The Disappearance of The International Tax World as We Know It: Understanding BEPS(zilla)

In a thought provoking interview, Eugenio Grageda speaks on how international tax is making a huge, impacting change, and what this means for all those who pay tax.

 

What the BEPS is everyone talking about?

The Base Erosion and Profit Shifting (BEPS) is a project initiated in 2012 by the G-20 and the Organisation for Economic Co-operation and Development (OECD) that encompasses the most overwhelming change in cross-border tax policies in a century.

It consists of 15 action plans where the aim is to curtail rampant tax avoidance strategies and to close gaps that have allowed multinational entities (MNEs) to exploit loopholes and mismatches in tax rules to artificially reduce their tax base, and shift profits to low or no-tax locations where the MNEs have little or no economic substance.

The BEPS project originated during the latest economic recessions, when governments’ concern grew on the low amount of taxes being paid by certain MNEs and the media started unveiling their international tax schemes. The public started accusing them of dodging taxes, and tax laws started being criticized for not having kept pace with international tax planning.

With an increased perception that the tax systems distort competition and that taxes are paid only by the naive, the necessity of a paradigm shift in the international tax playground gathered momentum.

 

What are BEPS principal objectives?

• Reinforcing transfer pricing (TP) rules to align outcomes with functions, risks assumptions and value creation;
• adjusting tax treaties to prevent the granting of benefits in inappropriate circumstances;
• preventing artificial avoidance of a permanent establishment (PE);
• limiting interest deductions in intragroup financing;
• avoiding double-deduction or double non-taxation scenarios triggered by hybrid mismatches;
• countering aggressive tax planning by increasing transparency, and
• addressing the challenges of the digital economy in new business models.

Who should be worried?

Almost any person with an international component in their operations.

 

How will BEPS be implemented?

In general, BEPS outputs were set as a menu of options for jurisdictions to choose from. To become enforceable, some measures will require domestic law implementation and others will need changes in bilateral tax treaties.

It is expected to see BEPS-driven legislation in the 100 countries which, as of 21 June 2017, have committed to the implementation of BEPS.  Even countries like Andorra, Liechtenstein, The Netherlands, and some tax havens have surrendered some of its tax appeal to the international pressure.

On the other hand, tax treaties will be amended through the implementation of a multilateral instrument (MLI), a super tax treaty whose terms will become obligatory after its articles have been cherry-picked by each country and recognised as applicable in all their tax treaties. This will be the biggest shockwave caused by BEPS(zilla) this year.

Conversely, reforms to TP guidelines will mostly become immediately applicable as many jurisdictions make them legally binding via a direct reference to them in their domestic laws.

 

How can I be affected by BEPS?

BEPS will reinstate taxation where income would have otherwise been untaxed.

Even when you have been a model taxpayer with a structure already reflecting the underlying economic reality, there are aspects of BEPS that could have an impact on your operations.

Chief amongst the measures that could adversely affect MNEs, is the huge increase in information to be gathered and exchanged for TP purposes (e.g. country-by-country revenue, capital, tangible assets, functions performed, intangibles, taxes paid, etc.). This will (has been) a rough increment in MNEs´ administrative burden. Parallelly, profits from transfers of goods, services, capital and intangibles within a multinational group would probably need to be reallocated based on the new substance criteria adopted by BEPS. More audits and disputes between tax authorities in this regard are to be expected.

Moreover, MNEs with no PE in a foreign jurisdiction could end up having one as a result of the lower thresholds to create a PE. Many companies would need to look closely at their stages of supply chain, services rendered and placement of their workforce internationally. For instance, enterprises generating substantial revenues from customers through digital means in another country may be considered to have a taxable presence therein (e.g. amazon case).

Other nasty impacts regard the limitations on the deductibility of certain royalty payments, interests paid in intercompany loans and products and services payments where they are not recognised as taxable income in the recipient country.

Lastly, access to treaty benefits could be denied by the new edges set forth by the MLI. No source taxation or reduced withholding scenarios would need to be reconfirmed under the scope of the MLI.

 

What to do?

MNEs need to revise their business models and adopt compliance policies within their organisation. Pressure will rise to justify prices, operations, payments abroad, use of tax treaty benefits and international distribution of operations.

Taxpayers will require to monitor BEPS developments to assure an opportune reaction and not to belittle potential effects even if the MNE has considered itself having proper business substance and intercompany prices that mimic that of third parties. BEPS provisions could be a catch-all net that traps both abusive and benign structures.

It could also be prudent to simplify their organisation structure by reducing the entities and countries involved to minimise the number of jurisdictions where potential litigation could arise.

In the famous US case Gregory v Helvering, it was said that companies are “not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes”. However, BEPS has made it difficult to leave it to patriotism the obligation to pay taxes. Now, it will be a matter of law.

Yet, it is unlikely that companies will stop looking for opportunities to be more profitable. After all, generally, that is a duty they owe to its investors. They will always be free to find ways to ameliorate their tax positions worldwide so long as, of course, its practices do not fall in tax evasion. As put in the US case Commissioner v. Newman “nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant”.

 

Will tax advisory change?

Yes. Now international tax lawyers are to provide BEPS-sensitive advisory. There will be new anti-abuse provisions, alterations to all tax treaties, new interpretation issues and rules that could make whatever previously learned, obsolete. It is of utmost importance for international tax advisors to study all the new relevant tax measures, study them more and reinvent their approach when aiding clients addressing their global tax issues.

 

Eugenio Grageda
egrageda@turanzas.com.mx

 

Eugenio Grageda is an international tax attorney based in Mexico who advises multinational companies and high-net worth individuals with cross-border activities, including reorganizations, financing and international investments.