The Organisation for Economic Cooperation and Development (OECD) issued the first recommendations on its Base Erosion and Profit Shifting project in September 2014, following endorsement by the G20 in July 2013. It aims to create a single set of consensus-based international tax rules to protect tax bases while, at the same time, providing increased certainty for taxpayers and avoiding double taxation. The most recent announcement by the OECD deals with the first seven recommendations, with a further eight to follow in 2015.
HMRC has already indicated that it will follow the country-by-country reporting recommendation as soon as possible. This proposal involves the introduction of a template for the reporting of multinational enterprises’ income, earnings and taxes paid for each tax jurisdiction in which they do business. This will be accompanied by a report for each jurisdiction on employment, capital, retained earnings and tangible assets, as well as an indication of the business activities of each entity in the group. The OECD has also proposed the extension of the ‘master file’ concept that currently applies in the EU to all jurisdictions. The end result will be that tax authorities have access to the master file, the local country file and the country-by-country report.
HMRC has already indicated that it will follow the country-by-country reporting recommendation as soon as possible
The recommendations
The second recommendation relates to value creation on intangible assets.
This may require broader definitions, as well as covering such issues as ensuring profits are allocated to where value creation occurs, introducing additional guidance on valuation and cost contribution agreements, the development of rules regarding the transfer of risks and capital among group members, and adapting transfer pricing rules to clarify when transactions may potentially be recharacterised.
The third recommendation covers the issue of changing the applicable exemptions from when a permanent establishment (PE) applies within Article 4 of the Model Double Taxation Convention. This is likely to involve deeming certain digital activities to have a local nexus, amending the concept of a PE to a ‘significant presence’, and applying withholding taxes or introducing a new bandwidth tax.
The fourth recommendation is about preventing the abuse of tax treaties by realigning taxation and substance. This will be based on ensuring that tax treaties do not override domestic anti-abuse regulations, which is likely to entail tougher action on treaty shopping. Tax authorities will need guidance on policies that should be considered when entering into new or renegotiated tax treaties.
The fifth recommendation focuses on dealing with harmful practices, which generally requires ensuring substantial activity or presence in a jurisdiction in order to qualify for preferential treatment. It is also likely to cover the issue of improving transparency through the automatic exchange of ruling applications information.
The sixth recommendation suggests a feasibility study on developing a multilateral instrument to amend bilateral tax treaties. The instrument would be used to enable faster and easier modification of double taxation treaties to simultaneously prevent abuse and eliminate double taxation.
The seventh and final recommendation revolves around the neutralisation of hybrid mismatch arrangements. This will involve eliminating arrangements that produce multiple deductions for a single cost or enable a deduction to be claimed in one jurisdiction without appropriate taxation in the other jurisdiction.
Ready for action
These recommendations will remain in draft form until the rest of the proposals are delivered. It is accepted that they will require detailed consideration and careful implementation. In addition, the Model Taxation Treaty will have to be modified. However, the G20 is committed to changing the current position and action will be taken sooner rather than later. The reporting requirements will increase the burden of compliance, so multinational enterprises should consider the proposals and recommendations carefully and work out what action may be necessary to support their transactions.
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