Inside this Edition: OECD Addresses base Erosion and Profit Sharing; Global Transfer Pricing Developments; and Interest Deductibility Around the World.
On February 12, 2013, the Organization for Economic Cooperation and Development (“OECD”) released its report Addressing Base Erosion and Profit Shifting (“BEPS”), as commissioned by the Group of Twenty Finance Ministers and Central Bank Governors commonly known as the G-20. This report discusses the ways in which interactions between different countries’ tax systems yield opportunities for multinational enterprises (“MNEs”) to substantially reduce or even eliminate taxation on a substantial portion of their profits in a manner that is inconsistent with the objectives of these tax systems. In other words, the recognition of profit can be disconnected from the locus of “real economic activity.” Gaps in the tax regimes that permit BEPS arise because the tax systems of many countries are based on outdated ideas about how businesses operate and drive value. The report also presents information that at least suggests that MNEs seem to be exploiting these gaps, and discusses the creation of a comprehensive action plan by the OECD that will help countries address BEPS issues. Given the breadth of causes of BEPS and the required coordination to address them, the BEPS project is a very ambitious undertaking by the OECD and will likely have far reaching effects.
According to the report, BEPS opportunities come from a variety of sources, one of which is transfer pricing. The paper places a particular focus on BEPS opportunities created through risk shifting arrangements and intangible movements. As intangibles have played an increasingly important role, and as technology has allowed MNEs to run integrated businesses that are spread across the globe, tax regimes have failed to keep up, resulting in significant BEPS issues. With respect to the transfer pricing issues identified, the fundamental questions relate to determining when taxpayers’ risk allocations (and intangible movements) should and should not be respected, and in particular, what level of economic substance should be required in order for those allocations to be respected. This theme was echoed in the OECD draft intangibles guidance released last year, which concluded that the only parties entitled to intangible related returns would be those that were actually involved in (rather than merely funding) the most critical aspects of intangible creation and management.
The OECD’s BEPS paper and intangible guidance clearly indicates that substance is likely to play an increasingly important role in defining the limits of the arm’s length standard. To date, the U.S. transfer pricing regulations have largely given deference to the way that taxpayers have chosen to structure their transactions, stating that as long as a transaction has economic substance, the IRS should respect it rather than forcing a characterization of the transaction to match “arm’s length behaviors.” In contrast to the US transfer pricing regulations, the language in the BEPS report and the OECD draft intangibles guidance seem a good deal more restrictive on these points, casting doubt on whether arrangements that are deemed to be “artificial” will be respected under future guidance and advice coming from the OECD.
In addition to transfer pricing, the report also identifies numerous other sources of BEPS opportunities, including (but not limited to): (i) tax jurisdiction gaps created by an increasingly digital economy, (ii) mismatched entity and instrument classification across different tax systems, and (iii) insufficient anti-avoidance measures. The report stresses that all of the sources of BEPS need to be addressed on a comprehensive and coordinated basis. To this end, the OECD will be developing an initial comprehensive action plan to present to the Committee on Fiscal Affairs in June of this year. This initial plan will (i) identify actions that need to be undertaken to address BEPS; (ii) set deadlines to implement these actions; and, (iii) identify resources and methods necessary to execute these actions. Components of this initial plan will also include proposals to develop tools to address each of the BEPS “pressure areas” on a coordinated basis.
It is clear that the efforts that will be undertaken as part of the BEPS focus (some of which, like the draft intangible guidance, are already underway), along with other developments (e.g., the United Nation’s efforts to provide transfer pricing guidance), have the potential to fundamentally change critical components of transfer pricing, as well as broader international tax regulation and administration worldwide. As such, it will be important to keep abreast of these developments.
Global Transfer Pricing Developments
Highlighted below are a few recent developments in the continuing evolution of national transfer pricing regulatory regimes.
Canada Releases 2012 Annual APA Program Statistics1
In January 2013, the Canada Revenue Agency (“CRA”) released its annual report on Canada’s APA program, covering the fiscal year ended March 31, 2012 (“FY 2012”). We highlight several key findings from that report below.
The CRA continues to focus on conducting comprehensive due diligence before accepting a taxpayer into the program in order to continue to move towards shorter average processing times and pare down its inventory of active cases.
Peru Amends Transfer Pricing Rules
Effective January 1, 2013, Peru issued a decree (DS No. 258-2012-EF) that amends its current income tax regulations (i.e., the Reglamento de la Ley del Impuesto a la Renta) in a continued effort by the taxing authorities to clarify previous changes to the country’s transfer pricing rules. We highlight the key changes of this decree which impact transfer pricing below.
Other initiatives of DS No. 258-2012-EF include clarification concerning whether an internal transaction may be considered comparable to the transaction under review, and under what circumstances certain transfer pricing methods may be used. This decree comes in an effort to lend greater clarity and guidance to Peru’s transfer pricing rules.
Greece Announces New Tax Law
The Greece taxing authorities published tax Law 4110 / 2013 (“Greek TP Law”) in the Government Gazette on January 23, 2013. The highlights of Law 4110 / 2013 are as follows:
The Greek TP Law will apply to all Greek companies and permanent establishments for accounting periods beginning on or after January 1, 2012, while the APA program will be available beginning January 1, 2014. Further clarification and guidance is expected to come from the Ministry of Finance in the coming months. However, the primary challenges facing Greek taxpayers will be finding the resources and information necessary to comply with the new documentation requirements.
Interest Deductibility Around the World
With the growing volume and visibility of loan transactions between related parties, tax deductibility of the resulting interest payments is a source of increasing concern for affected taxpayers. Tax authorities in various countries have challenged these payments, often on the assertion that the transaction in question is more akin to the provision of equity rather than bona fide debt. This assertion can at times be abetted by country-specific thin-capitalization (“thin cap”) rules, which refer to a maximum allowable ratio of debt to equity for tax purposes, and related provisions. While thin cap rules can evaluate a taxpayer’s overall tax structure, they are often aimed at limiting tax deductions for interest payments to related parties. Further, there is hardly any conformity in the relevant regulations and practices from country to country.
Some examples:
The lack of consistency in thin cap and related rules around the world, not to mention differing practices among tax authorities in applying them, certainly does not make it any easier for taxpayers to predict how various forms of intercompany financing will be treated. The consequences can vary from re-pricing of a loan to disallowed interest deductions (and perhaps re-characterization as dividends), with all the resultant tax consequences.
1. More information on Canada’s APA Process and 2012 Statistics are available at: http://www.cra-arc.gc.ca/tx/nnrsdnts/cmp/p_rprt12-eng.pdf
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