The concept of base erosion and profit shifting (BEPS) is defined by the OECD as:
"tax planning strategies that exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to locations where there is little or no real activity but the taxes are low resulting in little or no overall corporate tax being paid."
Arguable, many of the strategies employed by multinational organisations take advantage of the interaction between the tax rules of different jurisdictions, making it difficult for any single country to fully address the issue.
G20 finance ministers have called on the OECD to develop an action plan to address BEPS issues in a co-ordinated and comprehensive manner.
The OECD has developed an Action Plan on Base Erosion and Profit Shifting. Some of the actions identified in the Action Plan relevant to the banking industry include:
1. Prevent the artificial avoidance of permanent establishment status
There is a concern that multinationals may artificially fragment their operations among multiple group entities to qualify for the exceptions to permanent establishment status as per the relevant Double Taxation Treaty, such as conducting activities in a way that is preparatory or ancillary.
Given the complex nature of banks and central booking locations with traders, marketers and risk managers operating in different locations, this creates difficulty determining where income should be taxed.
Potential changes may include changing the definition of ‘permanent establishment’ in the Double Taxation Treaties. This may be affected by introducing multilateral instruments, where a group of jurisdictions may agree on a particular course of action, which will impact all treaties belonging to the jurisdictions impacted by those instruments.
2. Limit base erosion via interest deductions and other financial payments
The Action Plan has identified concerns with taxpayers’ use of related-party and/or third-party debt to achieve excessive interest deductions or finance the production of exempt or deferred income, and other financial payments that are economically equivalent to interest payments.
To address this issue, the OECD has suggested developing transfer pricing guidance with regard to the pricing of related party financial transactions, including financial and performance guarantees, derivatives (including internal derivatives used in intra-bank dealings), and other insurance arrangements.
Again, the complexity of global banking operations and funding mechanisms of books and desks concerns tax authorities, in particular the possibility that more than 100 percent of interest expenses globally might be claimed by multinational organisations.
3. Neutralise the effects of hybrid mismatch arrangements
The OECD is aiming to develop model treaty provisions and recommendations regarding the design of domestic rules to neutralise the effect (e.g. double non-taxation, double deduction, long-term deferral) of hybrid instruments and entities.
Financial institutions in Australia have been closely monitored in respect to hybrid mismatch arrangements and the revenue authorities have been reviewing the ongoing nature of these arrangements.
4. Transparency on certain transactions
Multinationals may be required to disclose to all revenue authorities in jurisdictions in which they operate, information of their income, economic activity and tax paid.
Australia has, for the first time, implemented measures to improve the transparency of the corporate tax system by requiring the Commissioner of Taxation to make publicly available certain information relating to the tax affairs of all corporate entities that have a reported total gross income of $100 million or greater. This will apply from the 2013 – 2014 income year. Given the relatively low threshold, many financial institutions will be affected by this measure.
For further information relating to the BEPS debate, David Linke, KPMG’s Head of Corporate Tax and Grant Wardell-Johnson, Leader of the Australian Tax Centre have made a series of videos in which they discuss this very important topic.