OECD final report on Base Erosion and Profit Shifting (BEPS): Overview

SUITS THE C-SUITE By Ma. Fides A. Balili and Maria Margarita D. Mallari-Acaban

Business World (10/26/2015 – p.S1/6)

(Second of two parts)

In last week’s column, we discussed how the Organization for Economic Cooperation and Development (OECD) issued its final report on all the 15 BEPS Action Plans on Oct. 5, which was the culmination of two years of work with the intent of restoring confidence in the international tax framework by addressing weaknesses that create opportunities for Base Erosion and Profit Shifting (BEPS). We previously looked at the first seven Action Plans, which discussed areas such as hybrid mismatch arrangements, controlled foreign company rules, interest benefits and treaty benefits, among others. We will now continue with the remaining six Action Plans.

ACTIONS 8-10: ALIGNING TRANSFER PRICING OUTCOMES WITH VALUE CREATION

The report on Action 8 aims to address BEPS by determining the risks contractually assumed by the party. If a party does not have control over the risks or does not have the financial capacity to assume the risk, the profit will be allocated to the party who has the control and the financial capacity to assume the risk.

The report on Action 9 aims to address a BEPS situation where a capital-rich member of a group primarily provides funding but only performs limited activities. If this entity does not, in fact, control the financial risk associated with its funding to the group, the report recommends that the entity should not be allocated the profits associated with the “financial risk” it purportedly assumed.

The report on Action 10 provides for guidance on transfer pricing (TP) methods and how to allocate profits to the most important activities of a group.

ACTION 11: MEASURING AND MONITORING BEPS

The report for Action 11 acknowledges the fact that the fiscal effects of BEPS resulted in a global corporate income tax (CIT) revenue loss, which was estimated to be between 4%-10% of the global CIT i.e. $100 to $240 billion annually.

Six indicators of BEPS activity were identified in the report to highlight the BEPS behavior as follows:

· The profit rates of MNE affiliates located in lower-tax countries are higher than their group’s average worldwide profit rate;
· The profit rates of MNE affiliates in low tax countries compared to those in high tax countries;
· The effective tax rates paid by large MNE entities are estimated to be 4 to 8.5 percentage points lower than similar enterprises with domestic-only operations;
· Foreign direct investment (FDI) is increasingly concentrated;
· The separation of taxable profits from the location of the value creating the activity is particularly clear with respect to intangible assets;
· The debt from both related and third parties is more concentrated in MNE affiliates in higher statutory tax-rate countries.

The report recommends that OECD countries coordinate among themselves, including other countries, to make data available to ensure that governments and researchers in the future will be able to improve their measurement and monitoring of the raised BEPS concerns and the actions taken to address them.

ACTION 12: MANDATORY DISCLOSURE RULES

The report on Action 12 primarily recommends the adoption of Mandatory Disclosure Regimes and provides for the modular framework, which countries may consider should they adopt a Mandatory Disclosure Regime. This is in response to the lack of timely and comprehensive information on aggressive tax planning strategies, which prevents tax authorities from addressing said issues or assessing tax deficiencies.

Should a country decide to adopt a Mandatory Disclosure Regime, the report outlined the following features that were considered as the key design features of a mandatory disclosure regime:

· Disclosure obligations;
· Inclusion of specific and general hallmarks which will trigger a disclosure;
· Establishment of a mechanism to track and link disclosures;
· Linking of the timeframe for disclosure to the scheme being made available to taxpayers when the obligation to disclose is imposed on the promoter; and
· Introduction of penalties to ensure compliance with mandatory disclosure regimes

The Report likewise recommends that countries to develop a disclosure mechanism for cross-border and intra-group transactions.

ACTION 13: TRANSFER PRICING DOCUMENTATION AND COUNTRY-BY-COUNTRY REPORTING

The report sets out a three-tiered standardized approach to TP documentation:

· MNEs will be required to provide tax administrations with high-level information regarding their global business operations and TP policies known as the “Master File” which shall be available to all tax administrations.
· MNEs will be required to maintain a “Local File” that details the transactional TP documentation specific to each country.
· MNEs will also be required to file a Country-by-Country Report, which will provide information of their annual revenue for each tax jurisdiction in which they do business.

The above reports are aimed at aiding tax jurisdictions in monitoring and determining an MNE’s TP practices, which have the effect of artificially shifting substantial amounts of income to tax-advantaged environments. For this purpose, an implementation package has been developed consisting of model legislation which could be used by countries to require MNE groups to file the Country-by-Country Report and competent authority agreements that are to be used to facilitate implementation of the exchange among tax administrations.

ACTION 14: MAKING DISPUTE RESOLUTIONS MECHANISMS MORE EFFECTIVE

The report acknowledges the importance of dispute resolution mechanisms in case of unintended double taxation as a result of the BEPS action plans. The measures developed under Action 14 aim to strengthen the effectiveness and efficiency of the mutual agreement procedure (MAP) process with the following minimum standards:

· Ensure that treaty obligations related to the MAP are fully implemented in good faith and that MAP cases are resolved in a timely manner;
· Ensure the implementation of administrative processes that promote the prevention and timely resolution of treaty-related disputes; and
· Ensure that taxpayers can access the MAP when eligible.

ACTION 15: DEVELOPING A MULTILATERAL INSTRUMENT TO MODIFY BILATERAL TAX TREATIES

The report on Action 15 recognizes the need for the creation of a multilateral instrument that would not only include the Action Plans on BEPS but also update the existing bilateral tax agreements between countries.

For this purpose, interested countries shall develop a multilateral instrument designed to provide an innovative approach to international tax matters, reflecting the rapidly evolving nature of the global economy and the need to adapt thereto.

THE FUTURE OF BEPS

With the release of the OECD final report, the BEPS initiative is now in full swing. The OECD is set to develop a framework for monitoring the implementation of the BEPS recommendations by the different countries. It has also been tasked to complete follow-on technical work related to the BEPS focus areas.

This leaves different jurisdictions, including the Philippines, with the challenge of adopting and implementing the recommendations under each action item, which will include legislating BEPS-driven laws and tax policies. For companies, especially those which have not started their own BEPS evaluation, this signifies the need to seriously consider the impact of the BEPS initiative on their businesses. The global tax environment is about to change in the next few years. It is best to be prepared for the significant changes ahead.

In the coming weeks, a more detailed discussion on each of the different BEPS Action Plans will be featured in this column.

Ma. Fides A. Balili and Maria Margarita D. Mallari-Acaban are a partner and a Senior Director, respectively, of SGV & Co.