In this edition: IRS Expands Scrutiny of Debt-Equity Cases Under Section 385.
OECD Releases Discussion Draft Addressing Interest in the Banking and Insurance Sectors
On July 28th, the Organization for Economic Cooperation and Development ("OECD") released a discussion draft regarding the treatment of interest in the banking and insurance sectors. The draft follows the final Action 4 report released by the OECD in October of last year that set out a framework for limiting the deductibility of interest. Specifically, the guidance offers taxing authorities two possible techniques, 1) the fixed-ratio or 2) the group-ratio rule, which could be used to define the maximum amount of deductible interest by a taxpayer within a given fiscal year. The recently released discussion draft is intended to augment the October report by addressing particular questions regarding the banking and insurance industries.
The discussion draft identifies several key factors which require a different approach be applied to companies in the banking and insurance sectors such as:
- Companies in the banking and insurance sector typically have net interest income rather than net interest expense which could create distortions given the fixed ratio and group ratio rules are applied to net interest.
- The nature of interest income and interest expense for banking and insurance companies is fundamentally different than for companies outside the financial sectors (i.e., interest income and interest expense are operating items akin to revenue and cost of sales for companies outside the financial sector).
- Companies in the banking and insurance sectors are typically subject to regulatory capital requirements which impact the nature of capital structures for companies in the industry.
Next, the discussion draft poses a total of 17 questions for consultation on how to apply Action 4 to the banking and insurance sectors. Ultimately, the draft makes clear that companies in the banking and insurance sector may need to be excluded from evaluation under the group ratio rule.
Commentary and discussion notes can be submitted in Word format to the OECD at the email address [email protected]. Suggestions must be submitted no later than September 8th, 2016.
For reference, a direct link to the OECD draft can be found here.
IRS Expands Scrutiny of Debt-Equity Cases Under Section 385
On June 30th, the IRS Office of Chief Counsel issued an internal notice requiring that any debt vs. equity issues arising under audit or other legal action be reviewed by an Associate Chief Counsel Office or the Special Counsel to the National Taxpayer Advocate. The IRS issued proposed regulations under Section 385 in April of this year which would impose a strict framework for what qualifies as intercompany debt. Those regulations have been hotly contested ever since. This notice comes despite the fact that the 385 regulations remain in proposed form. For taxpayers with intercompany debt this notice highlights how focused the IRS is on debt vs. equity characterization.
A copy of the IRS notice is available here. An overview from Duff & Phelps on the proposed 385 rules is available here.
Australia Provides Local File Guidance
On June 27th, the Australian Tax Office ("ATO") finalized Local File reporting requirements under Australian Country-by-Country ("CBC") reporting laws. The announcement follows a recent crackdown by Australia on global profit shifting as reported in the Transfer Pricing Times May 2016 edition.
The Local File is a standardized electronic form where taxpayers are required to report transfer pricing and business specific information. The Local File will begin to apply to Australian taxpayers in global groups with global income of more than AUD one billion – regardless of the size of their Australian operations – on January 1 2016. Additionally, a Short Form Local File will be made available for very small taxpayers, and those with immaterial related-party transactions.
Taxpayers with Australian operations should take careful note of the new Local File requirements as there is information required in the Local File that was not previously required under the old transfer pricing reporting regime in Australia. Additionally, there are discrepancies in both form and content from the global standard template put forth by the OECD. In this sense, the Australian Local File will be distinct from other countries – taxpayers will be forced to adjust their standard OECD Local File to fit the ATO’s requirements. A standard OECD Local File may not satisfy or protect against penalties. Therefore, careful attention to detail and management is needed.
The press release from the ATO is available here.
The IRS and OECD Issue Country by Country GuidanceOn June 30th, the IRS issued final regulations requiring companies with group revenues in excess of $US 850 million to file a country by country ("CbC") report. On the same day the OECD released guidance on the implementation of CbC reporting. As background, CbC reporting is part of the new transparency initiatives advanced by the OECD BEPS project. Specifically, CbC reporting is the requirement that multinational companies with group revenue in excess of €750 million report to tax authorities information on the "revenues, profits, taxes paid, capital, earnings, tangible assets, and the number of employees" for each country in which they operate.
The following is a brief summary of the recent updates from the U.S. and OECD on CbC reporting:
IRS Finalizes CbC RegulationsThe finalized revisions of the CbC regulations on June 30th considered several proposed commentaries from organizations, businesses and industry experts. Final comments given to the IRS addressed topics such as responsible parties required to file CbC reports, national security exceptions, partnership and stateless entity treatment, and penalties amongst several others.
A few takeaways from the finalized regulations are as follows:
- CbC data confidentiality will be maintained through the IRS’s ability to pause data exchanges between taxing authorities. If confidentiality requirements, data safeguards, and appropriate use restrictions are not strictly observed, the IRS will withhold report data from foreign tax authorities.
- MNE groups that carry sensitive government contracts will not be allowed an exception to CbC filing requirements. General descriptions of business activities included in CbC reports are not seen as a threat to national security.
- Final regulations do not allow a foreign-parented MNE group with a U.S. business entity to designate that U.S business entity as a surrogate parent entity for purposes of filing a CbC report. The U.S. business entity may file a CbC report on behalf of the parent entity, but may not take surrogate ownership in order to meet CbC reporting obligations.
IRS CbC regulations are meant to closely resemble and follow OECD guidelines as given in Action 13 and other subsequent publications. Official documentation of the comments and finalized revisions can be found here.
OECD Releases Guidelines on Implementation of CbC Reporting
On June 29, the OECD published additional guidance on CbC reporting implementation. Guidance was given on four areas of specific interest, namely: transitional filing options for MNE’s ("parent surrogate filing"), application of CbC reporting to Investment Funds and Partnerships, and the effects of currency fluctuations on the MNE filing threshold.
"Parent surrogate filing" guidance addresses timing issues amongst taxing authorities that are in the process of implementing CbC reporting. On this issue the OECD guidance states, "jurisdictions that will not be able to implement with respect to fiscal periods from 1 January 2016 may be able to accommodate voluntary filing for Ultimate Parent Entities resident in their jurisdiction".
In response to the treatment of Investment Funds and Partnerships involved in CbC reporting, the OECD maintained that it is advisable to review accounting consolidation rules. In both cases, if consolidation rules require company consolidation, they will be required to file a CbC report. It is advised that if company consolidation is not required, adequate documentation be given to address intercompany relationships and partnership structures.
Lastly, currency fluctuations have given rise to the issue of differing reporting requirements depending on the local exchange rates of differing taxing authorities. The OECD has resolved that the currency and exchange rate of the Ultimate Parent Entity will determine if the MNE will meet the established 750 million EUR threshold. Other local constituents outside of the Ultimate Parent Authority will not have the authority to impose a local filing requirement if the local exchange rate puts them over the 750 million EUR threshold.
Official documentation of the OECD CbC implementation guidelines can be found here.
OECD Agrees to Incorporate BEPS Amendments into the Transfer Pricing Guidelines
On May 23rd, the OECD Council agreed to incorporate the proposed revisions to the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations ("the Guidelines"), as set forth in the OECD’s Base Erosion and Profit Shifting ("BEPS") project. Not all Action Items from the BEPS project called for revisions to the Guidelines. Instead, key revisions lie in Action 8-10, "Aligning Transfer Pricing Outcomes with Value Creation", as well as Action 13, "Transfer Pricing Documentation and Country-by-Country Reporting".
Key transfer pricing practice areas that are revised under the Guidelines are as follows:
- Guidance for applying the arm’s length principle;
- Commodity transactions;
- Low value-adding intra-group services;
- Cost contribution arrangements; and
- Transfer pricing documentation
In lieu of drafting unique transfer pricing rules, many countries have domestic tax law which makes direct reference to the Guidelines. As a result of the approval to implement the BEPS revisions, countries that rely on this approach will be impacted accordingly once the necessary steps have been taken with their own domestic legislature to recognize the changes.
Read the OECD’s press release here.