In this edition: 2017 tax reform, important new requirements for Luxembourg finance company tax rulings and ATO hubs practical compliance guide.
2017 Tax Reform - Transfer Pricing Opportunities?
Corporate tax reform sits near the top of the agenda for both the Trump administration and the Republican controlled House of Representatives. Areas where both parties agree include:
- Tax Rate Reduction;
- Repeal of Corporate AMT, and;
- Tax Breaks for Repatriation of Foreign Earnings.
Border Adjustments is another area for potential reform that both Congress and the President have spoken to. Potentially a fundamental shift in the U.S. corporate tax system, Border Adjustments would have the effect of converting the U.S. system of taxing worldwide income to a territorial tax system. Congress has a border adjustment tax explicitly within the House Republican blueprint, while president Trump has said that Border Adjustments are “still on the plate” without endorsing the form of Border Adjustment in the blueprint.
The House Republican Border Adjustments proposal would require that corporations pay a “tax” on sales less inputs (capital expenditures, wages, raw materials, etc.) Border Adjustments are made to exclude foreign imports from inputs (effectively taxing those inputs) from deductible costs, and to exclude foreign exports from revenue (effectively rendering those sales tax-free).
Most industry groups have already made an initial determination of winners and losers under such a system. Retailers and other net importers have voiced concerns that their effective tax rates could increase by a factor of 2x or more. Net exporters, on the other hand, are projecting significant reductions in their tax bill. Economists have responded to each side of the agreement with research showing expected movement in exchange rates mitigating both results.
Many companies are currently examining the potential impact of these proposals and assessing the viability of strategies such as repatriation of foreign cash and/or IP as well as potentially shifting other value added activities to the U.S.
These U.S. Corporate Tax Reform proposals create uncertainty, but may also create significant tax planning opportunities that will depend on the ultimate form they take. As the process evolves, Duff & Phelps will continue to provide updates.
Further information on the tax reform is available here.
Important New Requirements for Luxembourg Finance Company Tax Rulings
For a long time, companies have been able to obtain relatively simple tax rulings in Belgium, Luxembourg and the Netherlands that make related party finance passing through those jurisdictions very tax efficient.
Following recommendations by the OECD’s Base Erosion and Profit Shifting project, such simple rulings are no longer possible in Luxembourg. Existing tax rulings will cease to have effect as from January 1, 2017 for tax years starting after 2016 and new economic studies must be submitted in order to continue to benefit from such rulings.
A new article 56bis has been added to the Luxembourg budget law dated December 23, 2016 and a new Circular Letter L.I.R. – No. 56/1 – 56bis1 has been issued explaining the amended tax treatment of indirect finance of this sort. Rather than being able to assume that the Luxembourg company has a standard amount of equity at risk, and then determining a fair reward for putting this equity at risk, an economic study will now be required to determine how much equity is actually at risk. If the functional analysis indicates that it is appropriate, a minimum after-tax return on equity at risk of 2% can be used for simple financing structures, or 10% for more complex group finance companies acting more like banks (both figures subject to review as market norms change).
In order to calculate the equity at risk, it will be necessary to calculate a credit rating for the final borrower. This can then be used to estimate the likelihood of default on the loan and the associated recovery rate, and from these two inputs the expected and unexpected loss for the Luxembourg financing company can be calculated and used to derive the calculated equity at risk. Where the functional analysis of the Luxembourg finance company indicates that it is appropriate, the standard 2% or 10% minimum required rates of return on this equity can be assumed. The expected loss and the cost of the opportunity can then be discounted back to the date of the financing, and this total payment can be annualized into an interest rate.
In addition, the Luxembourg finance company can no longer outsource the management of its risks to a third party or another group company.
It would be reasonable to expect similar changes to be made soon in Belgium and the Netherlands, and then for all three to make similar changes to their tax rulings for related party royalties that pass through those jurisdictions.
ATO Hubs Practical Compliance Guide
On January 16, 2017, the Australian Taxation Office ("ATO") released a Practical Compliance Guideline ("PCG") regarding a risk assessment approach for offshore related-party marketing hubs, with further guidance on other hub structures (e.g. procurement, distribution) to be provided in due course. While the principles outlined in the PCG are relevant to all types of offshore hubs and apply to both outbound and inbound goods and commodity flows, Schedule 1 of the PCG applies only to offshore marketing hubs. It is intended that over time additional schedules will be added for other types of hubs. The PCG is effective January 1, 2017, and applies to all new and existing hub arrangements.
The PCG provides taxpayers with self-assessment criteria to determine their risk category for overseas related-party hubs, as well as options available to reduce the risks of hubs. The PCG assigns hubs with one of six transfer pricing risk categories: White, Green, Blue, Yellow, Amber, or Red. Under such categorization, white and green categories represent those hubs that have either already been reviewed and confirmed by the ATO in an APA, settlement, or recent court decision, as well as those self-assessed as low risk, respectively. For low risk hubs, the ATO will not generally dedicate compliance resources to test and assess the transfer pricing outcomes beyond factual confirmations. However, for hubs that falls outside the low risk zone, taxpayers can expect that the ATO will monitor, test and/or verify the transfer pricing outcomes of these hubs, where hubs with a high-risk rating will be reviewed as a matter of priority.
The ATO has indicated that this guidance is a risk assessment tool, and should not be considered a replacement for the selection and application of the most appropriate TP method. Thus, the transfer pricing methods applied in the risk framework are for risk assessment purposes only and there is no requirement that taxpayers use these methods when pricing their hub arrangements. Further, there is recognition that, if the ATO reviews a taxpayer’s hub, it will apply what it considers to be the most appropriate method and comparable benchmarking data. The ATO has clearly identified that the PCG does not constitute a safe harbor, and the information provided does not replace or affect the ATO interpretation of the relevant law.
Further information about the PCG can be found here.