On 28 July 2017 the OECD’s Committee on Fiscal Affairs (CFA) issued a document entitled Neutralising the Effects of Branch Mismatch Arrangements, Action 2. This document was issued as part of the implementation of the action plan on base erosion and profit shifting (BEPS) through the Inclusive Framework. It sets out rules to combat branch mismatch arrangements.
Previously a discussion draft on branch mismatch rules was issued on 22 August 2016 with recommendations to bring the treatment of branch mismatches into line with the hybrid mismatch rules. Following consideration of comments received on the document and legal changes made by various countries the OECD has now finalized the document.
Branch mismatches are the result of inconsistency between domestic tax rules to determine income and expenditure subject to taxation. Branch mismatch structures may help the taxpayer avoid tax by exploiting differences between jurisdictions in rules determining if the taxpayer is subject to tax in a particular jurisdiction and differences in rules for including income and expenditure in the computation of taxable profit. These differences in rules may allow a taxpayer to leave an item outside the charge to tax in both jurisdictions or claim a deduction for the same item in both jurisdictions (double deduction).
Branch mismatch rules are similar to hybrid mismatch rules in their structure and outcomes. Therefore countries adopting hybrid mismatch rules have generally also adopted an equivalent set of rules relating to branch mismatches. The branch mismatch rules proposed by the OECD therefore apply similar analysis and solutions to the branch mismatch rules set out in the recommendations on BEPS action 2. By aligning the branch and hybrid mismatch rules jurisdictions can prevent taxpayers shifting from hybrid to branch mismatches to achieve similar tax advantages.
Types of mismatch arrangement
The OECD report sets out five types of branch mismatch arrangement:
- Disregarded branch structures – arising where the branch is not within the definition of a permanent establishment and does not have any other taxable presence in a jurisdiction;
- Diverted branch payments – arising where a jurisdiction recognizes the existence of the branch but the payment made to the branch is attributed to the head office in that jurisdiction, while the jurisdiction of the head office exempts the payment from tax because it was made to the branch;
- Deemed branch payments – arising where the branch is deemed to make a notional payment resulting in a mismatch in tax outcomes under the rules of the residence and branch jurisdictions;
- Double deduction branch payments – where the same item of expenditure creates a tax deduction under the laws of both jurisdictions; and
- Imported branch mismatches – arising where the payee offsets income from a deductible payment against a deduction arising under a branch mismatch arrangement.
Mismatches can also arise indirectly where a taxpayer invests through a tax transparent arrangement such as a partnership.
The document sets out recommendations relating to each type of branch mismatch, as follows:
- The scope and operation of the branch exemption can be adjusted so as to achieve a closer alignment with the policy of exempting income of a foreign branch under double tax relief rules;
- A branch payee mismatch rule would deny the payer a deduction for a diverted or disregarded branch payment to a related person or a payment under a structured arrangement to the extent that the payment is not included in income by the payee;
- A deduction would be denied for a deemed payment between a branch and head office (or two branches of the same person) to the extent that the payment results in a double non-income outcome and the resulting deduction is offset against non-dual inclusion income (dual inclusion income would be income taxable in both branch and head office jurisdictions);
- The double deduction rules are based on the rule set out in Chapter 6 of the report on BEPS action 2 but an adjustment would need to be made only when the payer jurisdiction allows the deduction to be set off against non-dual inclusion income; and
- An imported mismatch rule would deny a deduction for a payment made within the same control group or under a structured arrangement to the extent that the income from the payment is offset against expenditure giving rise to a branch mismatch.
On 6 April 2017, new legislation came into force that introduces a new type of limited partnership. The Order introduces private fund limited partnerships (PFLPs) and amends the 1907 Act, which applies to PFLPs and partners in PFLPs.
New and existing private investment schemes can be structured as limited partnerships. To register as a new PFLP, use Form LP7. An existing limited partnership applying for designation as a PFLP should use Form LP8. Some changes have also been made to the existing forms LP5 and LP6. All new and amended LP forms are available to download.
Japan: Tax treatment of income from U.S. limited partnerships is treated as fiscally transparent entity
On 9 February 2017, Japan’s National Tax Agency (NTA) released a report on its website confirming that a US limited partnership (US LP) is treated as fiscally transparent for Japanese tax purposes when applying the US-Japan Income Tax Treaty.
The announcement was released in response to concerns that a U.S. limited partnership would be treated as an “opaque entity” after a 2015 decision of Japan’s Supreme Court. In that decision, the Supreme Court held that a U.S. Delaware limited partnership was to be treated as a corporation for Japanese tax purposes. By this announcement, the NTA clarified:
-That it would treat a U.S. limited partnership that has not made an election to be classified as a corporation for U.S. federal tax purposes as a fiscally transparent entity; and
-That a Japanese resident (1) that derives income through a U.S. limited partnership, and (2) that meets all other requirements under the income tax treaty between Japan and the United States would be eligible to claim treaty benefits.
OECD invites comments on interaction between treaty-related BEPS provisions and treaty entitlement of non-CIV funds
A collective investment vehicle (CIV) is an arrangement that permits investors to pool their money and to purchase investments from that pooled fund rather than buying the investments directly as individuals. The report on Action 6 of the project on base erosion and profit shifting (BEPS) contained recommendations on the extent to which collective investment vehicles and their investors are entitled to tax treaty benefits. However in the case of funds that do not come within the definition of a collective investment vehicle the report noted that there would be further consideration.
On 6 January 2017 the OECD issued a discussion draft containing examples on the interaction of the tax treaty provisions of the BEPS report with the treaty entitlement of non-CIV funds.
Last year the OECD issued a consultation document on the subject with various questions concerning possible problems arising from the application of the BEPS recommendations in the case of non-CIV funds and how these problems could be dealt with. Following consideration of the comments received on that discussion draft the latest consultation paper provides information on the latest developments on the subject and conclusions arrived at when the relevant OECD Working Party met in May 2016. The latest draft also provides information on the development of examples of the way in which the Principal Purposes Test (PPT) will apply in the case of some common transactions concerning non-CIV funds.
Comments are invited on the examples by 3 February 2017. The comments are to be discussed at the February 2017 meeting of the Working Party.
On 28 July 2016 the OECD issued a discussion draft outlining approaches to combating base erosion and profit shifting (BEPS) involving interest in the banking and insurance sectors. This is part of further work following the final report on BEPS action 4 on limiting base erosion involving interest deductions and other financial payments.
That final report issued in September 2015 outlined an approach to dealing with BEPS involving interest and payments economically equivalent to interest. This used a fixed ratio rule to limit net interest deductions to a percentage of earnings before interest, tax, depreciation and amortization and a group ratio rule permitting a higher net interest deduction depending on a relevant financial ratio of the worldwide group.
The report suggested that a different approach would be required in the case of entities in the banking and insurance sectors owing to various factors relevant to these industries. Banks and insurance companies generally have net interest income rather than net interest expense. Interest plays a different role in these sectors and banking and insurance groups are subject to regulatory capital requirements that limit their ability to place debt in certain entities.
As a result of these differences the final report on action 4 allowed countries to exclude from the fixed ratio and group ratio rules all entities in banking and insurance groups and regulated banks and insurance companies in non-financial groups. The final report provided for further work to be conducted to identify suitable approaches to addressing BEPS in the banking and insurance sectors, taking into account the characteristics of these industries.
The use of deposits and short-term debt to make loans is the core business of most banks. Profit arises from the difference in interest rates on the money loaned as compared to interest rate paid on deposits. The interest is therefore an important source of profitability and can be compared to sales revenue and cost of sales in other industries. A bank would normally be highly leveraged with interest as the most significant expense item. There will generally be net interest income, depending on the mix of banking and non-banking activities.
Insurance companies invest premiums in income-producing assets such as long-term debt instruments to generate income to pay claims. Generation of interest income is an important part of the insurance company’s business. As most investments are funded by premiums rather than by debt the insurance companies generally have very low levels of leverage compared to banks. Owing to the income from investments they are generally net interest income recipients.
The latest discussion draft does not alter the conclusions of the final report on BEPS action 4 but looks in more detail at the BEPS risks in banks and insurance companies and the risks posed by entities in a group with a bank or insurance company, including holding companies, group services companies and companies carrying on non-regulated financial or non-financial activities.
A limited BEPS risk has been identified for banks and insurance companies and the discussion draft looks at why this may be the case. Regulatory capital rules require minimum amounts of equity to be held and also limit the level of leverage in a solo-regulated entity. The draft considers the protection provided by regulatory capital rules and the limits to this protection as they vary from country to country. Rather than putting forward a single approach to these risks the discussion draft suggests that countries should introduce rules that address the particular BEPS risks they are facing.
In the case of other entities that are part of a banking or insurance group the draft considers that there is a greater BEPS risk and therefore recommends that countries should consider applying the fixed ratio and group ratio rules to them, subject to certain modifications in some cases. Each country could take into account particular features of its own legal system.
Comments on the discussion draft are invited from interested parties and should be sent in by 8 September 2016.
At the 26 May 2016 IFA International Tax Conference, the Canada Revenue Agency (CRA) has confirmed that limited liability partnerships (LLPs) and limited liability limited partnerships (LLLPs) established in Delaware and Florida are to be treated as corporations for Canadian tax purposes. The CRA will also accept that an existing LLP or LLLP is a partnership if it is clear that the members are carrying on business in joint with a view to profit, all members and the LLP or LLLP have treated it as a partnership for ITA purposes, and the LLP or LLLP converts to a “true” partnership before 2018.
On 29 February 2016 the OECD issued a discussion draft on the tax treaty residence of pension funds. Changes are to be made to the OECD Model to ensure that a recognized pension fund is treated for the purpose of the tax treaty as resident in the State in which it is constituted, regardless of whether it enjoys a partial or complete exemption from tax in that State. The discussion draft contains the proposed changes to Articles 3 and 4 of the OECD Model and to the commentary on those articles.
The proposed changes add a definition of a recognized pension fund to paragraph 1 of Article 3. This refers to an entity or arrangement established in a State that is treated as a separate person under the laws of that State and is constituted to provide retirement or similar benefits to individuals and is regulated by the state or a political subdivision; and is constituted and operated exclusively to invest funds for the benefit of the entity or arrangement.
The commentary is amended to explain that the term “entity or arrangement” is inserted to cover situations where pension benefits are provided by a trust or similar vehicle which does not constitute an entity under the relevant law. The entity or arrangement must however be treated as a separate person under the taxation law of the State, otherwise the income would be treated as income of another person for tax purposes and the residence of the trust itself would not be relevant.
Paragraph 1 of Article 4 of the OECD Model will be amended to include a recognized pension fund within the definition of a resident of a contracting state.
Interested parties are invited to send in comments on the discussion draft to the OECD by 1 April 2016.