Progress on the reform of international taxation demands that accords be translated into actions this year. ACCA's Chas Roy-Chowdhury describes the potential hurdles
This article was first published in the April 2016 international edition of Accounting and Business magazine.
In 2016, the shake-up of international taxation will shift focus from firm agreements to hard actions. The world’s leaders and their finance ministers expect no less, following the consensus achieved on far-reaching reforms that could radically alter how multinational companies are taxed, as well as where they are taxed.
Since 2013, the Organisation for Economic Cooperation and Development (OECD) has been developing a 15-point action plan to tackle Base Erosion and Profit Shifting (BEPS). It was always going to be an ambitious project, but the OECD has risen to the challenge, bringing with it the G20 leaders, who voted to implement the final package in November 2015.
The OECD anticipates that the measures, if implemented in full by all the major economies, will go some way to reducing the estimated US$100bn-$240bn (£66bn-£160bn) lost through BEPS annually. This represents between 4% and 10% of global corporate income tax (CIT). This matters because of developing countries’ greater reliance on CIT as a percentage of their tax revenues.
The 15 action points have been presented in a consolidated package that the OECD claims to be the first substantial overhaul of international tax rules in almost a century. The final package of measures includes minimum standards on country-by-country reporting and treaty shopping, curbs on harmful tax practices, especially in areas of intellectual property, and mutual agreement procedures to ensure that the fight against double non-taxation does not result in unintended double taxation. There is also revised guidance on transfer pricing rules and a new definition of permanent establishment, together with new measures for controlled foreign companies, interest deductibility and hybrid mismatches.
Finally, we will see the development of a multilateral instrument that will incorporate the tax treaty-related BEPS measures into the existing network of bilateral treaties. This will arguably be the most complex aspect; as the OECD notes, there are nearly 90 countries working together on this action point, and the aim is to get the instrument up and running by the end of 2016.
The report says that the goal of Action 15 is to streamline the implementation of the tax treaty-related BEPS measures, an innovative approach with no exact precedent in the tax world, although such instruments do exist in other areas of public international law. This could be the biggest challenge for BEPS in 2016, but at only 50 pages in length (compared to some 400 pages for other action points), is there enough detail to push it through?
Development of the multilateral instrument is being taken forward by an ad hoc group, which has been tasked with hitting the end-2016 deadline. An initial conference to negotiate the instrument began in November 2015, under the chairmanship of the UK, supported by vice-chairs from China and the Philippines. More than 90 countries and jurisdictions have indicated they will participate in the negotiations. Once the instrument has been agreed, it will be available for countries to ratify. But it is expected that there will be significant flexibility so that participating countries might make different choices. This is going to be a tough point to get right.
This year will see movement on a number of the other action points. Those covering transfer pricing (Actions 8 to 10) and Action 13 on country-by-country reporting will be the first to take effect in 2016. Although the consolidated version of the transfer pricing guidelines is not due to be published until 2017, tax authorities are already starting to use the material released during the consultation process to open cases.
Country-by-country reporting, as set out in Action 13, will benefit from very clear guidance through a fixed template. The first sets of data for December 2016 year-end groups with global sales of €750m (£586m, $840m) must be delivered to tax authorities by 31 December 2017. These will, in turn, distribute this information by 30 June 2018. Multinationals are going to be busy with their systems work on gathering the necessary data in 2016.
Activity around patent boxes (Action 5, harmful tax practices) will also be busy in 2016. In the future, patent box incentives may be granted only where the related research and development is conducted in the same country. The UK, which is currently consulting on its own patent box rules, is expected to present legislation quickly to introduce the new regime from June 2016 and to close the existing patent box regime; at the time of writing it was expected that group transfers into existing boxes will not be allowed after 31 December 2015. There are indications that Germany, Ireland and the US may introduce their own BEPS-compliant intellectual property regimes as well.
Top of the agenda
Such activity will keep international tax close to the top of boardroom agendas. According to Deloitte’s most recent European tax survey, the importance of BEPS has increased during the past year, while progress is also being made to prepare for the coming changes. In Deloitte’s previous survey, nearly a third (31%) of companies said they had begun preparations for BEPS. In the latest survey, this figure had risen to just under a half (44%).
There is also acknowledgement that BEPS is likely to affect tax strategy. More than half of the companies in the Deloitte survey said they expected the cost of compliance to increase, and there was a significant increase in the proportion of respondents saying they would need to review or amend their entire international tax strategy. Half thought their compliance burden was likely to increase as a result of the initiative; a third thought this burden would increase primarily from the country-by-country reporting requirements, while the rest could see the burden increasing due to other requirements such as transfer pricing documentation and methodologies, and permanent establishment changes.
So 2016 – and beyond – will be a busy time for corporates as well as legislators and tax authorities. Legislative action at a national level will be required to tackle issues around hybrid mismatches and interest restrictions. Hybrids – where one party gets a tax deduction for a payment while the other does not have a taxable receipt, or where there is more than one tax deduction for the same expense – are tackled by the OECD. But it remains to be seen how many countries actually support this guidance. The UK government is considering legislation, while countries such as France already consider that their legislation outlaws such arrangements. But few other countries have publicly supported the OECD position.
Interest deductibility (Action 4) could prove interesting, if you’ll forgive the pun. The final report affords a degree of flexibility that could see a variety of different approaches to targeting interest deductibility. And whatever rules are adopted, there should be plenty of time allowed for corporate groups to reassess their capital structures so that they are still able to obtain relief for third-party interest expense. One thing is clear, however: the OECD does not want to see countries deliberately adopting a policy to attract international investment due to lenient interest deductibility rules.
But inevitably, some countries will prove to be more enthusiastic about BEPS than others. For instance, Australia has been seen as an early mover on BEPS, having adopted some measures even before the final recommendations became known. The UK, which has been accused of undermining the BEPS project through its diverted profits legislation, could be seen, if anything, as over-enthusiastic.
The Netherlands, which rightly or wrongly has been the target of accusations over its tax policies, is considering its response. There, legislation on country-by-country reporting came into force at the beginning of 2016, with changes to its patent box regime also expected during the year. Ireland will also legislate on country-by-country reporting and introduce a ‘knowledge development box’ that will comply with the OECD’s standards.
Then there is the US. It remains to be seen how the world’s largest economy will react and, if so, when. Caution seems to be the watchword here, even though the US played an active role in the BEPS process. The US government believes there is a risk of uneven and unfair application of the action points, and is particularly fearful that other governments will go after the trillions of dollars locked up in US international groups who have been keeping their earnings offshore. And the US is not keen for its corporate groups to be sharing their information with foreign authorities. Even if all the other hurdles are overcome, this could be one obstacle too many.
Chas Roy-Chowdhury FCCA is head of taxation at ACCA
"Legislative action at a national level will be required to tackle issues around hybrid mismatches and interest restrictions"