Can B.E.P.S. Survive Without U.S. Support?

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On May 28, 2015, the O.E.C.D. announced the countries that will participate in a meeting to begin substantive work on drafting a multilateral instrument under B.E.P.S. Action 15. Currently, more than 83 countries have expressed interest in joining the discussion, which will take place on November 5 and 6, 2015. The United States was noticeably absent from the list. However, the O.E.C.D. hopes that support will continue to grow in the intervening months and that the meeting may ultimately include as many as 100 countries.

The U.S. Treasury chose not to participate in negotiating a multilateral instrument under B.E.P.S. Action 15. After a careful review of the agenda for the discussion on the multilateral instrument, the U.S. Teasury felt that participation did not seem like a good use of its scarce resources. This decision was prompted by the question, “What is there for U.S. to gain by participating in the discussions?”

Transfer Pricing Implications of the B.E.P.S. Action Plan

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Determined to eliminate so-called “double non-taxation,” as well as no or low taxation, associated with practices that are perceived to segregate taxable income from the activities that generate them, the Group of Twenty (“G20”) and the Organisation for Economic Co-operation and Development (“O.E.C.D.”) released their Action Plan on Base Erosion and Profit Shifting (“B.E.P.S. Action Plan”) in 2013. Included in the B.E.P.S. Action Plan are several provisions related to transfer pricing:

• Action 4: Limit base erosion via interest deductions and other financial payments;
• Action 8: Assure that transfer pricing outcomes are in line with value creation – Intangibles;
• Action 9: Assure that transfer pricing outcomes are in line with value creation – Risks and capital;
• Action 10: Assure that transfer pricing outcomes are in line with value creation – Other high-risk transactions; and
• Action 13: Re-examine transfer pricing documentation.

The O.E.C.D. has since delivered a number of reports and recommendations related to these actions, including revisions to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (“Transfer Pricing Guidelines”), and it continues to perform additional work on deliverables scheduled for later this year.

Improving Dispute Resolution: The World of B.E.P.S.

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The Discussion Draft on Action plan 14 (the “Draft”) received an overwhelming response. On January 19, 2015, the O.E.C.D. published over 400 pages of comments on how to make dispute resolution mechanisms more effective.

Many believe that as a result of the B.E.P.S. program, the number of treaty-related tax disputes will increase. To accommodate this surge in tax cases, it is crucial to develop an effective dispute resolution mechanism that will enhance cross-border trade.

The Draft reflects a lack of consensus regarding the Mutual Agreement Procedure (“M.A.P.”). Most of the comments support creating a M.A.P. that facilitates final and binding decisions within a set timeframe. It is seen as a step towards improving the efficiency and effectiveness of the B.E.P.S. project as a whole. Creating an efficient M.A.P. will demonstrate the O.E.C.D.’s commitment to creating a mechanism that will provide progress.

Making the M.A.P. mandatory may not be enough, as other issues come into play. Here is a sampling of comments that appear in the 400 pages that were released:

• The fact that the initiative in solving the dispute remains with the Contracting States leaves the taxpayer with a limited role. As a result, the opportunity of having a smoothly functioning M.A.P. with taxpayer input bows to need protecting a States’ right to tax.
• The Draft pointed out that a taxpayer should not have an active role in the M.A.P. This is rooted in the belief that the involvement of the taxpayer will result in a lengthier process, which is more costly to the Contracting States. This observation may not be correct in all cases; the involvement of a taxpayer may motivate the Competent Authorities to promptly reach a good-faith agreement at an accelerated pace.
• Competent Authorities initiate M.A.P. with a belief in the validity of their position. Believing in the justification of their position will make it hard for a Competent Authority to concede. As a result, the Competent Authorities may have difficulty in preserving an atmosphere necessary to reach a solution through reconciliation.

Follow-Up Draft of Report on Action 6 (Treaty Abuse) and Public Comments Released

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Comments on the O.E.C.D.’s public discussion draft to the follow-up work on B.E.P.S. Action 6 (the “Follow-Up Draft”) were released on January 12, 2015. Action 6 of the B.E.P.S. Action Plan focuses on preventing treaty abuse and treaty shopping, which the O.E.C.D. has identified as being one of the most important sources of B.E.P.S. concerns.

The Follow-Up Draft modifies the “Report on Action 6 (Prevent the granting of treaty benefits in appropriate circumstances)” and identifies 20 issues on which interested parties may provide comments. It focuses on matters related to the application of the limitation on benefits (“L.O.B.”) rule and principal purpose test (“P.P.T.”) as well as the treaty entitlement of collective investment vehicles (“C.I.V.’s”) and non-C.I.V. funds. The 20 issues identified by the Follow-Up Draft and addressed in the comments are as follows:

Issues Related to the L.O.B. Provision

• C.I.V.’s: application of the L.O.B. and treaty entitlement,
• Non-C.I.V. funds: application of the L.O.B. and treaty entitlement,
• Commentary on the discretionary relief provision of the L.O.B. rule,
• Alternative L.O.B. provisions for E.U. countries,
• Requirement that each intermediate owner be a resident of either Contracting State,
• Issues related to the derivative benefit provision,
• Provisions dealing with “dual-listed company arrangements,”
• Timing issues related to the various provisions of the L.O.B. rule,
• Conditions for the application of the provision on publicly-listed entities, and
• Clarification of the “active business” provision.

The Future of Ireland as a Place to Carry On Business in Light of Recent E.U. & O.E.C.D. Initiatives

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INTRODUCTION

Ireland has long been established as the onshore location of choice for the world’s leading multinational enterprises (“M.N.E.’s”). Although Ireland’s attractiveness as a location for foreign direct investment is based on a number of factors, the low corporate tax rate of 12.5% is crucial.

Ireland’s corporate tax regime has received persistent and pervasive scrutiny from international media in recent times, focusing on topics such as the “Double Irish,” the O.E.C.D. B.E.P.S. initiative, and the Apple investigation. What must not be forgotten in the midst of such coverage is that Ireland has nothing to hide and nothing to fear from any of the above issues. Ireland is a small jurisdiction, and as far back as the 1950’s, the cornerstone of the economy has been foreign direct investment (“F.D.I.”).

Ireland makes no secret of its wish to compete with other jurisdictions for F.D.I., and its highly competitive corporate tax regime, including the 12.5% tax rate, forms part of a broader strategy that allows Ireland to “play to win.”

This article will discuss some of the main O.E.C.D. and E.U. initiatives impacting Ireland and the effects such initiatives are likely to have on Ireland and the M.N.E.’s which are based here.

B.E.P.S. Action 14: Make Dispute Resolution Mechanisms More Effective

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INTRODUCTION

The O.E.C.D. has continued to publish discussion drafts under its 15-part action plan (the “B.E.P.S. Action Plan”) for combatting base erosion and profit shifting (“B.E.P.S.”), with Action 14 being the most unique.

Action 14, entitled “Make Dispute Resolution Mechanisms More Effective,” provides as follows:

Develop solutions to address obstacles that prevent countries from solving treaty-related disputes under MAP, including the absence of arbitration provisions in most treaties and the fact that access to MAP and arbitration may be denied in certain cases.

While most components of the B.E.P.S. Action Plan address the problems caused by base erosion and profit shifting, the recently proposed discussion draft for Action 14 (“Discussion Draft” or “Draft”) addresses the mutual agreement procedures (“M.A.P.”) used to resolve treaty-related disputes. Action 14 addresses the current obstacles faced by taxpayers seeking M.A.P. relief to avoid economic double taxation and provides suggestions as to how to revise provisions in order to improve the integration of M.A.P. dispute resolution mechanisms. The O.E.C.D. describes it as a unique opportunity to overcome traditional obstacles and to provide effective relief through M.A.P. The Discussion Draft proposes complementary solutions that are intended to have a practical and measurable impact, rather than merely providing additional guidance which may not be followed.

B.E.P.S. Actions 8, 9 & 10: Assuring that Transfer Pricing Outcomes are in Line with Value Creation

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On December 19, 2014, the Organisation of Economic Co-operation and Development (“O.E.C.D.”) released a discussion draft on Actions 8, 9, and 10 of the Base Erosion and Profit Shifting (“B.E.P.S.”) Action Plan (“Discussion Draft” or “Draft”). Actions 8, 9, and 10 reinforce the goal of assuring that transfer pricing outcomes are in line with value creation.

In July 2013, the O.E.C.D. published the B.E.P.S. Action Plan for the purpose of establishing a comprehensive agenda to resolve B.E.P.S. issues. The B.E.P.S. Action Plan identifies 15 actions to combat B.E.P.S. and establishes deadlines for application of each action.

The Discussion Draft introduces revisions to Chapter I of the Transfer Pricing Guidelines and addresses the related topics in Actions 8, 9, and 10. Specifically, the Discussion Draft focuses on the development of the following:

(i) rules to prevent B.E.P.S. by transferring risks among, or allocating excessive capital to, group members. This will involve adopting transfer pricing rules or special measures to ensure that inappropriate returns will not accrue to an entity solely because it has contractually assumed risks or has provided capital. The rules to be developed will also require alignment of returns with value creation.

(ii) rules to prevent B.E.P.S. by engaging in transactions which would not, or would only very rarely, occur between third parties. This will involve adopting transfer pricing rules or special measures to: (i) clarify the circumstances in which transactions can be recharacterized.

(iii) transfer pricing rules or special measures for transfers of hard-to-value intangibles.

Insights Vol. 1 No. 10: Updates & Other Tidbits

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ISRAEL ANNOUNCES ADOPTION OF O.E.C.D.’S COMMON REPORTING STANDARD

Israel has announced that it will adopt the Standard for Automatic Exchange of Financial Account Information: Common Reporting Standard (“C.R.S.”) issued by the O.E.C.D. in February 2013.

The C.R.S. establishes a standardized form that banks and other financial institutions would be required to use in gathering account and transaction information for submission to domestic tax authorities. The information would be provided to domestic authorities on an annual basis for automatic exchange with other participating jurisdictions. The C.R.S. will focus on accounts and transactions of residents of a specific country, regardless of nationality. The C.R.S. also contains the due diligence and reporting procedures to be followed by financial institutions based on a Model 1 F.A.T.C.A. intergovernmental agreement (“I.G.A.”).

At the conclusion of the October 28-29 O.E.C.D. Forum on Transparency and Exchange of Information for Tax Purposes, about 50 jurisdictions had signed the document. The U.S. was notably absent as a signatory to the agreement. In addition to the C.R.S., the signed agreement contains a model competent authority agreement for jurisdictions that would like to participate at a later stage.

The O.E.C.D.'s Approach to B.E.P.S. Concerns Raised by the Digital Economy

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On March 24, 2014, ten days after the O.E.C.D. released its public discussion draft on prevention of treaty abuse, a second public discussion draft was released, addressing the tax challenges of the digital economy (the “Discussion Draft”).

The Discussion Draft emphasizes the concept that the digital economy should not be ring-fenced and separated from the rest of the economy, given its relationship to the latter. It provides a detailed introduction to the digital economy, including its history, components, operations, and different actors. Surprisingly, it does not propose any groundbreaking approaches to addressing the base erosion and profit shifting (“B.E.P.S.”) challenges encountered in the digital economy. It simply reflects an approach that is consistent with the fight against B.E.P.S. – seeking to determine where economic activity takes place in the digital economy in order to best achieve taxation in a non-abusive fashion.

The Discussion Draft singles out six factors that characterize the digital economy in light of B.E.P.S. concerns:

1. Mobility of all facets of the digital economy, including the intangibles used, the users themselves, and the business functions carried on by various players in the business model;
2. Reliance on data;
3. Network effects;
4. Use of multi-sided business models;
5. Tendency towards monopoly or oligopoly; and
6. Volatility

O.E.C.D. Discussion Drafts Issued Regarding B.E.P.S. Action 2 - Neutralizing the Effects of Hybrid Mismatch Arrangements

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INTRODUCTION

On March 19, 2014, the O.E.C.D. issued two discussion drafts proposing steps to neutralize abusive tax planning through hybrid mismatch arrangements. One report proposed changes in domestic law; the second proposed changes to the O.E.C.D. Model Tax Convention.

The discussion drafts reflect the O.E.C.D.’s attempt to bring “zero-sum game” concepts to global tax planning. In a zero-sum game, transactions between two or more parties must always equal zero (i.e., if one party to a transaction recognizes positive income of “X” and pays tax on that amount, the other party or parties generally must recognize negative income of the same amount, thereby reducing tax to the extent permitted under law). Seen from the viewpoint of the government, tax revenue is neither increased nor decreased on a macro basis if timing differences are disregarded.

If all transactions are conducted within one jurisdiction, the government is the ultimate decision maker as to the exceptions to the zero-sum analysis. For policy reasons, a government may decide to make an exception to a zero-sum game result by allowing the party reporting positive income to be taxed at preferential rates or not at all, while allowing the party reporting negative income to fully deduct its payment. But, when transactions cross borders and involve related parties, taxpayers have a say in what is taxed and what is not taxed.

The O.E.C.D. Announces Global Standard for Automatic Exchange of Information

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As we noted in our prior issue, the Leaders of the G-20 Summit endorsed automatic exchange of information reporting to combat tax evasion in September 2013. In particular, they stated:

We commend the progress recently achieved in the area of tax transparency and we fully endorse the OECD proposal for a truly global model for multilateral and bilateral automatic exchange of information. Calling on all other jurisdictions to join us by the earliest possible date, we are committed to automatic exchange of information as the new global standard, which must ensure confidentiality and the proper use of information exchanged, and we fully support the OECD work with G20 countries aimed at presenting such a new single global standard for automatic exchange of information by February 2014 and to finalizing technical modalities of effective automatic exchange by mid-2014. In parallel, we expect to begin to exchange information automatically on tax matters among G20 members by the end of 2015.

On February 13, 2014, the Organisation for Economic Co-Operation and Development (“O.E.C.D.”) announced a global standard for automatic exchange of financial account information. Over 40 countries made a joint statement an committed to an early adoption of this standard. On February 23, 2014, the G-20 finance ministers and central bank governors endorsed the proposal.