Six months have elapsed since the Organisation for Economic Co-operation and Development (OECD) released its 15-point action plan to address Base Erosion and Profit Shifting (BEPS). During this time, OECD has been working toward achieving the goal of the action plan by coordinating with G20 governments, including the United Kingdom.
At its heart, the action plan seeks to eliminate double nontaxation of corporate income and curtail tax minimization strategies that involve the segregation of taxable income from the business activities that generate that income. The action plan also seeks to introduce dramatically increased transparency and information sharing between multinational entities and taxing authorities. It ultimately will affect many multinational tax and business structures, including those not viewed as involving aggressive or abusive planning.1
The BEPS Action Plan: U.K. Implementation
The U.K. government officially supports the development of rules to implement the 15 points addressed by the action plan. From the U.K. government’s perspective, the most important of these points are:
preventing erosion through hybrid entities, such as partnerships and Delaware LLCs;
preventing treaty abuse; and
updating and strengthening transfer pricing rules (particularly in relation to intangibles).
The U.K. government also continues to work closely with the OECD and the EU in relation to reviews of the taxation of the digital economy, which is recognized as an issue to be addressed in parallel to BEPS.2 Other BEPS action points, such as strengthening controlled foreign company (CFC) rules and reporting tax avoidance schemes, are not seen as areas of legislation that still need large amounts of work in the U.K. because the government views its existing rules as already fulfilling some of the action points, though there is an effort to refine the rules.3
The U.K. government also is on record as viewing transfer pricing as a key mechanism to combat BEPS. This is in contrast to the U.S. government, which may be favoring an expansion of CFC rules as a mechanism to deal with BEPS on a residence basis (see “US Corporate Tax Reform: Stuck in Neutral”). In fact, the U.K. government has narrowed the scope of the U.K.’s CFC regime — partly in an effort to make the U.K. a more attractive jurisdiction in which to locate business — and so it is unlikely that the U.K.’s CFC regime will be expanded. These different starting points for the collaborating jurisdictions highlight some of the headwinds the BEPS project may experience.
The U.K. government (and other EU jurisdictions within the OECD) also must consider EU law, which implements the fundamental “freedoms,” such as the freedom of establishment and the free movement of capital. The Court of Justice of the European Union previously has found a prior iteration of the U.K.’s CFC regime to breach the freedom of establishment because, in certain instances, it applied to genuine commercial arrangements (e.g., where a subsidiary company of substance resident in a low-tax EU member state was carrying on genuine economic activities).
Because, under EU law, CFC rules generally should apply only to wholly artificial arrangements, such governments are unlikely to expand or introduce CFC rules that could tax profits of companies carrying on genuine commercial activities in other EU member states. This is another example of possible disagreement between the U.S. and EU member states as to the direction that some of the BEPS action points should take. The action plan’s two-year timeframe looks challenging.
Pending that implementation of anti-BEPS rules, these issues will have to be addressed using local anti-avoidance provisions, and it is likely that we will see increasing instances of cross-border situations where unilateral actions by tax authorities will lead to double taxation. Taxpayers will need to pressure the U.K. government and other jurisdictions to improve (i.e., cheapen and streamline) mutual assistance procedures whereby the competent authorities seek to agree which jurisdiction has taxing rights in certain circumstances falling within an applicable double-tax treaty. In this regard, we would welcome the implementation of another BEPS proposal: compulsory arbitration between countries in cases where the respective tax treaty demonstrably does not solve double taxation.
Much focus in the past year has been on BEPS, which only deals with direct taxation. Separate from the BEPS action plan, the OECD also is reviewing VAT rules and producing guidelines for cross-border supplies of services and intangibles. While these guidelines do not focus on intra-group supplies or those between connected persons, they are helpful in showing the direction that the OECD may take on this issue.
For VAT, the OECD favors the “destination principle” of taxation, whereby the tax charge arises in the jurisdiction in which the service/intangible is consumed. This makes sense for VAT because it is a consumption tax, and EU member states generally apply the destination principle for VAT on business-to-business supplies. Starting January 1, 2015, the destination principle also will apply to business-to-consumer supplies of telecommunications, broadcasting and electronic services.
Interestingly, the destination principle is one of a number of possible methods of corporate and income taxation that could be adopted to deal with BEPS. While adopting the destination principle for direct taxation may be attractive to countries with consumer economies, such as the U.S., it is unlikely to appeal to countries with manufacturing economies, such as China, or to countries that already have consumption taxes, such as the United Kingdom.
The draft guidelines also consider the apportionment of a supply for VAT purposes where a business receives services that are used in different branches in different jurisdictions. Two methods are being proposed:
The “recharge method” whereby VAT on the supply is levied in the jurisdiction of the contractual recipient. Then any internal recharges of the cost of the supply to different branches are treated as payments for separate supplies, which are then taxed. (In general, this currently happens where recharges are between two different entities but not where between different branches of same entity.) This is the preferred method, as it would track recharges that most businesses are expected to make in any event for nontax purposes; and
he “direct-use method” whereby the business analyzes which establishment uses what portion of the supply, and VAT is levied in the different jurisdictions accordingly. This is not the preferred method, as it is expected to be administratively burdensome and costly for businesses.
There is therefore some similarity of approach between the VAT guidelines and what is being discussed to deal with BEPS, including the direct-use method as a possibility for transfer pricing. It will be interesting to see how the VAT guidelines develop alongside the proposals that are produced under the action plan, especially because the destination principle of taxation is one of a number of possible methodologies that could be adopted to deal with BEPS.
The BEPS action plan remains ambitious in its timeframe, with the potential to dramatically change international taxation. The VAT guidelines also could add an extra layer of complexity to the proposals that come out of the action plan. However, it remains to be seen whether the OECD can meet the ambitious deadlines set out in the action plan. There is likely to be some disagreement between governments on various points, and the political will that has driven the BEPS project to date may wane if countries’ economies continue to recover in 2014 and 2015.
1 For a more detailed discussion of the BEPS action plan and its 15 points, see the Skadden alert “International Taxation – OECD Reboot for the 21st Century” (July 19, 2013), available at http://www.skadden.com/insights/international-taxation-oecd-reboot-21st-century.
2 A report by the EU Commission’s High Level Expert Group on Digital Taxation is expected to be delivered in the first half of 2014.
3 E.g., the U.K. government has proposed changes to the CFC rules to prevent their abuse by addressing U.K. base erosion through the transfer of profits from intra group lending offshore, as well as a new information disclosure and penalty regime for high risk promoters of avoidance schemes.
*This article appeared in the firm's sixth annual edition of Insights on January 16, 2014.