BEPS – the next international business challenge
The global economic crisis continues to impact governments and the business community to the extent that both sectors are constantly seeking ways to retain and build their cash flow. Governments, especially those in the G20 countries, have stepped up their efforts to halt the flight of investment and capital to countries with attractive low or no tax regimes.
International business centres (IBCs) such as Barbados that depend so much on the income from foreign direct investment are caught up in the dynamics of proving that it is legitimate when multinational corporations choose these offshore jurisdictions as their headquarters.
Not surprisingly, the G20 countries have periodically introduced legislation designed to prevent multinationals from shifting their profits offshore and for their high net worth individuals to pay more taxes at home. The United States was the first out of the blocks with its Foreign Account Tax Compliance Act, closely followed by the United Kingdom and others with similar legislation aimed at recouping more taxes for their treasuries.
The Organisation for Economic Cooperation and Development (OECD), which is often seen as an advocate for the G20 countries, has been busy with setting guidelines on how to combat “base erosion and profit shifting” (BEPS), noting that the aim is to curb multinational tax avoidance and offshore tax evasion in developing countries. BEPS is now the “flavour of the month” and its implications for developing countries and international business jurisdictions can be rather serious.
BEPS is defined by the OECD as the use of tax planning strategies to exploit gaps and mismatches in tax systems to make profits “disappear” for tax purposes or to shift profits to locations where there is little or no real activity, but the taxes are low, resulting in little or no overall corporate tax being paid.
The OECD has identified the following action plans with a view to changing how tax authorities design and interpret tax laws and treaties. Address the tax challenges of the digital economy, neutralise the effects of “hybrid mismatch” arrangements, strengthen “controlled foreign corporation” rules, limit interest deductions and other financial payments, counter “harmful tax practices”, prevent treaty abuse, prevent the artificial avoidance of “permanent establishment” (PE) status, address harmful transfer pricing practices relating to intangibles, enforce disclosure of aggressive tax planning arrangements
BEPS will certainly create new and additional tax obligations especially for countries where tax systems are not robust. Taxpayers can expect reduced interest payment deductions, critical transfer pricing adjustments, the creation of new permanent establishments and increased scrutiny under anti-avoidance rules. It will therefore be necessary to adapt. This may take the form of corporate reorganisations, revising financing arrangements, updating transfer pricing documentation or even changing IT systems. It will certainly be essential to keep abreast with the ongoing developments.
Tax authorities in some countries are analysing tax data to highlight the key drivers of tax base erosion. In Australia, the Australian Taxation Office is in the process of auditing a number of companies to ensure that there is no misuse of their tax rules. In other countries (France, Mexico), tax authorities have been targeting the double non-taxation of interest and mismatching of hybrid instruments. Companies deducting interest expense can only do so where it can be shown that the company earning the interest income will pay tax on that income. The crucial focus is to restrict companies that may use debt to finance production from exempt or deferred income. In Canada, the tax authorities have reduced their thin capitalisation ratio and restricted foreign-owned companies from obtaining debt which is used to acquire or finance subsidiaries in other jurisdictions.
IBCs do have some additional challenges as they relate to BEPS. The increased media attention and the inherent challenge of coping with this complex issue has created the unfavourable perception that multinationals often bend the tax rules to their advantage. These companies are often accused of avoiding taxes, especially when they operate in developing countries.
The tax revenue from multinationals contributes significantly to the Gross Domestic Product of IBCs and these revenues usually form the basis for long-term development. How these jurisdictions respond to the BEPS project will be determined by how nimble they are in dealing with the following:
Ineffective tax audit capacity – IBCs are often unable to monitor cross-broader tax planning structures to determine if they are consistent with global tax rules.
Limited tax legislation – in most IBCs especially those in the Caribbean, there is a lack of legislation that deals with certain risks associated with profit shifting, such as transfer pricing and thin capitalisation rules.
Access to information – not all IBCs have sophisticated enough information systems, to facilitate the gathering and retention of information to keep pace with the changes in global taxation and information exchange.
Technical know-how – the interpretation and implementation of international tax rules and solving tax disputes demand certain skills. However, the competencies of staff working with the tax authorities in many IBCs may not be up to the required level.
Political will – Governments in IBCs will be faced with the dichotomy of attracting foreign direct investment while facilitating the legislative changes to deal with BEPS.
Where the resources are deployed will be very much dependent on the political will and awareness.
The quick message from this discourse is to point out that BEPS will force IBCs to implement systems that lend to substance.
No longer will merely incorporating a company and having board meetings be acceptable to establish substance.
Multinational companies will have to demonstrate that they have sufficient economic substance in the form of maintenance and management activities over assets owned or attributed to companies in low or no tax jurisdictions.
The challenge to tax planners and taxpayers is to ensure that tax structures implemented are coherent, transparent and most of all have business substance.
• Ikins D. Clarke is tax partner, Deloitte Barbados.