July is traditionally a month for revolutionary activity, the US in 1776 and the French – twice! – in 1789 and 1830. So is July going to be a revolutionary month again in Paris in world tax policy with the anticipated publication of the Base Erosion Profit Shifting work plan this week?
Well we have already seen the opening shots reported in Vanessa Houlder’s article in today’s FT. The article focuses on “UK business leaders are warning their government to resist “radical new solutions” to profit shifting by multinationals.” But “The CBI will throw its weight behind calls to re-examine the rules on digital businesses, amid controversy over the tax arrangements of companies such as Google and Amazon. It said: “Urgent analysis is needed on whether there is a fundamental difference between selling physical goods and digital goods and services over the internet.”
This dichotomy seems to me to sum up the key challenge which business will face in responding to the report. This is a challenge for individual businesses and for business organisations representing business. That challenge is that business cannot oppose the proposals in the report wholesale given the current political climate. Instead business is going to have to accept that some of the BEPS proposals cannot be opposed and focus on those which need consultation. I’ve spoken to a number of people in business and government about what lies ahead and I think there are some real challenges.
For a company, the reaction will be different depending on what proportion of their earnings are dependent on tax planning. A number of large groups I have spoken to are concerned that they do not want to be associated with or seen to be supporting the tax planning which has been reported in the press in Europe. This is particulary the case where their competitors enjoy significantly lower tax rates (and higher earnings) as a result of tax planning.
For representative bodies the challenge is a difficult one. As broad churches they have difficulty responding to fundamental issues of tax reform where there are winners and losers. As in any political process, the losers always shout louder. However difficult this may be business needs to develop a strategic response to BEPS, tactical responses will not be enough.
So what should business do and what are the likely challenges? I haven’t been privy to the development of the BEPS workplan, but I think we can assume the following elements.
1 Digital Economy
This is clearly a major issue. I think the focus will be on looking at all taxes (so this will look at the basis of both corporate income tax and VAT) and will focus on how a company can have a digital presence in an economy either with a much smaller or even without a taxable one. I think there will be a focus on whether market information and presence provides a basis for taxation.
Clearly this is going to be an area of action. I would expect that action to include a review of the international building blocks of tax so the OECD model, domestic law provisions to address double non taxation, where either one end of the transaction is not taxable (the EU is working on this) or where a double deduction is achieved (the double dip) including looking at how tie breaker clauses should work. I’ve said before that unless there is a very good tax policy reason for a hybrid, which is articulated by government in legislation, I think business will struggle to oppose this workstream. What would be the principled reason for opposition?
This has not historically been an area of international cooperation, but I think it has to become one so expect some action here.
I would expect there to be a focus on deductions for debt given the linkage in many minds to the GFC (however unproven this may be). I don’t expect this to be limited but broad and it could extend beyond related party debt to guarentees and other quasi financial arrangements like captives.
I think there will be work on treaty shopping and permanent establishments. On treaty shopping, business might consider seeking consistent provisions in a country’s treaties which is probably one the main drivers of treaty shopping.
Transparency is still a key issue and we can expect more requirement for disclosure of “aggressive tax planning” arrangements to tax authorities. We can also expect the development of a template for disclosure of profits, taxable profits and tax paid to tax authorities. Again business needs to develop a strategic response to the issue of transparency. The issue has moved on over the last 12 months and there is greater recognition that it has changed from an if to a when question. If companies are required to report to tax authorities, they may wish to control how this information is used in the public arena by publishing and also seek to delineate themselves as not having anything to hide.
I was surprised in the Spring and Summer to see comments from some professional advisers that BEPS wasn’t a big issue and would all blow over. While there are indeed some difficult issues both technically and politically I think some commentators underestimate the potential degree of change at their peril.