October 2015 (155) – LIFE AFTER BEPS


The BEPS (Base Erosion and Profit Shifting) initiative of the OECD has been a fascinating insight into a politically driven project fuelled by public and media disquiet about the effectiveness the tax planning of multinationals, some of whom were paying very low levels of tax on income outside of their home base. The first set of Reports came out in September 2014 and the OECD wanted to present the entire 15 Action points as a completed project in October this year, so some of the Reports released now simply repeat what was said last year.

Outside of the international tax profession, the advent of the completed project has had little awareness. Perhaps because some of the elements had already been discussed and publicised, but principally because few journalists were prepared to read such a vast number of pages relating to each Action point. This month’s newsletter will highlight what we believe are the most important developments of BEPS, and the problems that may become apparent when countries seek to implement these recommendations. We have deliberately kept the newsletter limited in content to highlight the most important aspects of BEPS from the perspective of clients and their professional advisers.

We will be examining these issues in greater detail firstly at the IBSA discussion group in Paris this coming Thursday and then in the IBSA Annual Conference to be held at the Landmark hotel London on 19th November. For more details of all our events, please go to the IBSA website (click here).


Digital economy

It is believed that the digital economy provides opportunities for tax planning by transferring income into countries with low tax rates. The Report has a lot of background material describing the opportunities but is very short on solutions. It points to a number of other Action points and proposals related to the solutions, such as re-drafting the permanent establishment definition. It considers creating a virtual permanent establishment (PE) for electronic activities, but does not currently recommend this, although a special group working on the digital economy has in fact been set up and work is to continue.

What has been agreed is that the words ‘preparatory and auxiliary’ should be carefully reviewed, as currently an exception to the creation of a PE exists if the activities are merely preparatory and auxiliary to the principal activities of the entity concerned. The PE definition, which is a fundamental component of double tax treaties, has been due for reform for many years, and the issue of whether the activities of independent agents should be ignored when considering whether a PE exists is also considered.

Certainly commissionaire arrangements are highlighted as central to the activities of a foreign enterprise and thereby create a PE where the commissionaire is located. Also, one of the proposals is to prevent the artificial avoidance of the ‘per se’ status. In Article 5.4 there are a number of activities excluded from creating a permanent establishment, such as the maintenance of a stock of goods for a foreign enterprise, and the opening of a representative office for that enterprise. Thus warehousing a stock of goods was always considered as a ‘per se’ preparatory and auxiliary activity which would not create a PE. One of the recommendations is that for those countries who wish to do so, all of the 5.4 exceptions will require proof that the activity is preparatory and auxiliary. For example, maintaining very large warehouses in a country close to customers, so customers can go online at 12pm and get delivery the next day, is a key element of the business proposition.

Access to double tax treaties

As regards Action point 6, the OECD has not yet finalised its recommendations regarding a final Limitation of Benefits (LoB) proposal to prevent treaty access in certain circumstances. Indeed, the US has recently modified its own LoB provisions to widen the derivative benefits qualification, even encouraging treaty shopping by this albeit limited shift, perhaps in response to the need to encourage inward investment. Clearly the LoB provisions need a lot more consideration before a global implementation under the proposed multilateral instrument, as different countries have different investment requirements.

However, clearly treaty shopping is a major focus of the OECD, and this will apply not just to multinational enterprises but smaller companies as well. It may prove much more difficult in the future to rely on double tax treaty provisions than hitherto. An alternative proposition put forward by the OECD to the inclusion of a comprehensive LoB clause in double tax treaties, is a ‘principal purpose test’ (PPT) which the UK has had in some of the articles of its treaties up until now, and the UK has persuaded the OECD and G20 to offer this as an alternative applicable to the entire treaty. However, this will create uncertainty since it is based on the subjective intention of the relevant person, and this threat of uncertainty is a common thread emanating from the entire BEPS project.

Hybrid instruments

The first part on Action 2 on hybrid instruments was unveiled a year ago, and has a primary rule and a defensive rule. Where one has a payment treated as deductible interest in a source country but a non taxable receipt in the recipient country, then the primary rule would require the country of source to deny the deduction. If they do not do that, then the country of residence could refuse to give an exemption permitting the non taxable receipt.

What is interesting though is the extent to which countries such as Luxembourg will implement the primary rule, and indeed the defensive rule (no double deduction of expenses). There is likely to be peer pressure on these countries to adopt these measures and amend their legislation, but the OECD has also guaranteed the sovereignty and integrity of each country to adopt legislation necessary for their own economic and political purposes.

Limiting interest expense

Action point 4 is the issue of non-deductible interest and the cap of between 10% and 30% of EBITDA on both internal and external debt. Whilst limits have been imposed on internal debt for many years as a development of thin capitalisation rules, including external debt in the equation has far reaching issues. For example, the external recipient will always be taxed on the interest receivable, but the payor may have a limited deduction, resulting in a tax mis-match. And companies within an international group may require finance in particular sectors where EBITDA is limited, even thought the overall group finance is within the prescribed limits. This has in fact been recognised by the OECD and further work is intended on this potentially controversial issue.

The UK is planning to replace the worldwide debt cap with provisions on interest limitation designed on the basis of the OECD and G20 proposals. There would be for each country a de minimis limit, which for the UK would be £1 million of interest deduction per annum, thereby excluding all but the largest MNEs from this cap. Moreover, the OECD suggests that if a group can justify a higher interest deduction, it may exceed the 30% cap. Nevertheless, the interest cap on internal and external finance is likely to lead to uncertainty of tax liabilities between tax authority and the tax payer; again this element of uncertainty and the subjective approach recommended by the OECD in various of its Action points may lead to more conflicts than resolutions.

Transfer pricing

Turning now to what was initially considered as the focus of BEPS, Action points 8 – 10 contain recommendations related to transfer pricing, and the need for all companies of whatever size to prepare transfer pricing memoranda with a Master File and Local Files covering their group business and intercompany transactions. Existing transfer pricing concepts have been maintained, but the focus has been more on which companies are capable of accepting the risks inherent in creating the profits allocated to them. Also, the transactional profit split method seems to have been proposed as more relevant than previous OECD recommendations. What is interesting is that legal ownership is therefore not necessarily conclusive in determining profit sources, and quantifying risks is so subjective that it could automatically lead to many disputes in this area.

Thus the OECD recommendations move towards giving revenue authorities greater power to disregard what the corporate group has put into place, by way of cost contribution agreements, legal ownership of IP and indeed the whole issue of transfer of risk. For example, contractual allocation of risk to a company will not necessarily be respected if the company does not have the control over the risk or the financial resources to bear that risk. That will fundamentally conflict with freedom and sanctity of contract.

Again, this may create the potential for two or more tax administrations to make tax adjustments based on such subjectivity (e.g. who can bear the relevant risks) which could cause havoc to multinational companies without a very clear cut mutual agreement procedure which is adopted within a limited time frame?

Country by country reporting

MNEs with turnover in excess of €750 million will have to adopt country by country reporting for all countries in which they operate with effect from 1 January 2016. Although this apparently may only affect about 1,500 to 2,000 companies worldwide, there are major concerns with this approach.

Should the reports be made public, when the essential reason for having these reports is to effectively be a risk indicator of where a company might be under-paying in a particular jurisdiction? Besides this concern of confidentiality of data, the administrative burden of marrying up financial statements of subsidiaries (with perhaps differing accounting periods) with their relevant tax returns and the CbC template offered by the OECD, may prove very costly. And would tax administrations be able to assimilate and utilise all the information coming from CbC reporting statements? Clearly, the likely consequence of CbC reporting is that it will provide scope to revenue authorities’ for more enquiries with the multinationals concerned, leading to uncertainty of tax liabilities and ever increasing compliance costs.

Mutual agreement procedure

It is apparent therefore that there will be much more scope for arguments between taxpayers and revenue authorities, and indeed between revenue authorities themselves, as a result of the various recommendations made by the OECD. To some extent, these arguments have been relevant for many years, and the codification of the various recommendations perhaps do not create a fundamental additional set of arguments. But adopting the subjective issues within the recommendations may certainly create additional issues.

Fortunately, the OECD have recommended in Action point 14 that the Mutual Agreement Procedure (MAP) be strengthened and create certainty within a limited time frame of the outcome of investigations between tax authorities. Minimum practices contained in this Action point are a good start in creating binding MAPs and there will be a new forum on mutual agreement procedure where countries will come under peer pressure to live up to the recommendations. 20 countries have signed up in principle to arbitration where MAPs cannot readily conclude taxing rights and amounts, so this is a good start.

Multi-lateral Instrument

The last Action point 15 is a method of streamlining the process of amending tax treaties in accordance with the BEPS recommendations. This will automatically implement certain of these recommendations, such as the permanent establishment amendments, treaty abuse in the form of a limitation of benefits provisions and the incorporation of a Principal Purposes Test, into separately negotiated double tax treaties. The time frame for this multilateral instrument is that it should be drafted by 31 December 2016. However, the wholesale provisions may not be acceptable in their entirety to all countries, so the implementation of this instrument will be interesting as some countries see elements of the instrument contrary to their economic requirements.


The hype about BEPS has been very considerable over the past 2 years. With the greatest of respect to its protagonists, the reality is something of a damp squib. Far too many pages written on each Action point without the conclusions one would expect from a two year study (and indeed one that has been in progress for much, much longer than 2 years). It feels like a huge amount of time and money has been spent on attacking the practices of a limited number of multinational enterprises, whilst introducing uncertainties such as how much one is now able to rely on mutually agreed double tax treaties taking into account the existence of a multilateral instrument which will affect the provisions of the relevant bilateral treaty. BEPS also introduces many recommendations which are based on subjective ideas, such as the companies able to accept risk in the transfer pricing provisions, or what is the principal purpose of certain transactions.

Clearly this is an ongoing project, and rather than having a final outcome in October 2015, tax practitioners and their clients will face ever increasing uncertainties of their tax obligations and how their intercompany and external contractual arrangements should be implemented. The taxpayer’s charter for most developed countries is that there should be simplicity, fairness and clarity of tax legislation. My personal viewpoint is that the involvement of so many countries in attempting to codify aggressive tax planning is a retrograde step in achieving the essential elements of this charter.Your views would be welcome

With kind regards

Roy Saunders