Into action

Debbie Payne, director, PwC, looks at how the OECD intends to address perceived flaws in international tax rules and warns that, as a new action plan is launched, doing nothing is no option

On 19 July 2013 the Organisation of Economic Cooperation and Development (“OECD”) published its Action Plan to address perceived flaws in the international tax rules. 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.  

Whilst the current international tax laws seek to remove the risk of double taxation the view is that they are now being abused to allow double non taxation and shifting of profits to low/no tax jurisdictions.

The Action Plan contains 15 separate action points or work streams completion of which will take one or two years.  Whilst the timetable appears ambitious it would be unwise to under estimate the political momentum behind the Base Erosion and Profit Shifting (“BEPS”) agenda, which is driven by a need to find tax revenues to fill national deficits.

Within the OECD the agenda is being driven by the G20 and specifically the revenue authorities in those countries. Jersey is not a member of either organisation therefore it will difficult for Jersey to contribute to the debate on BEPS. 

However, we will be expected to make any required changes to our tax law and to follow the new global approach to taxation.

Papers on two of the action points have already been issued so BEPS is not just about what is going to happen in the future it is about what is happening now. The BEPS initiative is already influencing the approach of Revenue authorities, particularly HMRC, and legislators 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.

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 see 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 businesses in the financial services sector including funds notwithstanding that they are not the primary target.

So what is BEPS? For practical purposes the actions can be grouped into four areas:

  • General actions on BEPS including limiting interest deductions, countering harmful tax practices and strengthening the controlled foreign companies rules.
  • Treaty actions to prevent inappropriate use of bilateral treaties to achieve double non taxation.
  • Permanent establishment and transfer pricing. These are the most widely publicised aspects of BEPS with a clear direction of travel which seeks to ensure that tax authorities can see the global value change and prevents the artificial avoidance of permanent establishment status.
  • Data and transparency. Expect revenue authorities to share data including rulings and clearances.

The impact of all this is still to some extent uncertain and depends upon the actions of the tax authorities in different countries but our prediction is that:

  • Labour will be seen as more valuable than capital, in the OECD’s view, in aligning tax with substance.
  • 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, but there is no doubt this could impact Channel Islands structures.  This could impact digital business although there is a suggestion that an indirect tax response may be required to address this issue.
  • Organisations may look for safe “Kite Marked” tax regimes within countries which are not seen as harmful competition, to the extent that those regimes do not come under renewed scrutiny. Examples of these would be specific regimes for finance companies or intellectual property.
  • There will be an increased focus on the use of double tax treaties to mitigate tax.

While 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 and additional rules around relief for interest payments can be expected possibly along the lines of the UK debt cap legislation.

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.

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, applying withholding taxes or applying CFC rules where there is such a “deal”. It is worse when the deal involves a practice but the position is not secure even where the deal is part of the local law.

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 Jersey and 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 these are interesting times! The BEPS project has incredible political and public momentum. It will certainly result in fundamental changes to the way profits are taxed internationally. 

So the main message is that you will need to analyse and consider whether the 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