Base Erosion and Profit Shifting
Thomas May, Partner, New York
Carolinas Chapter
March 20, 2015
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OECD BEPS Project
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Recent OECD BEPS Discussion Drafts
Action 1:
VAT B2C
Guidelines
(Dec. 18)
Action 4:
Limit Base
Erosion via
Interest, etc.
(Dec. 18)
Action 6:
Treaty Abuse
(Nov. 21)
Action 7:
Prevent Artificial
Avoidance of PE
Status
(Oct. 31)
Actions 8-10:
Commodity
Transactions
(Dec. 16)
Actions 8-10:
Profit Splits
(Dec. 16)
Actions 8-10:
Risk /
Recharacterization
(Dec. 19)
Action 10:
Low ValueAdding Services
(Nov. 3)
Action 14:
Make Dispute
Resolution More
Effective
(Dec. 18)
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Unilateral vs. Multilateral Action on BEPS
–A lack of resolution on BEPS is resulting in many
countries contemplating unilateral action – U.S.
Senator Chuck Schumer
–Some countries may have decided to use the
opportunity they had at the time to do what they
thought was best – Raphaele Russo, Head of
OECD BEPS
–More than 30 unilateral BEPS-focused measures
were introduced by at least 19 countries in 2014
– PwC Survey
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European Union
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European Union
–Ruling Practice
– State aid investigation into ruling practices of
member states including Luxembourg (Fiat and
Amazon), Ireland (Apple), Netherlands
(Starbucks), Belgium, Gibraltar, etc.
– Transfer pricing rulings, excess profits rulings,
source of income rulings, etc.
– If rulings constitute state aid, the companies to
which they were granted would be required to repay
any taxes saved plus interest
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European Union
–Transfer pricing ruling
USCO
CV
Royalties
BV
3d Party
Royalties
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European Union
–Ruling Practice
– Tax transparency measures
– Every three months, national tax authorities of
member states will be required to send a short
report to all other Member States on all cross-border
tax rulings that they have issued
– Member States will then be able to ask for more
detailed information on a particular ruling
– Other transparency proposals
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United States
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United States
–A Unilateral Precursor to BEPS?
– Section 7701(o) economic substance doctrine
– transaction has economic substance only if
transaction changes in meaningful way taxpayer's
economic position and taxpayer has substantial
purpose (apart from Federal income tax effects) for
entering into transaction
– legislative history provides that the choice to utilize
a related-party entity in a transaction, provided that
the arm's length standard of section 482 and other
applicable concepts are satisfied
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United States – Caterpillar Parts
Before
3d Party
CAT
CSARL
3d Party
After
3d Party
CSARL
3d Party
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United States
–Senate Permanent Subcommittee on Investigations
– IRS should analyze transfer pricing under economic
substance, assignment of income, etc.
– Transfer pricing agreements should identify, explain
and justify profit allocation
– Participate in OECD efforts
– Eliminate auditing and tax consulting conflicts of
interest
–IRS is asserting “substance over form” and
“assignment of income”
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United Kingdom
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United Kingdom
–Diverted profits tax (2015)
– 25% tax (rather than normal rate of 20%) imposed
on diverted profits where there is:
– an overseas or UK mismatch involving a low-tax
entity that lacks economic substance, or
– a main purpose is tax avoidance
– Charging and notification mechanisms
–Hybrid mismatch rules (2017)
–Country by country reporting (2015)
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United Kingdom
–Hybrid Entity Structure
USCO
CV
Loan
BV
Loan
UKCO
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United Kingdom
–No Hybrid Entity Structure
USCO
Lux
Lux
UKCO
Branch
Loan
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France
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France
–Interest expense limitation (2014)
– Interest expense is not deductible if the
corresponding income is not subject to a minimum
tax rate (25% of the standard French CIT rate,
surcharges included) at the level of the creditor
(related party)
– French CIT rate is 34.44%
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France
–Swiss Finance Company
USCO
Finance Company Ruling
Full Tax Rate
Loan
Swiss
Assign Loan
Swiss
France
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Ireland
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Ireland
–Elimination of “double Irish” structure (2015)
– Ireland companies registered on or after January 1,
2015, are required to also be Irish tax residents
– Existing companies would have until end of 2020 to
come into compliance with new law
– Corporate income tax rate to remain at 12.5%
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Ireland
–Double Irish
USCO
Ire/Berm
Royalties
Ireland
UKCO
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Mexico
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Mexico
–Restrictions on deductibility (2014)
– Payments to related parties are nondeductible if:
– Mexican resident payer has control over
recipient
– Payments are interest income, royalty income,
or technical assistance; and
– One of the following is true
– payee is transparent entity) unless its participants
are taxed on income and payment arm's length);
– payment is disregarded for tax purposes; or
– payment is not taxable income
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Mexico
–Disregarded entity
USCO
USCO
Loan
Mex
Mex
Rev Hyb
Loan
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Anti-Treaty Shopping
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Treaty Abuse – Threats
– Requirement of minimum standard
to combat treaty shopping
– Combination LOB + Principal
Purpose Test (PPT), or
– PPT alone, or
– LOB + anti-conduit rule
– Preamble statement of no intention to create double nontaxation
– Specific anti-abuse rules (e.g., anti-triangular provision)
– Speed of implementation may depend on multilateral
instrument
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Treaty Abuse – Threats
– PPT in effect a treaty GAAR
– Much uncertainty re application
– Limited procedural safeguards
– LOB based on highly restrictive
US Model
– Changes liable to affect structures such
as:
– Regional holding or distribution companies
– IP holding companies
– Treasury centers
– Etc.
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Treaty Abuse – Response
–Analyze exposure and consider need for fallback
structures (with particular focus on income flows
between foreign subsidiaries)
–Document the business case for new and existing
arrangements that depend upon treaty protection
–Consider use of treaties for which a “derivative
benefits” argument can be made
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Intangibles/Principals
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Intangibles/Principals – Key Challenges
–Overarching goal—make profits follow “value
creation” (i.e., people in country)
–Threats to typical IPCo/Principal structures:
– Ability to earn residual profit by funding development
– Ability to allocate risk contractually
– Broaden circumstances warranting profit split
approach
– Limit Patent Box regimes via “nexus” approach
– “Special measures” (e.g., disregard cashbox IP)
– Creeping formulary apportionment
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Intangibles/Principals – Response
–Bolster people “substance” in IPCo/Principal
– More managerial functions in Principal location
– Consider management branch in friendly country
– Consider US R&D branch
–More robust functional analysis to blunt profit
splits
– Tighter comparables with same people functions
– Limit relevant people to truly non-routine activities
– Best method rule still alive
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Intangibles/Principals – Response
–Consider onshoring of IP
– Marry IP with people substance
– Minimize local tax via amortization and interest
deductions and/or patent box regimes
– Eliminate targeted “nowhere” income
– Minimize reputational risk
– Optimal timing?
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Permanent
Establishments
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PE Definition – Threats
–Article 5(5) dependent agent PEs:
– Commissionaires
– Sales / marketing personnel who
negotiate or even just promote
– Limited risk distributors?
– Exclusive or near-exclusive agents
for group
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PE Definition – Threats
–Article 5(4) preparatory or auxiliary activity
exceptions:
– Overarching preparatory / auxiliary caveat?
– Elimination of exceptions for delivery, purchasing,
collecting information?
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PE Definition – Response
–Analyze potential exposure
–Consider various options:
– Convert to buy-sell distributors
– Use independent agents
– Closely monitor promotional / sales activity of in-country
personnel
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