OECD BEPS project & OECD guidance on country by country documentation

Nexia Tax Conference, 2014Maulik Doshi - SKP

Background

Globalization has benefited our domestic economies and has impacted countries’ corporate income tax regimes

As the economy became more globally integrated, it opened up opportunities for MNEs to greatly minimize their tax burden

However, this has led to rise of tax fairness issues as follows: governments have to cope with less revenue and a higher cost to ensure

compliance Individual taxpayers are harmed as they bear a greater share of the tax

burden. corporations that operate only in domestic markets have difficulty in

competing with MNEs that have the ability to shift their profits across borders to avoid or reduce tax

Background

• GE - $81 billion during the past decade, but paid an average of just 2.3% of its income in taxes since 2002.

• DuPont - thanks to some interesting accounting practices, not only avoided paying taxes, but also got $109 million tax benefit from the government.

• Google - in 2010, the company brought in a profit of $10.8 billion, paid taxes @ only 2.4%.

• Amazon - sales in the UK of £3.35bn in 2011, only reported a "tax expense" of £1.8m.

& Consequences follow...

World protests

WHAT THE BEPS IS THIS ?

BEPS

BEPS is tax planning, which exploits gaps in tax rules, making profits shift to locations with little or no activity and having low taxes

Three popular mechanisms for profit shifting are: Hybrid Mismatch Special Purpose Entity / Vehicle Transfer Pricing

Not always illegal, but taking advantage of current archaic tax rules that is disassociated with today’s environment

What is BEPS ?

BEPS

Hybrid mismatches in entity and instrument Profits from delivery of digital goods and services; Financial transactions - debt-financing, captive insurance etc; Transfer pricing - shifting of risks and intangibles; The effectiveness of anti-avoidance measures - GAARs, CFC

regimes etc; and The availability of harmful preferential regimes

Key pressure areas giving rise to opportunities for BEPS

BEPS

In July 2013, having regard to the pressure areas, OECD has set forth 15 actions to address BEPS which are based on 3 core principles: Coherence Substance Transparency

Each of the action plans lay down: Expected output Timelines

Action Plan

BEPS – Action plans

Address the tax challenges of the digital economy

Neutralize the effects of hybrid mismatch arrangements

Strengthen CFC rules

Limit base erosion via interest deductions and other financial payments

Counter harmful tax practices with transparency and substance

Prevent treaty abuse

Prevent the artificial avoidance of PE status

Assure, TP outcomes are in line with value creation - Intangibles

Assure, TP outcomes are in line with value creation - Risks and capital

Assure, TP outcomes are in line with value creation - Other high-risk transactions

Methodologies to collect and analyze data on BEPS and the actions to address it

Require taxpayers to disclose their aggressive tax planning arrangements

Re-examine transfer pricing documentation

Make dispute resolution mechanisms more effective

Develop a multilateral instrument

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5

6

4

3

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11

98

7 10

12 13

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BEPS - Action plan

Specific action areas to ensure transfer pricing outcomes are in line with the value creation – Action plans 8, 9 & 10 aims at aligning taxing rights with

substance

Re-examine transfer pricing documentation- Action plan 13 aims at ensuring transparency while improving

certainty

BEPS action plan – Transfer pricing areas

Action plan – Transfer pricing areas

The OECD will develop rules to prevent profit shifting by moving intangibles by:

Adopting a broad and clearly delineated definition of intangibles; Ensuring profits are appropriately allocated in accordance with value

creation; Creating special guidelines for transfers of hard-to-value intangibles; and Revisiting guidance on cost contribution arrangements.

Expected Output: Changes to the Transfer Pricing Guidelines and possibly to the Model Tax Convention

Deadline: September 2014 – September 2015

Action 8: Intangibles

Action plan – Transfer pricing areas

The OECD will develop rules to prevent profit shifting by transferring risks/allocating capital by:

Adopting TP rules so that returns do not accrue to an entity solely because it bears contractual risk or provides capital; and

Aligning returns with value creation

Expected Output: Changes to the Transfer Pricing Guidelines and possibly to the Model Tax Convention

Deadline: September 2015

Action 9: Risks and capital

Action plan – Transfer pricing

The OECD will develop rules to prevent profit shifting by entering into transactions that would not/only rarely occur between unrelated parties by:

Clarifying circumstances in which transactions can be recharacterised; Clarifying the application of TP methods (in particular profit splits with

respect to global value chains); and Providing protection against common types of base eroding payments,

such as management fees and head office expenses

Expected Output: Changes to the Transfer Pricing Guidelines and possibly to the Model Tax Convention

Deadline: September 2015

Action 10: Other high-risk transactions

Action plan – Transfer pricing

The OECD will develop rules regarding TP documentation to enhance transparency, taking into consideration the compliance costs for business. This may include rules requiring disclosure to governments of:

Global allocation of income; and Economic activity and taxes paid among countries

Expected Output: Changes to Transfer Pricing Guidelines and Recommendations regarding the design of domestic rules

Deadline: September 2014

Action 13: Re-examine transfer pricing documentation

BEPS – Action plan

Fast track progress till dateAction Issues Progress1 Digital Economy A Task force is convened. Draft issued for

public discussion in March 2014

2 Hybrid mismatch agreements

Drafts (recommendations for domestic laws and treaty issues) were issued in March 2014 for public discussion

6 Preventing treaty abuse

Draft issued for public discussion in March 2014

8 Intangibles Revised draft issued in July 2013 for discussion pursuant to BEPS Project

13 Transfer Pricing documentation

Draft issued in Feb. 2014 for public consultation

OECD Guidance on Country by Country (“CBC”) Reporting

BEPS – CBC documentation

To provide tax administrations with the information necessary to conduct an informed transfer pricing risk assessment

To ensure that taxpayers give appropriate consideration to transfer pricing requirements – While establishing prices and other conditions for transactions between AE’s,

and; While reporting the income derived from such transactions in their tax returns

To provide tax administrations with the relevant information Conduct an appropriately thorough audit of the transfer pricing practices

Objectives

BEPS – CBC documentation

1. Master file containing standardized information relevant for all MNE group members

2. A local file referring specifically to material transactions of the local taxpayer

This approach to transfer pricing documentation will provide tax administrations with relevant and reliable information to perform an efficient and robust risk assessment analysis

Approach – 2 tier

BEPS – CBC documentation

The master file should contain common standardized information relevant for all MNE group members

The information required in the master file provides a “blueprint” of the MNE group and can be grouped in five categories :– the MNE group’s organisational structure – a description of the MNE’s business or businesses – the MNE’s intangibles – the MNE’s intercompany financial activities – the MNE’s financial and tax positions

The country-by-country data required in the master file may be helpful in risk assessment processes

Documentation approach - Master File

BEPS – CBC documentation

Organisational structure

Chart illustrating the MNE’s legal and ownership structure and geographical location of operating entities

Description of the business- Profit drivers, Supply chain- Service arrangements- Top 25 compensated employees - FAR

Intangibles- Development, ownership & exploitation- List of intangibles & owners- Agreements for intangibles- Desc of group’s TP policy- Details of trf of intangibles

Interco financial

activities & tax positions - Source of financing- Central financing entity, if any- MAP / APA / AAR- CBC templateMaster file

BEPS – CBC documentation

The information required in the local file supplements the master file

Assuring compliance with arm’s length principle material transfer pricing positions affecting a specific jurisdiction

Information relevant to the transfer pricing analysis related to transactions between a local country affiliate and AE’s in different countries Material information in the context of the local country’s tax system

Documentation approach - Local File

CBC – Model Template

Country

Constituent Entities Organized in the Country

Place of Effective Management

Important business activity code(s)

Revenues

Earnings Before Income Tax

Income Tax Paid (on Cash Basis)

Total Withholding Tax Paid

Stated capital and accumulated earnings

Number of Employees

Total Employee Expense

Tangible Assets other than Cash and Cash Equivalents

Royalties Paid to Constituent Entities

Royalties Received from Constituent Entities

Interest Paid to Constituent Entities

Interest Received from Constituent Entities

Service Fees Paid to Constituent Entities

Service Fees Received from Constituent Entities(a) To

Country of Organisation

(b) To All Other Countries

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2.

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Total1.

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3.

4.

Total

CBC – Model Template contents

• Draft requires reporting for each entity in MNC group arranged by country of organization, with branches treated as entities for this purpose

• Information required in draft template: – Place of effective management – Important business activity codes – Revenues – Earnings before income tax – Income tax paid on cash basis to country of organization and to all other countries – Total withholding tax paid – Stated capital and accumulated earnings – Number of employees and total employee expense – Tangible assets (other than cash and cash equivalents) – Royalties paid to and received from related entities – Interest paid to and received from related entities – Service fees paid to and received from related entities

• Space provided for any further brief information that taxpayer considers necessary or that would facilitate understanding of the required information

• Entire template, with all entity and country information, would be provided to the tax authority in each country in which the MNC has an entity or branch

BEPS – CBC documentation

Significant increase in compliance burden for MNEs and expanded audits Significant increase in documentation for MNEs

Local file and the master template ask for much more information than companies currently collect and have readily available

Complexities in gathering specific information like; Total number of employees on the payroll Income tax paid by all entities for the relevant fiscal year Withholding tax paid etc.

Possible reluctance amongst the group entities to owing to potential risk of exposure of confidential information

Practical Issues

BEPS – CBC documentation

Timing of information Different reporting period of different entity in the group

Onerous for Small and Medium Enterprises (SME) A lot of information at the disposal of tax authorities which could lead to

risk of potential misuse of the information by tax authorities Tax payers in jurisdictions pursuing aggressive tax administrative measures

could be particularly vulnerable to this potential risk.

Practical Issues

Thank YouMaulik Doshi

SKP