Course to new international tax rules
“The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted”
This famous quote from the Gregory v. Helvering case of the US Supreme Court of 1935 is still used as an argument in public and private disputes about tax moral. However, actually the taxpayer lost that case, because the court ruled the transaction has no substantial business purpose other than the avoidance or reduction of Federal tax.
Evidently, such disputes repeated for the last 80 years and the taxpayers continuously face administration’s scrutiny when applying business structures leading to tax optimization. Now, the public debate on the matter has a name – BEPS (Base Erosion and Profit Shifting), and enjoy the extreme public interest.
The BEPS project is announced as a response to the growing concern of governments about the low level of taxes paid by certain multi-national enterprises (MNEs), which take advantage of the gaps between the tax systems of different countries and the outdated conventions for avoidance of double taxation, being much behind the modern business models.
Just as economy has become globally integrated so have corporations. They have transformed their business models from country-specific to globally-operated. This, according to G20 and the OECD has “opened up opportunities for MNEs to greatly minimize their tax burden” by artificially segregating income from the activities that generate it. Local revenue administrations of the Western countries started investigations against multinational corporations claiming that they are not paying their “fair’ share of tax in their home countries.
In 2012 G20 instructed OECD to analyze the issues that raise such concerns. In 2013 the OECD published an Action Plan with specific actions aimed to deal with BEPS on an international level.
The report analyzes the existing environment and concludes that in setting domestic tax rules in many cases the states do not take into account the tax effects of these rules in other jurisdictions. As a result, although coherence may be achieved on a domestic level it is not achieved in an international context. A clear example is the use of hybrid financial instruments, such as preferential shares with guaranteed dividend. The latter give rise to recognition of debt and respective financial cost by the issuer of the shares, while in the jurisdiction of their holder the respective amounts are seen as tax-exempt dividend. Another example is making huge revenue through distant or online sales which remain untaxed in the state in which the customers are located.
These and many other cases that provide opportunities for decrease of profit, avoid creation of taxable presence where the sales are made, lack of substance, e.g. when using preferential tax regimes, hybrid instruments mismatches, shifting of valuable assets in low-tax jurisdictions, are now examined by the OECD.
What is different nowadays, since countries are fighting tax avoidance for many years? It is rather the approach of a new quality – we are talking about structured plan of 15 action points adopted on international level, which address the BEPS areas and proposed measures. There are few groups of intended actions:
- Addressing the challenges of the digital economy, which is totally advancing the existing tax systems – which is in fact a sole action point;
- Filling in existing gaps and mismatches in the legal framework, which allow the MNEs to invent structures and introduce harmful tax practices;
- Recognize value creation as triggering taxation and prevent high risk payments eroding tax base, such as those related to intangibles, intragroup financing and management services fees;
- Improve and further develop collection of information, mutual assistance and disclosure mechanisms between the countries, ensuring transparency and effective performance of the new taxation rules;
- Swift implementation measure of innovative nature, superseding the need to amend one-by-one the existing arrangements (bilateral treaties, national law, etc.).
Those actions are very much intended to interact with each other, having the ultimate purpose to put an end to BEPS. We can view them as being the different branches of one (BEPS) tree having common roots, color and life, rather than separate tracks for different runners…
This fall the OECD, being the driver of the project, published reports and drafts for discussion on most of the action points, mainly those related to filling in gaps and triggering taxation of value creation. Some examples:
- New types of taxes are proposed to address the business models of the digital economy;
- Treaty shopping would be much harder to achieve, by embracing some existing practices, such as ‘limitation on benefits’ clause from the US treaties.
- In the compliance area, some of the new rules and concepts are already known regionally, e.g., the master file – local file structure of the transfer pricing documentation file adopted in EU.
Other proposed measures introduce brand new approaches and change the flavor of the tax environment. The proposed country-by-country (CbC) reporting will provide a snapshot of the group’s allocation of assets, personnel, revenue, certain amounts paid within the group (e.g., management fees) and tax actually paid. This would facilitate the tax authorities in their desktop analysis, having much better chances for quick initial assessment of the group tax position and possible risk areas that may need further investigation.
The rules of the tax game would tighten. Will this be the end to BEPS? – We are about to see. The fact is that the countries look more united than ever in their commitment to overcome BEPS and the new tools of exchange of information may facilitate them to enforce the anti-BEPS strategy.
How would this grand plan be implemented? And in what time? The need of an effective mechanism to achieve results is not an easy task. For instance, there are more than 3,000 treaties in place – would they have to be amended one by one? (This would take decades!) That is why, the plan inevitably deals also with inventing the proper legal instrument that would ensure application of the new rules. Whether that would be a ‘super tax treaty’ having priority over all existing treaties and national rules – we are about to see in the coming 1-2 years. For this purpose, an international tax conference would be convened in the early 2015, having the ambitious goal of inventing the needed instrument, as per the report published in September 2014.
One would say – isn’t that too remote in time? Isn’t Bulgaria too small and so, why worry now? Let’s recall we are part of the EU for 8 years and the EU being part of G-20 would probably have obliged to implement agreed measures. As a personal opinion of the authors, knowing how EU Regulation and Directive could impose common rules and framework throughout Europe, we would not be surprised to see such in the EU Official Gazette.
Aleksandar Stefanov, Tax Manager
Tanya Dzhupanova, Tax Manager