While a host of topics — from the necessity and the proposed scope of corporate tax reform, to corporate rate reduction and corporate inversions — are of major concern to those engaged in international tax, the overriding issue is BEPS and its Action Plan agenda.
BEPS, or Base Erosion and Profit Shifting, is an initiative of the Organization of Economic Cooperation and Development that is seen as an answer to the tax planning by multinational enterprises that makes use of gaps in the interaction of different tax systems to artificially reduce taxable income or shift profits to low-tax jurisdictions in which little or no economic activity is performed. In response to this concern, and at the request of the G-20 group of major economies, the OECD published an “Action Plan on Base Erosion and Profit Shifting” in July 2013. The BEPS Action Plan identifies 15 actions to address BEPS in a comprehensive manner, and sets deadlines to implement different actions.
The actions include: addressing the tax challenges of the digital economy; neutralizing the effects of hybrid mismatch arrangements; strengthening controlled foreign company rules; limiting base erosion via interest deductions and other financial payments; preventing treaty abuse; preventing the artificial avoidance of permanent establishment status; ensuring that transfer pricing outcomes are in line with value creation; requiring taxpayers to disclose their aggressive tax planning arrangements; re-examining transfer pricing documentation; and making dispute resolution mechanisms more effective.
“BEPS has caused ripples of change around the world,” said Selva Ozelli, a New York-based tax attorney and CPA. “It seeks to equip countries with the necessary tools to ensure that profits are taxed where the economic activities generating them are performed and where value is created. BEPS intends to provide greater certainty and predictability in the application of international tax rules.”
“Much of what is in the OECD BEPS Action Plan is already addressed in U.S. tax law, although not in a way that precludes stateless income,” she said. “There are a number of legislative proposals aimed at addressing BEPS issues, including ones that attempt to curb inversion’ transactions,” she said.
SPREADING ROUND THE WORLD
BEPS work hasn’t just included the 34 OECD member states, but also the BRICS — Brazil, Russia, India, China and South Africa — and other emerging economies that are in the G-20 but not the OECD, Ozelli noted. “The eight non-OECD G-20 members — the five BRICS countries as well as Argentina, Indonesia and Saudi Arabia — all participate in the BEPS projects on an equal footing with OECD countries and have a key role in steering the entire BEPS project,” Ozelli said.
Since January, Albania, Azerbaijan, Bangladesh, Croatia, Georgia, Jamaica, Kenya, Morocco, Nigeria, Peru, the Philippines, Senegal, Tunisia and Vietnam directly participate in BEPS work through meetings of the Committee on Fiscal Affairs and BEPS technical working groups, she added. “The African Tax Administration Forum and the Center for Inter-American Tax Administration also have joined the CFA and its working groups as observers, on equal footing with the International Monetary Fund, the UN and the World Bank.”
“BEPS has the potential to apply to a lot of companies,” observed Bill Roth, a partner in BDO’s National Tax Office — International. “It’s a function of the rest of the world trying to figure out the tax structures that have impacted their treasuries adversely.”
Some countries have jumped the gun on implementing the BEPS proposals, according to Roth. “For example, the U.K. just enacted a Diverted Profits Tax on April 1,” he said. “It’s aimed at companies that have large U.K. operations but pay very little in U.K. tax. It’s somewhat like out Alternative Minimum Tax. It has a higher rate than the regular tax, 25 percent compared to 20 percent. The incentive is to pay at the normal rate, or you will be taxed at the higher rate.”
“BEPS is at least making countries think about how they can increase their tax revenue,” he said. “There is a downside for the U.S., in that it could decrease our tax revenue. We determine tax on a worldwide basis, and give a credit for foreign taxes paid. So to the extent more taxes are paid to foreign tax authorities, theoretically that would reduce the tax to be paid in the U.S.”
“For example, if a corporation pays 5 percent to a foreign taxing authority, when the revenue is repatriated to the U.S. it is subject to the U.S. rate of 35 percent, with a credit for the 5 percent already paid to the foreign jurisdiction, so the U.S. will receive 30 percent. If the foreign jurisdiction collects 15 percent, the U.S. will only get a net tax of 20 percent [35 percent minus the 15 percent credit] so the U.S. treasury could actually be harmed if some of these BEPS provision are enacted by foreign countries. At the end of the day, it’s like fighting over the same piece of pie,” he said. “The U.S. realizes this, and that’s why it is participating in discussions on BEPS — everyone has their own turf to protect.”
AIMING FOR TRANSPARENCY
The BEPS Action Plan provides for 15 actions covering coherence of corporate income taxation, re-alignment of taxation and relevant substance, and ensuring transparency while promoting increased certainty and predictability. One of the initiatives of BEPS, country-by-country reporting, is seen by the OECD as the most important achievement of the international tax transparency agenda, according to Roth. “Much of this is related to transfer pricing,” he observed. “They want country-by-country reporting, with the major countries providing information regarding profitability so everyone has more information. The intent is to have more information on what companies are earning, and where they are earning it.”
“The issue is what to do with the information once they have it,” he added. “The thought is that it will enable their particular audit functions to zero in on some specific items.”
The OECD wants to implement more stringent provisions in tax treaties, Roth noted. “The U.S. has been doing this for years, but the rest of the world is trying to catch up,” he said. “Limitation of benefits — LOB — means essentially that just because you’re headquartered, say, in the U.K., you don’t automatically get benefits under the U.K.-U.S. treaty. You have to have some substance in the U.K. That’s one of the initiatives under BEPS aimed at avoiding treaty-shopping. LOB provisions put some substance on what you need to be doing in a particular treaty country to get the benefits under the treaty.”
There are also initiatives on hybrid instruments, Roth explained: “For example, if the U.S. treats an instrument as debt but the U.K. treats it as equity, you might get an edge by playing off the two jurisdictions.”
“They’re trying to level the playing field,” he said. “The difficulty is probably going to be, even if you agree in principle, how do you get each country to go back and get their legislatures and taxing authorities to agree to it and not change or deviate much from what was agreed to in principle. That will be a challenge in the next couple of years.”
“BEPS has been out there for a year and a half since its launch,” he said. “Most of the groups have put out one or two working papers, so it’s been done at a pretty quick pace, given how government bodies usually move on these types of things. But they’re going to have to get everyone on board if they’re going to be successful at this.”
“They’re trying to take on a lot in a very short period of time,” agreed John Kelleher, international tax partner at Top 10 Firm Crowe Horwath. “I just wonder how effective that will be.”
Some countries are actually changing their domestic law ahead of BEPS, he noted. For example, in March 2015, the European Commission introduced a tax transparency package under which member states would automatically exchange tax ruling information on a quarterly basis. “While some countries have tried to adopt rules in the draft guidelines ahead of time, nothing yet has been finalized in BEPS,” he said.
“Besides BEPS, the other huge unknown is whether we will get any kind of substantial tax reform,” Kelleher said. “Japan just lowered their rate again, so we have the highest corporate tax rate in the industrial world. The ability to get tax reform done is tied to all these issues.”
THE WORLD AND THE U.S.
One of the issues the tax reform advocates want addressed is the current U.S. system of taxation of worldwide earnings, as opposed to a territorial system. “On this issue, Democrats and Republicans are far apart,” said Dave Kautter, partner-in-charge of Washington National Tax at Top 6 Firm McGladrey LLP.
“Most of the major developed economies use a territorial system, which means earnings are only taxed in the country in which they are earned,” he said. “The U.S. is the only developed economy that uses the worldwide system. Since the competition for U.S. companies are headquartered in the major developed economies, the U.S. companies find themselves at a competitive disadvantage to their foreign-headquartered competitors. That’s the reason for corporate inversions.”
Corporate inversions, in which a U.S.-based multinational group restructures so that the U.S. parent of the group is replaced by a foreign corporation, typically in a low-tax jurisdiction, allow firms to reduce their level of worldwide taxation. A company that inverts continues to pay the U.S. corporate rate on profits earned through U.S. operations, and foreign profits brought back to the U.S. will get taxed by the U.S. However, the profits earned abroad escape being taxed by the U.S.
“Inversions are out there, but at the end of the day, it’s headline stuff,” said Roth. “It’s great for politicians to jump on the bandwagon, and it’s interesting to talk about, but most companies are not in a position to take advantage of the rules that would allow them to invert.”
There has been widespread bipartisan talk for several years over the need for corporate tax reform and lower tax rates for U.S. corporations, but most observers don’t expect to see much movement soon. “It probably won’t happen this year,” said Keleher. “I don’t think Congress and the president are on the same page as to what their objectives are.”
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