In this Edition: Deductions of Interest Payments.
In December of 2014, the OECD released a Discussion Draft on Action Item #4, dealing with tax deductions for interest payments from unrelated as well as related parties. In February, written public comments were submitted to the OECD (including by Duff & Phelps) (see Transfer Pricing Times, Volume XII, Issue 2). The Discussion Draft recommended doing away with a traditional arm’s length approach to evaluating the ability of a legal entity to borrow from a related party, as well as to price that debt, which included performing a stand-alone credit analysis of the borrower. Instead, the Draft favors rules which limit the level of interest expense or debt in an entity by reference to a fixed ratio (“group ratio rules”); or rules which allocate group net interest, or interest capacity, by some measure of relative economic activity (“interest allocation rules”); or a combination of such approaches.
Later in February, U.S. government officials serving as delegates to OECD Working Party No. 11, which addresses aggressive tax planning, said at an International Fiscal Association conference that the Working Party is indeed likely to adopt some sort of combination approach to determine interest deductibility. Additionally, they stated that the U.S. is likely on board with a combination approach, though not necessarily the same one that is currently favored by the OECD. It has yet to be determined what the exact structure of the combined approach to be recommended will be, including the order in which the rules are to be applied. In any case, the traditional arm’s length method for analyzing intercompany debt seems to be hanging by a thread.
Final OECD recommendations on this matter are expected later this year.
U.S. to Adopt Country-by-Country Reporting
In response to the Organization for Economic Cooperation and Development’s (OECD’s) proposed country-by-country (CbC) reporting template under its Base Erosion and Profit Shifting (BEPS) Action Item #13, the U.S. Treasury has announced that it plans to implement the template and will develop a reporting file that mirrors the OECD’s CbC recommendation. In addition, the U.S. is trying to meet the timeline presented in the OECD guidance, which would require companies above a specified revenue threshold to file their first CbC template by year-end 2017, but did regard this as aspirational. The U.S. ultimately plans to share this form with other tax administrations via tax treaties and tax information agreements.
One outstanding issue remains on whether the U.S. Treasury and Internal Revenue Service (IRS) have the authority to implement this guidance without implementing new legislation. Treasury has stated that existing IRS regulations do in fact allow for the solicitation of the information to be requested in the CbC filing without new legislation.
For more details regarding the OECD implementation guidance on CbC reporting, click here.
HMRC Amendments to the Diverted Profits Tax
Following the Autumn Statement 2014 announcement and subsequent technical consultation (see Transfer Pricing Times, Volume XI, Issue 11), Her Majesty’s Revenue and Customs (HMRC) confirmed that the Diverted Profits Tax (DPT) will be introduced on April 1, 2015.
Draft legislation on DPT was first published on December 10, 2014 with about 60 written responses received during the technical consultation. An open day was held on January 8, 2015, for interested parties to share their views with HMRC officials. Following the consultation, the draft legislation was amended to ensure that the original policy objectives are achieved, while increasing the clarity of the legislation and reducing unnecessary burdens.
The key changes to the legislation are the following:
- The legislation targets “contrived” arrangements that lack economic substance; therefore, an actual transfer of economic activity to another location may not be covered by the DPT;
- The onerous self-assessment/notification requirement has been narrowed to where there is “significant risk” that a charge will arise if HMRC does not know about the arrangements. Therefore, Advanced Pricing Agreements (APAs) and informal agreements should be respected in the majority of cases, although “significant risk” still needs to be further clarified;
- Once a company has been notified for one period of account, there is no requirement to notify in the next period if there is no material change in the facts;
- Timelines have been relaxed so that a company with a December 31, 2015, year-end will not need to notify the HMRC until June 30, 2016;
- There is clarification that the DPT does not apply where the tax mismatch outcome is solely as a result of differences in the way debits and credits related to are brought into account;
- Traditional transfer pricing rules will be applied to compute any potential charge (in most cases, with an upfront payment of tax);
- It is “beyond doubt” that DPT will not be applicable if a company decides to take advantage of lower tax rates in Country A by means of “a wholesale transfer of the economic activity needed to generate the associated income”. This ensures that business restructurings remain valid; however, at odds with the OECD Intangibles guidance, the economic activity performed in Country A must be more than “holding, maintenance or legal protection of the asset;” and
- The agreed international principles for attributing profits to a permanent establishment will apply.
European Commission Proposes Mandatory Exchange of Information
On March 18, 2015, the European Commission (EC) issued a proposal for mandatory exchange of information on advance cross-border rulings and APAs. Should the proposal be approved, it would become effective on January 1, 2016. The published proposal would include rulings and pricing arrangements issued after the effective date as well as any rulings or pricing arrangements issued less than ten years ago that are still in effect. The intent of the proposal is to increase transparency between Member States to help alleviate aggressive tax planning and potentially abusive tax practices. The automatic exchange referred to in the proposal would include a defined set of basic information to be outlined to all Member States and the EC.
Developing Countries Increasing Participation in BEPS Work
On March 17, 2015, Pascal Saint-Amans of the OECD announced that a new group comprised of 14 developing countries will be participating in upcoming OECD meetings focused on the BEPS imitative beginning March 23, 2015.
The announcement came in response to a series of OECD meetings that addressed developing countries’ concerns on transfer pricing related issues linked to the BEPS project (e.g., see Transfer Pricing Times, Volume XII, Issue 1). With the addition of these 14 developing countries (i.e., Albania, Azerbaijan, Bangladesh, Croatia, Georgia, Jamaica, Kenya, Morocco, Nigeria, Peru, the Philippines, Senegal, Tunisia and Vietnam), there are now 61 countries participating directly in the BEPS work.
More information about the OECD’s work on developing countries and BEPS can be found on the OECD’s website here.
Luxembourg Aligns More Closely with OECD Initiatives
In response to the OECD’s BEPS initiative, Pierre Gramegna, the Luxembourg Minister of Finance, announced on March 3, 2015, that Luxembourg will be overhauling its intellectual property (IP) regime in favor of a plan that better complies with the OECD’s latest recommendations. The change will attempt to ensure that taxpayers cannot benefit from favorable tax treatment of IP income in Luxembourg unless a significant amount of economic activity towards the development of the IP actually occurred in Luxembourg.
The Luxembourg IP regime will follow the “Modified Approach” recommended by the OECD’s Forum on Harmful Tax Practices (FHTP). The Modified Approach, originally issued by the FHTP in February 2015, recommends that tax benefits due to IP in a regime be proportional to research and development (R&D) expenditure within that regime. The Modified Approach also offers guidelines on tracking R&D expenditure and on the grandfathering of existing IP regimes.
UK Issues Latest Transfer Pricing Statistics
On March 6, 2015, HMRC released its transfer pricing statistics for the year ending March 31, 2014, covering:
- Time to resolve enquiries;
- Transfer pricing yield;
- APA statistics;
- Advanced Thin Capitalization Agreement (ATCA) statistics; and
- Mutual Agreement Procedure (MAP) statistics.
The figures confirm the very positive impact of the creation of HMRC's Transfer Pricing Group and its improved approach to transfer pricing enquiries (audits). This appears to have achieved a steady state now, with the average time taken to settle an enquiry having fallen from 38 months in 2008 to 25 months in each of the latest two years. The UK focus is on greater specialization and teamwork, higher risk cases, agreeing on enquiry action plans with taxpayers, and active monitoring of progress.
The number of APAs agreed to annually has become quite stable, with 29 having been agreed in the last year. However, there are signs of a backlog emerging as over 40 applications have been made in each of the last two years, and the average time taken to complete APAs has increased above two years for the first time in each of the last two years (most recently to 28 months). This reflects the success of the program, especially when account is taken of the additional anonymous early-stage enquiries as to whether an application would be considered for this formal process. Some of these early stage applications will not proceed because HMRC's strong preference is for bilateral or multilateral agreements.
HMRC enters into a separate subset of agreements for thin capitalization purposes, with 510 now in force and a historically high figure of 198 having been agreed in the latest year. The average time taken to agree on ATCAs is fairly steady at 11 months.
The number of MAP cases resolved has been remarkably consistent across the last three years (at 46 annually), but the sudden leap in the number of new cases admitted (from 40 to 61) is presumably an early warning of the impact of BEPS-type challenges to traditional transfer pricing arrangements. Once an adjustment is made for exceptional items, the average time taken to settle MAP cases has remained steady at 21 months.
HMRC's Transfer Pricing Group calculates that it has secured £5.8bn in additional tax since its creation in 2008, and the "Transfer Pricing Yield" in the most recent year was £1,137m.
For more information the complete publication is available here.