BEPS Action Plan: Action 5 – Harmful tax practices

It is understandable that the OECD would wish to put the topic of harmful tax practices back on the agenda of its BEPS Action Plan. Commentary and links to content relating to action 5 are covered here.


5 May 2016

On this action item, the next meeting for the forum on harmful tax practices (FHTP) is in July and will be an initial ‘take stock’ meeting looking at...

what has happened on transparency and intellectual property/ patent boxes. There will then be a follow up meeting in the Autumn which will consider what additional action/ work may be required.

On transparency, they have been agreeing a schema and preparing a back office package to make exchanges efficiently but there may in the interim need to be some exchanges before all this is in place. (In the EU there is a directive that has been agreed which is similar but differs in some areas and the OECD is working with the EU to have one schema and one approach.)

On intellectual property/ patent boxes, the ‘box around the box’ approach effectively requires the FHTP to check how counties have implemented the nexus approach now, in the period to 2021 and then for the future.


29 January 2016

The Forum on Harmful Tax Practices (FHTP) will be the body responsible for progressing the work on Action 5 and it appears that its primary ongoing responsibilities in the BEPS area will be...

  • monitoring preferential regimes (especially, but not limited to, the existing IP regimes)
  • monitoring the transparency framework (exchange of rulings, etc., including most urgently the finalisation of the XML schema required to establish the format for sharing and then the application of the 25% related party threshold which many companies felt should be closer to 50%)
  • further development of a strategy to expand participation to third countries (countries not part of the BEPS process), and
  • considerations of revisions or additions to the existing FHTP criteria (including that there is “an artificial definition of the tax base” and the second factor that “the regime is ring-fenced from the domestic economy”).

Pursuant to the Action 5 report, existing IP regimes that do not comply with the agreed ‘nexus approach’ must be closed to new entrants after 30 June 2016. Taxpayers already within these regimes may continue to receive benefits for existing IP assets until 30 June 2021. However countries have agreed on safeguards to prevent taxpayers from using the transitional period inappropriately to receive tax benefits under existing IP regimes. In particular, IP transferred directly or indirectly from a related party after 1 January 2016 that did not already qualify for an existing IP regime, will not qualify for grandfathering.

The Action 5 report also included initial views on other categories of preferential regimes and the substantial activity requirements that may apply. These include:

  • headquarters regimes
  • distribution and service centre regimes
  • financing or leasing regimes
  • fund management regimes
  • banking and insurance regimes
  • shipping regimes, and
  • holding company regimes.

Potential areas in which the Forum may consider further work, particularly given the participation on an equal footing of developing counties, are other forms of IP that have sometimes been described as “non-obvious, useful, and novel” or other forms of tax relief or incentive, with a possible distinction between those targeted at disadvantaged areas within a country and those applied to attract particular foreign direct investment (FDI) to a country.

For countries that have the necessary legal basis to permit the transfer of this information to a foreign territory, exchange of information will take place from 1 April 2016 for future rulings, and the exchange of certain past rulings will need to be completed by 31 December 2016. The framework for exchange is limited to six categories of rulings:

  • rulings related to preferential regimes
  • cross-border unilateral advance pricing arrangements (APAs) or other unilateral transfer pricing rulings
  • rulings giving a downward adjustment to profits
  • permanent establishment (PE) rulings
  • conduit rulings, and
  • any other type of ruling where the FHTP agrees in the future that the absence of exchange would give rise to BEPS concerns.

The report also sets out best practices for cross-border rulings; this area will likely receive significant interest from a wide range of stakeholders. The volume of future rulings may also be intriguing.


5 October 2015

In looking at the need for substance in preferential regimes, nexus in the form of using expenditure as a proxy for activity has come to the fore. Since February...

the IP box approach has been finessed so tracking and tracing of expenditure has been agreed. On qualifying assets, definitions now seek to bring into scope patents, copyrighted software and similar assets but rule out marketing intangibles like trademarks. There are tighter transitional rules as well.

Automatic exchange of rulings has been confirmed in relation to various named areas of particular risk, with clarification of the exchange being with the countries of the immediate parent and the ultimate parent plus residence countries of affected related parties (and those of the corresponding head office or PE for PE rulings). This compulsory exchange must take place within three months for rulings issued after 1 April 2016 (rulings from 1 January 2010 still extant at 1 January 2014 need to be exchanged by 31 December 2016).

The review of the non-IP regimes in the list of 43 preferential regimes originally identified appears not to have made much progress. This review will continue in 2016 along with the development of a strategy for wider implementation which draws in more non-OECD countries plus a clearer statement of the new criteria for what is ‘harmful’ (and an ongoing monitoring mechanism).


20 February 2015

In our response to the proposals on the IP box nexus solution, we acknowledge that the approach has been endorsed by all OECD and G20 countries but...

we do have concerns that a large number of businesses which can clearly demonstrate development and ownership of valuable patents and substantial R&D activity in a relevant territory will, nonetheless, obtain little or no benefit from IP regimes intended to incentivise the development of patented IP. This is due to the mechanical formula adopted which, when applied on an entity by entity basis, can lead to restrictions that go far beyond the substantial activities principle stated in BEPS Action 5.

Modified Nexus potentially imposes significant administrative or systems requirements to track and trace expenditure and income. We believe that overly prescriptive tracking requirements that would work for all businesses would be virtually impossible to design. It is therefore necessary to design requirements that are flexible enough to accommodate different businesses whilst providing a clear framework to ensure IP regime benefits are commensurate with R&D activities. Our experience of R&D tax credit regimes (which are inherently more straightforward than Modified Nexus) is that there needs to be scope for claims to be approached in a number of different ways, using ‘best available’ information. Indeed, such claims based on ‘best available’ information, could be used as part of R&D tracking and tracing requirements, thus minimising the administrative burden for companies.

A significant number of businesses undertake R&D under a cost sharing arrangement. These include both internal group arrangements and a minority involving third parties. Our view is that a rule would need to be incorporated within the proposed Modified Nexus Approach to make this work for cost sharing as intended.

PwC understands the basis for the FHTP considering safeguards to prevent taxpayers from inappropriately using the transitional period to obtain tax benefits under existing IP regimes. That said, PwC considers that there is relatively limited risk of abuse for regimes which already include an active business test, since qualification is only possible where the IP regime claimant carries on substantive activities.

We understand that a number of Patent offices have been facing backlogs of patent applications for some time now, and companies submitting applications are beholden to the Patent Office when it comes to processing times. Our view is that the grandfathering provisions must apply to patents filed before 30 June 2016 rather than granted. This also aligns with the legal form, whereby a patent exists from its filing date, providing it is granted.

PwC welcomes the inclusion of robust detailed guidance to determine what will be regarded as qualifying IP assets under the Modified Nexus approach. In this respect, PwC recommends a number of points are considered when designing such guidance.


10 March 2015

We participated in an OECD/BIAC informal consultation meeting (under the Chatham House rule) for the OECD to hear from businesses regarding the practical application of the proposed modified Nexus approach to IP/patent boxes.


6 February 2015

OECD and G20 countries have agreed criteria to assess whether preferential treatment regimes for intellectual property (patent boxes) are harmful or not...

The IP box nexus solution proposed by Germany and the UK on how to assess whether there is substantial activity in an intellectual property regime was already endorsed and has now been further formalised.

The proposal – based around a “nexus approach,” which allows a taxpayer to receive benefits on Intellectual Property income in line with the expenditures linked to generating the income - has since been endorsed by all OECD and G20 countries.

Transitional provisions for existing regimes, including a limit on accepting new entrants after June 2016, have been agreed, and work on implementation is ongoing.


2 December 2014

The UK’s Treasury has today released a Written Ministerial Statement confirming the earlier UK:Germany joint proposal was broadly welcomed by OECD members together with...

a summary of frequently asked questions that address some of the points of uncertainty:

  • there is a little more detail around how the 30% uplift will work, to compensate companies sub-contracting to related parties and/or incurring acquisition costs
  • that businesses may wish to consider restructuring/realigning their IP to mitigate any adverse impacts of the reformed Nexus approach
  • that grandfathering will apply to existing IP already elected in by 30 June 2016 (with further consideration needed for patents filed but not granted before 30 June 2016)
  • consultation on 'track and trace' of R&D expenditure will commence in January 2015 with input/ feedback from companies welcome (to conclude by June 2015)
  • a hurdle or gateway provision, applied to the current regime, may be consulted on
  • legislation is not expected to be finalised until 2016
  • current EU Code of Conduct Group assessments of existing preferential IP regimes will be concluded


13 November 2014

This week saw UK and Germany agree a joint proposal to advance the BEPS negotiations on new rules for preferential Intellectual Property (IP) regimes for discussion...

at the Forum for Harmful Tax Practices (FHTP) meeting on 17-19 November.

  • Current Patent Box schemes would continue to be available until 2021 for companies who entered into existing schemes before June 2016. However, new IP and products would not be admissible after the 2016 cut off.
  • Essentially, the Nexus Approach is designed to ensure claimant companies have good substance in the territory of claim. It restricts qualifying IP income that can benefit from the Patent Box by reference to the claimant company’s qualifying research and development (R&D) as a percentage of total R&D and IP acquisition expenditure of the group.
  • A concession with respect to related party outsourced R&D expenditure is proposed, by providing a maximum 30% uplift on qualifying expenditure to compensate for related party outsourcing and IP acquisition disallowances (subject to a cap based on actual expenditure).
  • The UK is recommending that the FHTP work to reach agreement by June 2015 on a practical and proportionate tracking and tracing approach that can be implemented by companies and tax authorities, and which includes transitional mechanisms.


24 September 2014

‘Substantial activity’ is the touchstone in the G20-approved report on harmful tax practices as...

it is throughout the BEPS Action Plan. The focus on aligning taxation with the “substance” of transactions seems to be defined as determining where people are located, and where the performance of significant people functions takes place. Nonetheless, determining the location of substantial activity is inevitably a subjective determination, making objective criteria difficult.

The report also voices concerns with regimes that apply to mobile activities and that unfairly erode the tax bases of other countries, potentially distorting the location of capital and services. There is some overlap of this work with that in the transfer pricing space relating to intangibles and risk and capital, as well as similar issues being addressed in the report on the tax challenges of the digital economy.

Proposals for improving transparency through compulsory spontaneous exchange on taxpayer-specific rulings related to preferential regimes contribute to the third pillar of the BEPS project, which is to ensure transparency while promoting increased certainty and predictability. It should also be noted that the word “compulsory” is understood to introduce an obligation to spontaneously exchange information wherever the relevant conditions are met, meaning this is a further step in moving more generally from exchange of information upon request to automatic exchange of information.

The work will now move on to consider the regimes of non-OECD members before then revising as required the existing harmful tax framework.


26 May 2014

The OECD’s webcast today noted that the Working Party/Task Force discussions had focused on...

resurrecting the previous work done in this area, initially using the same methodology, but working toward a realignment of the criteria.


16 April 2014

It now seems clear that the Action to be completed by September 2014 to review existing OECD Members will take place...

using the ‘old’ established criteria, so that no Discussion Draft will be expected in advance of that.

There will be a report of the OECD’s findings at this stage and that should help awareness and a ‘common understanding’ of the current position and options for change.


2 September 2013

As long as there is full transparency and sufficient economic activity, we believe states should be at liberty to develop tax regimes to encourage...

economic activity and investment. There’s likely to be a ‘read-across’ to this area from Action 13 on the requirement for MNCs to provide information regarding their global allocation of income, economic activity and taxes paid. In other words, if the bulk of an MNC's income were disclosed as arising in a tax haven (taking advantage of the absence of a corporate profits tax), that would almost certainly lead to a requirement for demonstration of appropriate substance there.

We believe that countries will indeed continue to adopt policies to suit economic needs, but may be smarter about designing them within certain boundaries (those that don’t may be ‘cold shouldered’ and businesses may think twice about the reputational impact of using such regimes).


6 August 2013

Lowly taxed regimes have been created in many countries, whether for example in relation to particular geographical development areas, sectors or income streams...

Evidence points to its being an increasing phenomenon rather than a decreasing one.

It’s possible that the OECD will seek to develop a commentary on regimes they think are harmful, which may discourage certain states from adopting or maintaining such regimes. However, a focus on the competitive behaviour of states, not companies, may make some states rather less co-operative in dealing with the issues raised. This may also mean that it becomes more difficult for the OECD to make progress on the issues raised.


26 July 2013

Notwithstanding the overall nature of the OECD BEPS undertaking, (i.e., the focus on the actions of corporates) there remain objections that it’s the privileged tax regimes...

created by states that are the source of much of the problem. It is therefore understandable that the OECD would wish to put the topic of harmful tax practices back on the agenda of its Action Plan. However, it still seems a little surprising that the proposal is largely to revamp the work (from the late 1990s and early 2000s) on harmful tax practices, given the struggle encountered at that time with developing a consensus within the OECD for this work.

19 July 2013

Unlike the other actions in the Plan, this action point is concerned with the actions of states, not corporations. The discussion in the Plan refers to...

the original 1990s work of the OECD on harmful tax practices, and notes that the concerns raised 15 years ago on the mobile income tax base remain just as relevant today. It is stated that traditional ring-fencing (a major target of the OECD’s work some years ago) is less relevant now given the prevalence of across-the-board tax rate reductions on particular types of income. The February BEPS report calls for solutions to counter harmful regimes more effectively, taking into account factors such as transparency and substance: the work of the Forum on Harmful Tax Practices is now to be refocused to develop more effective solutions toward this goal.

There are three major elements to the work. First, there will be a review of member country regimes, to be completed within one year. Second, a strategy is to be developed to expand participation in this area to non-OECD members. Third, and more challenging, it is proposed that revised criteria on harmful tax practices will also be developed. Both of these latter actions are intended to be completed within approximately two years.