Action Plan on base erosion and profit shifting (BEPS)

DTA between Japan and Slovenia will enter into Force

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The Japanese Ministry of Finance on 26 July 2017 issued a press release announcing that the double taxation agreement (DTA) between Japan and Slovenia, signed on 10 September 2016, will enter into force on 23 August 2017.

The Treaty contains following treaty-based recommendations from the BEPS project:

  • Action 2 (neutralizing the effects of hybrid mismatch arrangements);
  • Action 6 (preventing the granting of treaty benefits inappropriate circumstances),
  • Action 7 (preventing the artificial avoidance of permanent establishment status); and
  • Action 14 (making dispute resolution mechanisms more effective).

In addition, its preamble clarifies that tax treaty is not intended to be used to generate double non-taxation or reduced taxation through tax evasion and avoidance and in cases where a person other than an individual is resident in both Japan and Slovenia, both competent authorities shall endeavour to determine by mutual agreement the Contracting State of which the person shall be deemed to be a resident. Furthermore, the Treaty contains a PPT.

On the PE front, the Treaty contains an anti-fragmentation rule and the new definition of agency PE. Moreover, the Treaty enables taxpayers to present a case for mutual agreement procedure to the competent authorities of either Contracting State and any unresolved issues arising from the case shall be submitted to arbitration if the person so requests.

Japan and Slovenia also have signed the MLI. Given that the treaty already incorporated the treaty-related BEPS minimum standards, it can be expected that this treaty will not be listed as a covered tax agreement and thus will not likely be further modified by the MLI.

UK: Updated draft guidance on corporate interest restriction

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On 4 August 2017 HMRC issued for public consultation updated draft guidance in relation to the corporate interest restriction rules to be included in the Finance Bill (No 2) 2017. The latest draft guidance amends and updates the initial draft guidance that was issued on 31 March 2017 and takes into account technical changes made and included in amended clauses published on 13 July 2017. Comments on the updated draft guidance are invited by 31 October 2017.

The corporate interest restriction generally follows the recommendations of the report on action 4 of the OECD project on base erosion and profit shifting (BEPS). The rules aim to restrict tax deductions made by a group in relation to interest expense and other financing costs. The deductible amount will be restricted to an amount commensurate with the group’s taxable activities in the UK. To arrive at that amount the rules take into account the amount the group borrows from third parties. The rules are to apply for periods beginning on or after 1 April 2017.

The rules apply to all groups within the charge to UK corporation tax but the restriction will not apply to groups with less than GBP 2 million of net interest expense and other financing costs per annum. Those groups will not be subject to any reporting requirements but should perform appropriate calculations to ensure the restriction does not apply to them.

For all other groups tax deductions for interest expense will be restricted to the group’s net third party interest expense, or the part of that expense that is proportionate to the taxable earnings before interest, tax, depreciation and amortisation (tax-EBITDA) in the UK. The rules will be applied after transfer pricing adjustments and adjustments for anti-hybrid rules but before the loss restriction rules are applied.

The default method for calculating the restriction is the fixed-ratio method. This applies two main limits on the interest deduction for tax purposes. The first restriction is by reference to a fixed ratio of 30% of the tax-EBITDA of companies within the group that are within the charge to UK corporation tax. The tax-EBITDA and the interest would be computed by reference to the amounts taken into account for UK corporation tax.

The second restriction is a debt cap that limits the net interest deduction to a measure of the worldwide group’s net external interest or economically similar expenses.

An alternative method for calculating the interest restriction called the group ratio method may be applied. Under this method the net tax deduction for interest is restricted by applying the group ratio to the tax-EBITDA. The group ratio is effectively the ratio of group interest to group EBITDA, measured on the basis of the consolidated accounts of the group. Under this method there is also a debt cap applicable based on the measure of the group interest expense used in calculating the group ratio.

Interest that exceeds the limit and is therefore disallowed in a particular year can be carried forward indefinitely. This interest can be used in a subsequent period if there is sufficient interest allowance available. Unused interest allowance may be carried forward for up to five years.

Optional alternative rules apply to the application of the restriction to public infrastructure assets. There are also some special provisions in relation to certain types of company and types of transaction.

 

OECD: Report on branch mismatch rules

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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.

Recommendations

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.

 

OECD updates guidance on country by country reporting

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On 20 July 2017 the OECD published updates to the guidance on country by country (CbC) reporting requirements under Action 13 of the project on base erosion and profit shifting (BEPS). This guidance for tax administrations and multinational groups was first issued by the Inclusive Framework on 29 June 2016 and updated on 5 December 2016 and 5 April 2017. It is intended to clarify questions of interpretation arising in the implementation stage.

Aggregate date to be reported per jurisdiction

The updated guidance clarifies the reporting requirement where there is more than one constituent entity in a particular jurisdiction. The CbC reporting rules require reporting on an aggregated basis for all the entities in the jurisdiction that are members of the group. The guidance clarifies that the results should be on an aggregated rather than a consolidated basis. In other words the results of the entities are aggregated without any adjustments for transactions between related parties and regardless of whether transactions were cross border or within the jurisdiction.

If the group considers that further explanation of the data is necessary it can use Table 3 of the CbC report to clarify the presentation of the data in the CbC report.

However if the jurisdiction of the ultimate parent entity permits consolidated reporting for tax purposes, eliminating intragroup transactions from the results, that jurisdiction may give taxpayers the option to use consolidated data at the level of the jurisdiction provided that consolidated data are then used by that group for every jurisdiction when completing Table 1 of the CbC report and that the use of consolidated results is also consistent from one year to the next.

If this option is chosen the taxpayer should then state in Table 3 of the CbC report that “this report uses consolidated data at the jurisdictional level for reporting the data in Table 1”. The explanation should specify the columns of Table 1 for which the consolidated data differs from figures that would appear if data were just aggregated, for example the total revenues column.

The guidance urges the countries in the Inclusive Framework to implement as soon as possible the recommendation on aggregated reporting with an option for consolidated figures in specified circumstances. However as some time may be required for adjustments the guidance recommends that flexibility should be permitted during a short transitional period, for example fiscal years beginning in 2016, during which taxpayers reporting consolidated data can provide any required explanations of their data in Table 3 of the CbC report.

Entity owned by more than one group

New guidance clarifies that if an entity is owned or operated my more than one unrelated multinational group, for example a joint venture, its treatment for CbC reporting should follow the accounting treatment. The entity’s treatment should therefore follow the accounting rules applicable for each of the multinational groups to which it belongs. Where the accounting rules require the entity to be consolidated (under full consolidation or pro rata consolidation) the entity would be considered to be a constituent entity of the group and its financial data would be included in the group’s CbC report. Where the applicable accounting rules do not require the entity to be consolidated (e.g. equity accounting rules apply) its data would not be included in the CbC report.

Where pro-rata consolidation is applied in preparing the consolidated financial statements jurisdictions may allow that pro rata share of the entity’s total revenue to be taken into account for applying the EUR 750 million threshold for CbC reporting. The pro-rata share of the entity’s data may be included in the CbC report instead of the full amount of financial data.

Under the pro rata accounting basis the revenues, expenses, assets, liabilities etc of an entity are allocated to the consolidated accounts of the participant (shareholder) based on its ownership share of the entity. In full consolidated accounting the results of the whole entity are consolidated. Where equity accounting rules apply an entity is treated in the consolidated balance sheet as an investment (based on the share of the entity’s assets), with the income from the investment reported in the consolidated income statement.

Parent surrogate filing

The list of jurisdictions where parent surrogate filing of the CbC report is possible has been updated at 29 June 2017. The list is updated periodically and a link to the list is provided in the guidance.

 

Slovak Republic: Government declares new corporate tax measures

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The Government announced several changes in the corporate taxation area on 20th June 2017, including the introduction of a new patent box regime in line with the modified nexus approach developed as part of BEPS Action 5. The government also proposes the introduction of measures to comply with the EU anti-tax Avoidance Directive (Council Directive (EU) 2016/1164), including new exit taxation rules. The changes also include controlled foreign company (CFC) rules, and hybrid mismatch rules, as well as new transfer pricing rules regarding intangibles and measures against VAT fraud. The first draft texts are subject to further negotiations within the Government after which they will be submitted to the Slovak Parliament. These new measures are intended to be effective from January 1, 2018.

Austria: Federal Council approves MLI to implement tax treaty related BEPS measures

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On 5 July 2017, the Federal Council of Austria approved the Multilateral Convention to Implement Tax Treaty Related Measures to prevent Base Erosion and Profit Shifting (MLI). Austria must now complete the ratification process and deposit its instrument of ratification so that the MLI can enter into force.

OECD: Inclusive framework meeting for francophone countries

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The second regional meeting of the Inclusive Framework for the francophone countries was held from 3 to 5 July 2017 in Benin. The meeting was organized by the OECD in partnership with CREDAF, an organization that brings together the tax administrations of 29 francophone countries in Africa; and Le Pôle Stratégies de Développement et Finances Publiques, a joint initiative between France and the UNDP.  Participants included delegates from the francophone countries and representatives of regional and international organizations.

The jurisdictions participating in the inclusive framework are involved in the development of the monitoring process for the four minimum standards under the OECD project on base erosion and profit shifting (BEPS) and in the review mechanisms for other parts of the BEPS package. The inclusive framework is also involved in developing toolkits to assist developing countries in BEPS implementation.

The Benin meeting gave an opportunity for the francophone countries to gain more information about the functioning of the Inclusive Framework particularly regarding the peer reviews of the minimum standards under the BEPS project. Information was presented on recent developments in relation to the implementation of BEPS in the context of the Inclusive Framework and in particular the transfer pricing and tax treaty developments. For the participants the meeting offered an opportunity to share experiences and discuss the challenges posed by BEPS implementation.

The meeting also covered the OECD initiatives relating to capacity building for tax administrations in developing countries, such as the programs of Tax Inspectors Without Frontiers and bilateral assistance programs. Information could also be presented and discussed in relation to the toolkits under preparation, in particular those in relation to comparable transactions for transfer pricing analyses and the other toolkits aiming at outcomes compatible with the needs of developing countries. At the same time the participants could raise issues relating to their needs and concerns.

The participants of the meeting emphasized the necessity of involving the highest political authorities in their countries in the implementation of BEPS measures so that measures can be introduced efficiently. They therefore proposed that regional and international organizations help to communicate the importance of the measures. The OECD has already included in its program consultations with Finance Ministers in individual country members of the Inclusive Framework with a view to working out the path to BEPS implementation for each country.

The OECD emphasized that the main objective of the preparation of the toolkits is to help developing countries implement measures to combat BEPS. The participants confirmed their interest in the toolkit on comparables for transfer pricing studies and noted that this toolkit can assist them to overcome the difficulties they face during tax audits. They also expressed an interest in the toolkit on transfer pricing documentation that is currently being prepared.

The participants confirmed their intention to adopt the BEPS measures within the timescale appropriate for their implementation in developing countries.  Some CREDAF member countries have already begun putting in place BEPS measures, in particular those relating to double tax treaties, through the signature of the multilateral instrument and the implementation of country by country reporting.

The participants noted the importance of the multilateral instrument on tax treaty related BEPS measures and its role in strengthening their bilateral tax treaties and introducing minimum standards on preventing treaty abuse and the artificial avoidance of permanent establishments. However the participants regretted that the multilateral instrument could not be used to modify treaty provisions other than those relating to the minimum standards. They are therefore looking forward to the development of a toolkit on tax treaty negotiation.