The Organisation for Economic Cooperation and Development (OECD) is on the march for your money. And it’s come up with a plan, specifically the Base Erosion and Profit Shifting (BEPS) Action plan, to get it.
The BEPS Action Plan is the organization’s attempt to address the perceived tax evasion by multinational corporations (see related story here). By its own admission, the OECD acknowledged that “with the data currently available, it is difficult to reach solid conclusions about how much BEPS actually occurs.” Still it’s created a list containing 15 “action areas” and it’s serious business.
That’s because they likely mean fundamental changes are coming for MNC tax structures and unless more is done to stop them, treasury is going to have to help tax clean up a big mess.
At the “Path to Bolder RMB Implementation” roundtable this week at Standard Chartered, one of the key takeaways (see related post here) was that the biggest challenge with setting up cross-border lending for China is getting the transfer pricing, or an arm’s length interest rate in the intercompany loan right. Given the significance of the China market, it pays to do the work internally with tax and legal and external experts to conduct a thorough transfer pricing study to justify the rate choice in the context of the loan structure.
This got us thinking about the bigger picture of such transfer pricing in the context of the OECD BEPS Action Plan. What if all this hard work on transfer pricing is about to get undone?
Since OECD BEPS is on the agendas for our Treasurers’ Group of Thirty 1 and 2 meetings next month, with the national tax office/international corporate tax services heads from KPMG and PwC sharing their insights, iTreasurer has been digging into the topic. The public comments on some key Action Item discussion drafts distributed last December were released by the OECD earlier this month, including the all-important Action 4 on Interest Deductions and Other Financial Payments and Actions 8, 9, 10 on Revisions to Chapter 1 of the Transfer Pricing Guidelines (Including Risk, Recharacterisation, and Special Measures). Unfortunately, the comment period closed on February 6, but more should and can be done to impact these prior to implementation.
A game changer
What we learned from a Deloitte tax expert at a Citi Liquidity Advisory Roundtable a few weeks back is that interest and interest deductibility along with transfer pricing are being totally re-thought. Proposals on interest deductibility will introduce caps based on fixed debt ratios or an allocation to affiliated group companies based on, for example, total net third-party group interest expense. Arm’s length rates of interest will have little bearing on deductibility and arm’s length, meanwhile, will take on new meaning depending on the commercial and financial relationship between entities and the nature of the service.
Other Big Four firms similarly point to the fundamental nature of the changes being proposed. Per KMPG’s comment letter on the transfer pricing actions:
KPMG believes that the OECD needs to start its recommendations around risk and recharacterization from the premise that the vast majority of the transactions that will be governed by its guidance are ones that are a necessary part of international business, and which do not involve harmful tax practices, but where double taxation is much more likely than double non-taxation. Therefore, the primary focus of its guidance should be to provide the separate legal entities within an MNE group with the correct amount of income per the broad parameters of Articles 7 and 9.
KPMG recognizes that the above approach may lead to cases in which controlled entities realize income that may not be taxed appropriately under OECD tax policy objectives, and that additional guidance is therefore needed to address any resulting double non-taxation. Such guidance, however, should be specifically targeted at that issue, and should not undermine taxpayers’ ability to comply requirements in the numerous cases where the tax authorities involved in the transaction are taxing the income that is appropriately reported in their jurisdiction.
While a limited amount of this targeted guidance may lead to some limitations on the application of the arm’s length principle by setting minimum substance requirements and/or establishing parameters around the amount of profits that can be shifted by “de-risking” local entities, this is primarily a question of determining what exceptions to the arm’s length principle should be made as a matter of tax policy rather than changing the arm’s length principle itself.
In connection with what got us started on this, we should note that MNCs preparing and then submitting the results of their TP studies, including those for China, should look at Action 13, Guidance on the Implementation of Transfer Pricing Documentation and Country-by-Country Reporting.
Plowing through the discussion drafts and comment letters underscores the point being made by tax experts that this is going to be a game changer for MNCs’ business and financial structures, including most tax-driven treasury structures. But it is also going to be a game changer for many more activities that are not generally thought of as tax driven, including intercompany loan programs, in-house banks and cash pools.
With these last items on treasurers’ priority lists for this year, it is all-important to include these OECD BEPS Actions’ potential impact and related tax/transfer pricing considerations in any projects undertaken that touches them.