OECD action plan to counter base erosion, profit shifting 

July 19: The Organisation for Economic Co-operation and Development (OECD) today publicly released its “action plan” for multilateral cooperation to address tax base erosion and profit shifting (BEPS).

The OECD’s Action Plan on Base Erosion and Profit Shifting [PDF 1.45 MB] was presented to the G20 Finance Ministers at their meeting in Moscow, and launches a global collaborative effort to modernize the international tax system. The OECD action plan describes 15 proposed actions, identifies expected outputs, and establishes the anticipated timeframe for each output.

Following is a summary of the action steps identified in the OECD action plan as well as comments and observations about certain proposed actions.

Action steps in OECD action plan

Action 1 - Address the tax challenges of the digital economy Identify the main difficulties that the digital economy poses for the application of existing international tax rules and develop detailed options to address these difficulties, taking a holistic approach and considering both direct and indirect taxation

Expected output - Report identifying issues and possible actions to address the issues by September 2014
Action 2 - Neutralize the effects of hybrid mismatch arrangements Develop model treaty provisions and recommendations for the design of domestic rules to neutralize the effect (e.g., double non-taxation, double deduction, long-term deferral) of hybrid instruments and hybrid entities

Expected output - Revise OECD Model Tax Convention and make recommendations regarding the design of domestic rules by September 2014
Action 3 - Strengthen CFC rules Develop recommendations regarding the design of CFC rules

Expected output - Recommendations regarding design of domestic rules by September 2015
Action 4 - Limit base erosion via interest deductions and other financial payments Develop recommendations regarding best practices in the design of rules to prevent base erosion through the use of interest expense, for example through the use of related-party and third-party debt to achieve excessive interest deductions or to finance the production of exempt or deferred income, and other financial payments that are economically equivalent to interest payments.

Expected output - Recommendations regarding design of domestic rules by September 2015; changes to transfer pricing guidelines by December 2015
Action 5 - Counter harmful tax practices more effectively, taking into account transparency and substance Revamp the work on harmful tax practices with a priority on improving transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, and on requiring “substantial activity” for any preferential regime

Expected outputs -

  • Finalize review of member country regimes by September 2014

  • Establish strategy to expand participation to non-OECD members by September 2015

  • Revise existing criteria for identifiying preferential regimes by December 2015

Action 6 - Prevent treaty abuse Develop model treaty provisions recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances

Expected output - Changes to the OECD Model Tax Convention and recommendations regarding domestic rules by September 2014
Action 7 - Prevent the artificial avoidance of PE status Develop changes to the definition of permanent establishment (PE) to prevent the artificial avoidance of PE status in relation to BEPS, including through the use of commissionaire arrangements and the specific activity exemptions

Expected output - Changes to the OECD Model Tax Convention due by September 2015
Action 8 - Assure that transfer pricing outcomes are in line with value creation/intangibles Develop rules to prevent BEPS by moving intangibles among group members including: adopting a broader and clear definition of intangibles, ensuring that profits associated with the transfer of intagibles are associated with value creation, developing special rules for hard-to-value intangibles, and updating guidance on cost contribution arrangements

Expected outputs - Changes to the OECD transfer pricing guidelines and the model tax convention by September 2014 - September 2015
Action 9 - Assure that transfer pricing outcomes are in line with value creation/risks and capital Develop rules to prevent BEPS by transferring risks among, or allocating excessive capital to, group members including adopting rules to prevent inappropriate returns from accruing to entities solely on the basis of provision of capital or contractual assumption of risks

Expected output - Changes to transfer pricing guidelines and possibly the OECD Model Tax Convention by September 2015
Action 10 - Assure that transfer pricing outcomes are in line with value creation/other high-risk transactions Develop rules to prevent BEPS by engaging in transactions that would not, or would occur only very rarely between third parties including adopting recharacterization rules, clarifying the application of transfer pricing methods in global value chains, and protecting against base eroding payments such as management fees and head office expenses

Expected output - Changes to transfer pricing guidelines and possibly the OECD Model Tax Convention by September 2015
Action 11 - Establish methodologies to collect and analyze data on BEPS and the actions to address it Develop recommendations on the indicators of the scale and economic impact of BEPS and ensure tools are available to assess effectiveness and impact of measures to address BEPS

Expected output - Recommendations on data to be collected and analytic methodologies by September 2015
Action 12 - Require taxpayers to disclose their aggressive tax planning arrangements Develop recommendations regarding the design of mandatory disclosure rules for aggressive or abusive transactions, arrangements, or structures, taking into consideration the administrative costs for tax administrations and businesses and drawing on experiences of the increasing number of countries that have such rules

Expected output - Recommendations regarding the design of domestic rules by September 2015
Action 13 - Re-examine transfer pricing documentation Develop rules regarding transfer pricing documentation to enhance transparency, including a requirement that multinational entities provide all “relevant governments” with information on global allocation of income, economic activity, and taxes paid among countries in accordance with a common template

Expected output - Changes to transfer pricing guidelines and recommendations for the design of domestic rules by September 2014
Action 14 - Make dispute resolution mechanisms more effective Develop solutions to address obstacles that prevent countries from solving treaty-related disputes under Mutual Agreement Procedures (MAP), including the absence of arbitration provisions and denial of access to MAP in certain cases

Expected output - Changes to the OECD Model Tax Convention by September 2015
Action 15 - Develop a multilateral instrument Analyze tax and public international law issues related to the development of a multilateral instrument to enable jurisdicitons that wish to do so to implement BEPS measures and amend existing bilateral treaties

Expected outputs -

  • Report on relevant public international law and tax issues by September 2014
  • Develop a multilateral instrument by December 2015

Challenges presented by ambitious timetable

The OECD action plan sets forth an ambitious 24-month timeframe for reaching consensus on changes and modifications necessary to modernize the international tax system. While there is a value in working quickly to reduce the period of uncertainty, the challenge that policymakers will face is to modernize over 75 years of international tax law in only two years without jeopardizing the aspects of the current system that work well.

KPMG observation

As anticipated based on a February 2013 OECD report, today’s OECD action plan focuses on a number of key areas including the digital economy and intangibles, hybrid mismatch arrangements, harmful preferential regimes, aggressive tax planning, and greater transparency and disclosure.

  • The digital economy in its broadest sense presents difficult and complex issues. The planned holistic approach to understanding business models before specific proposals are made is critical to a balanced consideration of these issues.
  • The call for action to address hybrid mismatches has been anticipated, and is likely to have a significant impact on multinational companies. As with a number of the other proposals in the plan, this proposal requires changes to domestic laws and extensive coordination among governments.
  • The OECD action plan also calls for revamping the work on harmful tax practices. In this regard, providing clarity and establishing consensus around the criteria for identifying harmful tax practices versus acceptable tax competition would be welcome.
  • The action plan calls for improving mechanisms for dispute resolution including the widespread adoption of mandatory arbitration. Collaboration to facilitate earlier and swifter resolution of tax disputes would be a positive and welcome outcome of the BEPS initiative.
  • In its earlier report (February 2013), the OECD indicated it did not intend to depart from the arm’s length principle. However, today’s action plan suggests that the OECD is considering measures which go beyond the arm’s length principle. This raises serious concerns.
  • The OECD action plan proposes changes to domestic legislation to permit greater disclosure to global tax authorities regarding certain aggressive transactions. Providing clear definitions and establishing consensus as to which transactions this will apply will be essential to the effectiveness of this proposal.
  • The OECD action plan calls for enhanced documentation requirements. The proposals around re-examining transfer pricing documentation appear to be moving towards a version of country-by-country reporting to tax authorities. If this is what is intended, it will be important to ensure that the practical considerations and costs to the taxpayer are fully assessed and appropriately taken into account relative to the benefits such reporting would serve in addressing BEPS concerns.
  • A number of the proposals will require domestic law changes that may be in conflict with EU rules (such as, limitations on the deductibility of interest expense, CFC rules, and treaty anti-abuse rules). In the past, resolving these mismatches has presented significant challenges. It is not clear whether the benefits of a coordinated action plan will provide sufficient incentives to overcome these challenges.
  • The OECD action plan proposes adoption of a multilateral convention among participating governments to implement a number of the proposed actions. This will present considerable challenges, but it may be the only realistic mechanism for effecting change within the proposed time frames.
  • Today’s OECD action plan proposes significant changes to the international tax landscape in a very short period of time. It is thus very encouraging that the OECD is emphasizing the importance of consulting with a range of non-governmental stakeholders in moving forward.

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