BEPS progress by the OECD

The OECD’s unit working on the Base Erosion and Profit Shifting (BEPS) project have been releasing documents based on the points in the Action Plan published last year.  The full set is here.

Yesterday, a discussion document for Action Point 1: Taxing the Digital Economy was published.  It is a very wide-ranging document.  One of the notable suggestions are the proposals to allow/force the greater taxation of companies selling digital products in their “market jurisdictions”.  This primarily arises from the ability of such companies to circumvent the existing rules on permanent establishment because of the intangible nature of the product.

The proposal is not a move to formulary apportionment. The document puts forward proposals to alter the existing source principle of corporation tax to try and ensure that more/some of the profits earned by these companies are attributed to the country of their customers using changes to PE rules.  Other proposals include the new concept of a “virtual” permanent establishment, the creation of a withholding tax on digital transactions and the use of consumption tax options.

There is a lot in the document and some extracts summarising the problems the OECD group are trying to tackle in this area are below the fold.  Whether there will be any effective solutions by the end of the process remains to be seen.

Permanent establishment and the digital economy.

124. Companies in many industries have customers in a country without a permanent establishment in that country, communicating with those customers via phone, mail, and fax and through independent agents. That ability to maintain some level of business connection within a country without being subject to tax on business profits earned from sources within that country is the result of particular policy choices reflected in domestic laws and relevant double tax treaties, and is not in and of itself a BEPS issue. However, while the ability of a company to earn revenue from customers in a country without having a PE in that country is not unique to digital businesses, it is available at a greater scale in the digital economy than was previously the case. Where this ability, coupled with strategies that eliminate taxation in the State of residence, results in such revenue not being taxed anywhere, BEPS concerns are raised. In addition, under some circumstances, MNEs may attempt to artificially fragment their operations among multiple group entities to qualify for the exceptions to permanent establishment status for preparatory and auxiliary activities, or to otherwise ensure that each location through which business is conducted falls below the permanent establishment threshold. Structures of this type may permit an MNE to artificially avoid tax in the market jurisdiction, which raises BEPS concerns.

Paragraph 133 gives a useful summary of the techniques used to minimise tax in an “intermediate” country where a company has a taxable presence (such as Ireland).

133 Companies may also reduce tax in an intermediate country by generating excessive deductible payments to related entities that are themselves located in low- or no-tax jurisdictions or otherwise entitled to a low rate of taxation on the income from those payments. For example, an operating company located in an intermediate jurisdiction may use intangibles held by another affiliate in a low-tax jurisdiction. The royalties for the use of these intangibles may be used to effectively eliminate taxable profits in the intermediate jurisdiction. Alternatively, an entity in an intermediate jurisdiction may make substantial payments to a holding company located in a low- or no-tax jurisdiction for management fees or head office expenses. Companies may also avoid taxes in an intermediate country by using hybrid mismatch arrangements to generate deductible payments with no corresponding inclusion in the country of the payee.  Companies may also use arbitrage between the residence rules of the intermediate country and the ultimate residence country to create stateless income. In addition, companies may assert that the functions performed, assets used, and risks assumed in the intermediate country are limited.

Paragraph 135 is a thinly-veiled reference the wide-scale system of tax deferral available to US companies for their non-US-sourced income.

135 In addition, companies in the digital economy may avoid tax in the residence country of their ultimate parent if that country has an exemption or deferral system for foreign-source income and either does not have a CFC regime that applies to income earned by controlled foreign corporations of the parent, or has a regime with inadequate coverage of certain categories of passive or highly mobile income, including in particular certain income with respect to intangibles. For example, the parent company may transfer hard-to-value intangibles to a subsidiary in a low- or no-tax jurisdiction, thereby causing income earned with respect to those intangibles to be allocated to that jurisdiction without appropriate compensation to the parent company. In some cases, a CFC regime might permit the residence jurisdiction to tax income from these intangibles. Many jurisdictions, however, either do not have a CFC regime, have a regime that fails to apply to certain categories of income that are highly mobile, or have a regime that can be easily avoided using hybrid mismatch arrangements.

And paragraph 146 promises the end of “stateless income”

146 Structures aimed at artificially shifting profits to locations where they are taxed at more favourable rates, or not taxed at all, will be rendered ineffective by ongoing work in the context of the BEPS Project. At the same time, the work on BEPS will increase transparency between taxpayers and tax administrations and among tax administrations themselves. Risk assessment processes at the level of the competent tax administration will be enhanced by measures such as the mandatory disclosure of aggressive tax planning arrangements and uniform transfer pricing documentation requirements, coupled with a template for country-by-country reporting. The comprehensiveness of the BEPS Action Plan will ensure that, once the different measures are implemented in a coordinated manner, taxation is more aligned with where economic activities takes place. This will restore taxing rights at the level of both the market jurisdiction and the jurisdiction of the ultimate parent company, with the aim to put an end to the phenomenon of so-called stateless income.

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11 thoughts on “BEPS progress by the OECD”

  1. This report shows good progress with a target for the OECD to present final proposals in September a year after receiving a mandate from the G-20.

    Of course there are complexities but for most companies identifying sales per jurisdiction isn’t a problem when VAT returns have to be made.

    In its quarterly report Google identifies the UK as it biggest overseas market with about 11% of global revenues.

    The report shows that Irish ICT services exports are just behind India’s, which are the highest in the world. In a few years time, Ireland could see up to €50bn in virtual services exports scrubbed from the national accounts.

    Corporate Tax Reform: OECD says Ireland/ India top global ICT services exporters

  2. The difficulty for the OECD is that it operates on an inter-governmental basis which requires unanimity for any decisions the nature of which is unclear. Not so the EU which operates in a supranational legislative context with considerable independent powers delegated to the Commission in the context of the control of state aids!

    http://europa.eu/rapid/press-release_IP-14-309_en.htm

    Insofar as early substantive progress towards correcting BEPS is concerned, this is most likely in response to focused pressure from the Commission and more generalised pressure in the context of the OECD.

  3. @ DOCM

    Germany, UK and France jointly agreed to get the G-20 involved in Feb 2013 and the US was supportive.

    At the time, the EC had been unable to make much headway with members on the consolidated tax base proposal.

  4. @ MH

    To do what?

    The CCCTB is at least a formally drafted legislative proposal from the Commission and is on the table. The fact that it has not been agreed is simply a confirmation of the difficulties involved.

  5. @ DOCM

    Good to know it’s still “on the table.” :roll:

    Savings directive amendments were “on the table” for six years but the change in international sentiment in respect of personal and business tax evasion helped the last holdout to give way last week.

    However, it’s likely that a tax haven within the EU would again play for time on bigger reform.

    Several individual countries and their citizens support reform.

  6. fyi other forms of profit sharing – geopolitical economy

    fyi

    ‘Dear to Our Hearts’: The Crimean Crisis from the Kremlin’s Perspective

    The EU and US have come down hard on Russia for its annexation of the Crimean Peninsula. But from the perspective of the Kremlin, it is the West that has painted Putin into a corner. And the Russian president will do what it takes to free himself.

    http://www.spiegel.de/international/world/a-look-at-the-crimea-crisis-from-the-perspective-of-the-kremlin-a-960446.html#ref=nl-international

    @all
    Any taxation chanes will be long, long, long drawn out. Bit like the ‘Banking Union’ and ‘turning the corner’.

    @all

    Blind Biddy & Paddy Zhukov are in London for the evening! LONDON! Ahh Nice one.

  7. @ MH

    Of course! That is exactly my point. A detailed legally binding proposal has first to be tabled. What happens thereafter is a matter of conjecture.

    There are three distinct contexts; (i) action by the EU on the basis of a legislative proposal by the Commission (ii) independent action by the Commission under its treaty delegated powers in relation to state aid and (iii) action internationally on the basis of intergovernmental cooperation. While political developments may be driving all three, mixing them up only leads to confusion.

    Russia is – still – a member of the G20. Accession talks for Russian membership of the OECD have been put on hold. On the G8, to quote the Russian FM “The G8 is an informal club. No one hands out membership cards and no one can be kicked out of it”. The same holds true of the G20.

  8. Change is coming. That is clear. Ireland is not ahead of the curve….it continues as before as if the change is in the far distant future….as per some of the comments already (and regularly heard among the KPMG, PWC, E&Y, Deloitte, etc. brigades).

    Not this time. What’s happening internationally in finance right now is “structural”, going to the core of governance & related. “Hardening political attitudes” is among the latest FT headlines. Indeed. Previously, Ireland survived in the cracks…however, the tax balance sheet in Ireland has become too big to be ignored, and so it will not be ignored. Recent Govt /DoF statements (many recently made during NYC and London gatherings around Paddy’s Day) that there will be relative safety by being “in the herd” will not work so well as we move forward.

    Best economic analysis piece in the last week has been from MEI in my view:

    http://www.ft.com/cms/s/0/c252434a-b022-11e3-b0d0-00144feab7de.html

    Beware the random, radical (political, geopolitical) event. Economics will not have a simple answer for that.

  9. King Digital Entertainment, the largest game developer on Facebook and maker of the popular mobile video game Candy Crush, announced terms for its IPO (initial public offering) on Tuesday and has raised $500m, valuing the company at $8bn on a fully-diluted basis.

    It is due to float on the New York Stock Exchange Wednesday

    The ‘Irish’ company was founded in Sweden, has its operations in London, and registered office in Dublin where it doesn’t even have a phone line, providing its London number in its regulatory filings.

    Ireland isn’t a tax haven.

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