diligence on investments or attend board meetings. If this is sufficient to create a taxable presence in a particular country the business model would become unsustainable.
  • Data and transparency, expect revenue authorities to share data including rulings and clearances.

How likely is it the changes will be implemented?

BEPS is largely a European problem so the EU will almost certainly look to implement a number of the proposals within Europe if the OECD fails to achieve consensus. Indeed, the European Commission  has already started an investigation into the tax rulings granted by Ireland, Luxembourg and The Netherlands which in their view may be in breach of the State Aid provisions.

At present the agenda is being driven by the G20 and specifically the revenue authorities in those countries. As Guernsey is neither an EU or G20 member stare, it will difficult for us to contribute to the debate on BEPS. However, Guernsey will be expected to make any required changes to its tax law and to follow the new global approach to taxation.

We also need to be clear that BEPS is not just about what is going to happen in the future, it’s impacts are already playing out: Papers on two of the action points have already been issued and it’s influencing the approach that Revenue authorities (particularly HMRC) and legislators take to the affairs of major multinational corporations. 

In some cases tax authorities are already seeking to apply the principals set out in the Action Plan. Other tax authorities are publishing proposals which they hope will protect them against some of the changes. For example The Netherlands has set out what it requires in terms of ‘substance’ before it will grant a tax ruling, although for many countries their proposals do not go far enough.

What will the impact be for Guernsey’s finance sector?

Although BEPS is mainly aimed at large multi-national companies such as Starbucks and Google, it is clear from the Action Plan that the OECD are planning to use a number of ’weapons‘ in their armoury when it comes to addressing the perceived 'abuse' of the international tax system. 

Use of some of these weapons may have knock-on implications for us locally, both for digital / other enterprises and businesses in the financial services sector including funds. Exact impact is still to some extent uncertain and depends upon the actions of the tax authorities in different countries. We currently predict that:

  • In the OECD’s view,  labour will be seen as more valuable than capital, aligning tax with substance.

Although the main target here is multinational companies that use supply chain management to book relatively little profit in high tax jurisdictions where their customer base is actually based, there is no doubt that this could impact Channel Island structures. This could impact digital business although there is a suggestion that an indirect tax response may be required to address this issue.

  • There will be an increased focus on the use of double tax treaties to mitigate tax.

Whilst there is no specific suggestion that companies used to minimise withholding taxes in funds (e.g. the Luxembourg  double-tier structure) constitute a "harmful tax practice", the same legal structures including profit participating loans can also be used in corporate structures to achieve mismatches and/or low effective tax rates through interest-stripping. There is a risk that in dealing with one issue, there may be collateral damage. Also, additional rules around relief for interest payments can be expected although the UK is expected to strongly resist some of the proposed changes.

Similarly, custodians, brokers and paying agents may be more reluctant to apply treaty rates of withholding tax in order to avoid taking exposure themselves, which may increase the cashflow and compliance burden for funds/trusts and their managers/trustees in reclaiming withholding taxes.

  • The death- knell for tax rate ‘deals’, with a definite move to achieve greater transparency.

    Private rulings where the terms differ from company to company will be viewed as harmful.  For any taxpayer whose effective tax rate relies on a “deal” with a territory, they should be considering their position. The OECD cannot unwind the “deal” but the climate is very much in favour of Revenue authorities denying deductions, or applying withholding taxes where there is such a “deal”. Certainly the European Union is looking to take action in this area and whilst this would not include Switzerland you can expect changes to a number of the current tax regimes favoured by investment funds. Corporates will need to make sure that profits arising in territories where the tax is low do so in a way that is consistent with OECD norms rather than by way of a “deal”. To be clear, tax regimes such as Guernsey which have a very transparent and easy to understand tax regime albeit with low tax rates would not be seen as harmful per se; it is all a question of aligning profits with the new definition of substance.

Clearly the landscape is shifting.  The BEPS project has incredible political and public momentum and it will almost certainly result in fundamental changes to the way global corporation profits are taxed internationally.  

The main message is that you will need to analyse and consider whether your group tax strategy and structure needs to change as a result of BEPS. Doing nothing may well result in an unwelcome tax bill when tax authorities reallocate your profits using the principals outlined in BEPS.