Base Erosion and Profit Shifting (BEPS) is currently the subject of intense discussion among tax professionals worldwide, but it remains a confusing area that is constantly evolving. This Alert highlights the key aims of BEPS, the current state of play and projected timeline and the most significant areas of controversy at present. The rules proposed under BEPS have not yet been finalised, and this Alert aims to bring some clarity to a complex and jargon-rich environment.
What are BEPS and the BEPS Action Plan?
What areas are being targeted by the BEPS Action Plan?
What is the process for implementing the BEPS Action Plan
When will BEPS actually enter into force and be effective?
What are the key areas of controversy at the moment?
What should businesses consider doing about BEPS at the moment?
Q: What are BEPS and the BEPS Action Plan?
A: As stated, BEPS stands for Base Erosion and Profit Shifting. The BEPS Action Plan is an Organisation for Economic Co-operation and Development (OECD) initiative designed to create a global standard in certain key areas for tackling perceived cross-border tax abuse. The OECD publishes papers on certain identified areas, recommending new international agreements, changes to the OECD model treaty and/or changes to domestic law.
Q: What areas are being targeted by the BEPS Action Plan?
A: The BEPS Action Plan is divided into 15 Actions. They are:
Action 1 – address the tax challenges of the digital economy
Action 2 – neutralise the effects of hybrid mismatch arrangements
Action 3 – strengthen controlled foreign companies (CFC) rules
Action 4 – limit base erosion by interest deduction and other financial payments
Action 5 – counter harmful tax practices more effectively, taking into account transparency and substance
Action 6 – prevent treaty abuse
Action 7 – prevent the artificial avoidance of permanent establishment (PE) status
Action 8 – assure that transfer pricing outcomes are in line with value creation: intangibles
Action 9 – assure that transfer pricing outcomes are in line with value creation: risks and capital
Action 10 – assure that transfer pricing outcomes are in line with value creation: other high-risk transactions
Action 11 – establish methodologies to collect and analyse data on BEPS and the actions to address it
Action 12 – require taxpayers to disclose their aggressive tax planning arrangements
Action 13 – re-examine transfer pricing documentation
Action 14 – make dispute resolution mechanisms more effective
Action 15 – develop a multilateral instrument to implement the BEPS actions
Q: What is the process for implementing the BEPS Action Plan?
A: The process varies by Action, and the Actions are at different stages. Generally speaking, the process is that discussion drafts or requests for input are released, followed by a public consultation session. A further memorandum or discussion draft is then released. Sometimes, there is a webcast or a request for input prior to the release of a discussion draft, and sometimes the discussion draft stage is omitted in favour of an immediate public consultation meeting.
Currently, the transfer pricing Actions (8, 9, 10 and 13) have been the subject of a public consultation with a further public consultation due on 19 May 2014 in relation to documentation. Preventing the artificial avoidance of a PE (Action 7) was the subject of a request for input in November 2013, but nothing further has been published. Preventing treaty abuse, addressing avoidance through hybrids and the challenges of the digital economy (Actions 6, 2 and 1) have all been the focus of recent or ongoing discussion drafts, with the prevention of treaty abuse also being the subject of a recent public consultation. Analysis methodologies (Action 11) is due for a request for input on a date to be confirmed. Actions 3, 4, 5, 12, 14 and 15 have not yet been subject to external consideration.
Q: When will BEPS actually enter into force and be effective?
A: Again, this depends upon the Action in question. However, the OECD has stated that it anticipates half the Action rules to be finalised by September 2015, with the rest being finalised in September 2015 or December 2015. This timetable is generally regarded as optimistic.
Q: What are the key areas of controversy at the moment?
A: There are a number of areas of existing controversy in relation to BEPS. Currently, they can be divided into general issues and those concerned with the Actions most under discussion at present – treaty abuse, hybrid mismatches and the digital economy (Actions 6, 2 and 1).
Some general opposition remains as to the concept of BEPS in that it erodes the ability of countries to negotiate their own terms on treaties, etc., and to decide between them what is appropriate. It can be contended that there is no reason why these issues should not be resolved between jurisdictions. Similarly, some of the proposals relate to domestic law changes, which would appear to be the remit of individual jurisdictions, and the implementation of such domestic proposals will likely affect the operation of the BEPS measures.
There is also some opposition in relation to the timeline for input and comment on BEPS. For example, the OECD released a discussion draft on treaty abuse (Action 6) on 14 March 2014 with the discussion period closing on 9 April 2014. Similarly the draft discussion paper on hybrid instruments (Action 2) was released on 19 March 2014 with comments due by 2 May 2014.
Action 1 – digital economy
It has long been recognised that the OECD model tax treaty has not kept pace with technology, and thus, change in this area was generally perceived as necessary. However, the discussion document released by the OECD elicited some criticism for certain areas in which digital businesses were treated differently to others. Most commentators consider that neutrality should apply and that businesses should be treated in the same way. It is also felt that the discussion document was insufficient on specifics in relation to certain proposed definitions, such as "fully dematerialised digital activity." It is hoped that the impending public consultation will assist in these areas.
Action 2 – hybrid mismatches
Two discussion drafts were released in relation to hybrids – one containing recommendations for domestic law changes and one recommending proposed treaty changes. In each case, the target is arrangements or entities that are treated differently in different jurisdictions, resulting in a double tax deduction for the parties or a deduction with no corresponding income. The documents place considerable emphasis on intra-group arrangements.
The main issue has been the potential complexity involved in actual compliance with the proposals. For example, there would be instances in which a deduction might be claimed in one jurisdiction but not be subject to inclusion in the other for some time, necessitating some anticipation in relation to compliance. Equally, the detail of compliance with some other recommendations is considered likely to be burdensome. In addition, there is no "purpose" test to prevent the rules from being applied inappropriately. Furthermore, the success of the OECD's recommendations will depend upon the extent to which the domestic proposals are implemented globally. As with the digital economy, public discussion is due on this Action shortly.
Action 6 – treaty abuse
This Action is vital for nearly all international businesses since they invariably rely on treaty benefits being available to them. However, some areas of conflict are present. In terms of anti-avoidance provisions, the OECD proposals currently include both a "main purpose" test, which denies treaty benefits to artificial structures in which the "main purpose or one of the main purposes" is to obtain treaty benefits, and a "limitation on benefits" (LOB) provision that limits the categories of those entitled to treaty benefits. These tests have been the subject of much debate, with some contending that the main purpose test should be abandoned for absence of clarity and others maintaining that the LOB provisions should be abandoned for absence of flexibility. Interestingly, jurisdictions tend to support the rules with which they are most familiar, with the United States being in favour of the LOB provisions and the United Kingdom preferring the main purpose test.
The LOB provisions have been the subject of specific criticism from those involved in collective investment. As currently drafted, the vast proportion of investment fund holding structures would fall outside the LOB provisions and investors would not be eligible for benefits, even if they would have been so eligible had they invested directly. Representations have been made in this regard.
Q: What should businesses consider doing about BEPS at the moment?
A: Currently, from a purely practical perspective, nothing needs to be done. It may be worthwhile for businesses to remain aware and ensure that their interests are represented.