OECD Base Erosion and Profit Shifting (BEPS) Update/media/Files/Insights/Events...OECD Base Erosion...

OECD Base Erosion andProfit Shifting (BEPS) UpdateASC 740 Accounting for Income Taxes:Foreign Tax Provisions and US International Tax Issues

Eric Ryan, Partner, DLA Piper – Silicon ValleyChris Kotarba, Associate, DLA Piper – Silicon Valley

June 3, 2014

*This presentation is offered for informational purposes only, and the content should not be construed as legal advice on any matter.

OECD BEPS update agenda

US tax regime and relationship to BEPS

OECD BEPS updates

Selected country reactions to BEPS

US reactions to BEPS Administration statements discussion

Proposed legislation

Possible corporate action items now

2June 3, 2014OECD BEPS Update

Current US corporate tax regime

The US now has highest statutory corporate tax rate among all OECD members Many OECD members have gradually

reduced rates, year after year US is also one of the few remaining

OECD members with a worldwide (WW) tax system (but has a Foreign Tax Credit mechanism) Others include Chile, Ireland, Israel,

Korea and Mexico Most OECD members now use a territorial

system (generally not taxing foreign profits)

Highest corporate tax rate + WW tax system = US may also have the highest average tax rate of any OECD member

Notwithstanding, US companies (Apple, Google, Starbucks and Caterpillar) are at forefront of criticism for inappropriate tax planning – particularly “mailbox” companies or “stateless income”

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Source: OECD Tax Database (2012)

June 3, 2014OECD BEPS Update

US MNEs – offshore earnings

June 3, 2014OECD BEPS Update 4

BEPS timeline to date

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March 24, 2014: OECD publishes discussion draft on the Digital Economy (Action 1)

February 12, 2013: OECD publishes first report “Addressing Base Erosion and Profit Shifting,” listing 6 key pressure areas

January 30, 2014: OECD publishes discussion draft on CbCReporting (Action 13)

July 19, 2013: OECD publishes second report “Action Plan on Base Erosion and Profit Shifting,” listing 15 actions with deadlines

June 2012: G20 asks OECD at leaders’ meeting to report on “the need to prevent base erosion and profit shifting”

January 23, 2014: OECD presents webcast on 2014 deliverables

September 6, 2013: G20 leaders endorse OECD’s work on BEPS at Russian summit


April 11, 2014: OECD releases public comments on Treaty Abuse (Action 6)

May 7, 2014: OECD releases public comments on Hybrids (Action 2)

April 16, 2014: OECD releases public comments on the Digital Economy (Action 1)

February 23, 2014: OECD releases public comments on CbC Reporting (Action 13)

March 14, 2014: OECD publishes discussion draft on Treaty Abuse (Action 6)

March 19, 2014: OECD publishes two discussion drafts on Hybrids (Action 2)

July 30, 2013: OECD published revised discussion draft on Intangibles (Action 8)

May 26, 2014: OECD presents webcast on BEPS project update

October 22, 2013: OECD releases public comments on Intangibles (Action 8)

BEPS action plan

Action Deadline Action Deadline

1. Tax challenges of the digital economy

Sept. 2014 9. TP for risks and capital Sept. 2014

2. Hybrid mismatch arrangements

Sept. 2014 10. TP for other high-risk transactions

Sept. 2015

3. CFC rules Sept. 2015 11. Data on BEPS and actions addressing it

Sept. 2015

4. Deductibility of interest and other financial payments

Sept. 2015/Dec. 2015 12. Aggressive tax planning arrangements

Sept. 2015

5. Harmful tax practices Sept. 2014/Sept.2015/Dec. 2015

13. TP documentation Sept. 2014

6. Prevent treaty abuse Sept. 2014 14. Treaty dispute resolution mechanisms

Sept. 2015

7. Artificial avoidance of PE status

Sept. 2015 15. Multinational instrument for amending bilateral tax treaties

Sept. 2014/Dec. 2015

8. TP for intangibles Sept. 2014/Sept. 2015


= Discussion draft already released

Action 1 – digital economy

Discussion draft released: March 24, 2014 Public comments released: April 14, 2014 Five “options” proposed to the Task Force:

1. Modify/eliminate “preparatory or auxiliary” exception to PE2. New nexus – enterprises engaged in “fully dematerialised digital activities”

would have a PE if they maintain a “significant digital presence” in a country

3. Virtual PE – three alternatives from the Business Profits TAG: Virtual fixed place of business PE Virtual agency PE On site business presence PE

4. Withholding tax on digital transactions Tax could be withheld by credit card institutions

5. Consumption tax options – agreement that VAT options should be pursued

Sample public comment: “These options are all generally unworkable” – TEI


Action 2 – hybrid mismatch arrangements

Discussion drafts released: March 19, 2014 Unique to Action 2, the OECD released two discussion drafts: one for domestic law and

one for treaties Public comments released: May 7, 2014 Key domestic law recommendations:

Hybrid instruments – deny deduction or require payee to include in income at ordinary rates

Hybrid entities – prevent “deduction no inclusion” outcomes and “double deduction” outcomes through denial of deduction or mandatory inclusion in income

Reverse hybrid entities – require that investor include payment in income or, alternatively, intermediate jurisdiction follows tax treatment of controlling investor

Key OECD model treaty recommendation: New Article 1 language – income derived by/through an entity/arrangement “that is treated as

wholly or partly fiscally transparent” under the law of either state shall be income of a resident, “but only to the extent that the income is treated, for purposes of taxation by that State, as the income of a resident of that State”

Sample public comment: The policy basis for recommended rules should be “more fully articulated so that the advisability

and content of the rules can be better evaluated.” – NFTC What’s missing? General attack on CTB (except as mentioned). Will likely come with

Action 3 (CFC rules)


Action 6 – prevent treaty abuse

Discussion draft published: March 14, 2014 Public comments released: April 11, 2014 Key treaty recommendations: Include explicit preamble statements that the treaty partners intend to prevent tax

avoidance Introduce US-style Limitations of Benefits (LOB) clause But proposal specifically rejects a derivative benefits test due to base erosion potential

General anti-abuse provision that applies if a “Main Purpose” is to obtain treaty benefits But OECD recognizes comment that having both LOB and Main Purpose could result in

double disadvantage for some taxpayers Look to competent authority determinations of residency country for dual-resident

persons (other than individuals) Include explicit references to tax policy considerations

Sample public comment: The USCIB has concerns about the “singular focus on combating treaty abuse without due regard for the impact it would have” on upstanding beneficiaries of income tax treaties


Action 8 – TP for intangibles

Originally a separate project, the OECD’s work on Chapter VI will influence the BEPS project

Revised discussion draft published: July 30, 2013 Public comments released: October 22, 2013 Key changes: Starting point for TP analysis is location where material functions relating to

intangible assets are performed. Legal ownership of an intangible is not sufficient to entitle an entity to profits from that intangible Departs from the arm’s length principle

Broad definition of “intangible” -> any asset that is not physical or financial New section addressing intangibles arising from the local market, location savings

(e.g., lower wage costs), assembled workforce and corporate synergies New section on TP aspects of use of corporate names

Sample public comment: “The mission of the OECD…should be to stand firm on the [arm’s length] principle, which is embodied in Article 9’s respect for the contractual arrangements of the parties, and to draft guidelines that reinforce this principle instead of creating exceptions to it” – TEI

Revised deadline: December 2014 Will incorporate work on risk, recharacterization, capital and special measures


Action 13 – CbC reporting

Discussion draft published: January 30, 2014 Public comments released: February 23, 2014 Three-tiered approach: CbC Template, Master File and

Local FileMaster File needs to include: Detailed description of the overall business (full legal entity chart, flows

of goods globally, services, etc.) Detailed description of all intangibles (where are they, who pays for

them, etc.) Detailed description of intercompany loans

Proposed Master File includes things like: Who are your top 25 employees in terms of remuneration? Where are they located? and a requirement to disclose all APAs and ATRsMaster File can be in English; Local File in the local language


CbC reporting – public comments

The “income tax paid” column, which would require a multinational group to report income tax paid, on a cash basis, to its country of organization, has “nothing to do with transfer pricing” – BIAC

“TEI urges the OECD to clearly delineate the purpose or purposes behind the CbC reporting template and conduct a detailed assessment of what the template should be used for, before enshrining the template in Chapter V or anywhere in official OECD guidance. As currently proposed, the risk that many tax authorities will use the information in the current template to propose transfer pricing adjustments that are inconsistent with the arm’s length principle is palpable. Thus, TEI strongly recommends that the OECD sever the CbC reporting template from Chapter V and change the deadline for its completion to the end of the BEPS project (i.e., December 2015) to allow for proper development of the template with considered stakeholder input” – TEI

“Taxpayer burden must be reduced. Multinational enterprises already provide an enormous amount of information to tax authorities to explain their operations and, in particular, justify their transfer prices. The goal of the TP documentation revision is to improve the quality of the information while at the same time reducing taxpayer burden. It seems that the burden reduction aspects have been given short shrift” – USCIB


CbC reporting – initial outline

Recent statements from OECD indicate scope will be scaled back somewhat and CbC will not be part of Master File


CbC reporting – open issues

Will reporting use local financials (Statutory Accounts) or common parent company financials (US GAAP)? Likely Statutory Accounts

Will the Master File be provided to all jurisdictions, and if so, how? Likely Master File will be provided to parent company tax authorities, and thereafter provided on request by other tax authorities

Will CbC reporting be on an accrual or cash-tax basis? Likely cash-tax basis

Will CbC reporting be publicly available? Likely not

Will new data be required to be generated by taxpayers? Yes

When will CbC reporting be required? Likely 2015


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Selected country reactions to BEPS


Ireland passed a law eliminating double Irish “stateless” structures -> Companies incorporated in Ireland but managed and controlled in an EU / treaty partner country (e.g., the US) will be treated as Irish tax resident unless such companies are tax residents in those countries Still allows Irish Non-Residents to be resident in Cayman, Bermuda, etc.

No plans to increase 12.5% tax rate or eliminate Irish non-resident regime

The Netherlands codified substance requirements for obtaining treaty benefits, requiring an executive declaration on tax returns

But has indicated it will not eliminate its CV-BV regime

APAs for BV functional activities still encouraged


Selected country reactions:incentive jurisdictions

Selected country reactions:incentive jurisdictions

Switzerland is currently undergoing major corporate tax reform Three cantonal ruling regimes will be abolished: Holding

Company, Domiciliary Company and Mixed Company Principal Company Regime may also no longer be available in its

current form

Different proposed alternatives: Flat low federal rate – similar to Ireland (12-14%) License box – combined ETR between 10-12% Notional interest deduction Abolishment of 1% capital tax / stamp duty

Effective date is expected to be 2018 Will likely be grandfathering available for rulings that extend beyond

2018

June 3, 2014 17OECD BEPS Update

Selected country reactions:consumer markets

French government published a commissioned report written by two economists (Colin & Collin), which recommended that the treaty definition of PE be expanded to include “users” of social media websites Report also proposed a tax on the collection of data Also, the French tax authorities recently asserted a €1b fine against Google relating

to a commissionaire structure Italian parliament passed the first BEPS legislation, the “Google tax,” which

requires that local Italian companies purchase Internet ads only from companies registered for Italian VAT Due to controversy, Italy delayed implementation of the law until July 2014 – now

repealed Also, Italian news agency ANSA recently reported that Apple only paid €8m tax in

2013 on €300m revenue (2.66% ETR) Australia strengthened its general anti-avoidance rules, modernized its transfer

pricing regime and proposed legislation for publication of taxes paid by largest Australian companies, proclaiming such measures were enacted to combat BEPS

Vietnam now imposes a withholding tax on outbound payments for digital services and online advertising Taiwan has a similar rule, and India is considering one


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US reactions to BEPS andselected provisions of key US tax

reform proposals


US tax reform proposals

In the past few years, President Obama and members of Congress have held extensive hearings and introduced a number of plans. These generally involve lowering the US corporate income tax rate while overhauling the international tax system. Each varies somewhat: Camp Discussion Draft (Oct. 2011) – options A, B and C Microsoft / HP Hearings (Sept. 2012) – transfer pricing and §956 Levin Stop Tax Haven Abuse Act (Sept. 2013) Baucus Discussion Draft (Nov. 2013) – options Y and Z Camp Discussion Draft (March 2014) – territorial system with option C Obama “Green Book” (March 2014) – digital economy / inversions Caterpillar Hearings (April 2014) – arm’s length standard / economic

substance Wyden WSJ Op-Ed (May 2014) – inversions reform However, other democrats want inversions to be part of comprehensive reform

EXPIRE Act (ongoing) – would retroactively extend research credit, §954(c)(6) and §954(h) through 2015

Our prediction: comprehensive tax reform will be enacted in 2015


Camp discussion draft (2014)

Repatriation holiday – one-time mandatory 8.75% tax imposed on US shareholders (10% or more) of their foreign subs’ E&P (accumulated since 1986) not previously subject to tax Non-cash E&P reinvested in PPE taxed at 3.5% Can elect to pay tax in installments over 8 years Foreign taxes can be credited against this tax

Participation exemption – 95% of dividends by foreign corps to US corporate shareholders (10% or more) would be excluded At the 25% statutory rate, results in a 1.25% effective tax rate FTCs not allowed for foreign taxes paid/accrued; §902 indirect credit repealed Parent must reduce basis in foreign sub by amount of exempt dividend

Option C – US parents would be currently taxed under Subpart F on their and their CFC’s “foreign base company intangible income” (FBCII) at a reduced 15% rate FBCII defined as excess of CFC’s gross income over 10% of CFC’s adjusted basis

in depreciable tangible property Exception for income subject to foreign tax at 15% or greater Income from property sold for use/consumption/disposition in US still taxed at 25%


Obama “green book” (2015)

Digital economy – new Subpart F category, “foreign base company digital income” (FBCDI), for income derived from the sale/lease of a digital copyrighted article or provision of a digital service, where the CFC uses IP developed by a related party – including through a CSA – and the CFC does not make a “substantial contribution” to the development of the article/service Exception for customers located in the CFC’s country of incorporation that use/consume the

article/service in that country Mfg. service arrangements – FBCSI is expanded to include income from the sale of

property “manufactured” on behalf of the CFC by a related person Hybrid instruments – denies deductions for interest paid to a related party and, because

the instrument is a hybrid, the income is not included by the recipient Would also deny a deduction for hybrid payments to a recipient subject to a “preferential

regime” (≤75% statutory rate) Reverse hybrids – denies relief under §954(c)(3) (same-country exception) and §954(c)(6)

(CFC look-thru rule) for deductible payments made to foreign reverse hybrid entities Inversions – for inversion transactions, reduces the 80% shareholder continuity test to only

50%, and eliminates the 60% shareholder continuity test Regardless of shareholder continuity, expatriated entity treated as US corp if “substantial

business activities” in the US and foreign corp “managed and controlled” in US Earnings stripping – for groups with foreign parents, limits a US member’s interest

expense deduction to its interest income plus a proportionate share of the group’s net interest expense


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BEPS implications andpotential action items now


Example – two-tier IP / ops

Digital Co has a to two-tier deferral structure (e.g., IR / INR). Reduction of foreign ETR

Problem? Disaggregation of functions (i.e., people) from profits (based on contractual risk)

Action 1 (digital economy) – Will Italy… assert that OpCo has a “significant digital presence”? impute a withholding stream from Italian subscribers? charge more VAT?

Action 3 (CFC rules) – US Tax Reform may tax offshore profit under new Subpart F rules, eliminating benefit from two-tier structure

Actions 8, 9 and 10 (TP of intangibles and risk): Higher substance requirement / functional alignment

in TP Guidelines Criteria to test whether IP ownership should be

accepted Could Italy assert that S&M Provider has created /

exploited valuable marketing intangibles? Could Italy use profit split methods?

Action 13 (TP documentation) – Digital Co will need to document its global profits on a CbCbasis

Action 15 (multilateral instrument) – Will OECD members deny treaty benefits to Ireland if it doesn’t tax IPCo as a resident?


Digital Co(Delaware)

IPCo(Irish

Nonresident)

S&M Provider(Italy)

Cost-PlusService Fee

Servers

OpCo(Ireland

Resident)

Non-US Subscribers

Users

Engineers / Servers

$

US Subscribers

$

US IP

ROW IP

Royalty

CSA

Anticipated changes in tax environment

1. Numerous OECD position papers on the 15 BEPS Actions will be issued in 2014 and 2015

2. Likely many countries will jump the gun and implement anti-BEPS initiatives before all OECD work is completed

3. Substantial pressure on “stateless income” and entities in structures with no operational substance

4. Likely required CbC disclosure of complete taxpayer structures and legal entity profits to all relevant tax authorities in 2015

5. Likely more tax authority assertions of PE6. New country restrictions on use of hybrid entities / hybrid

transactions7. Some enhanced US CFC rules, perhaps accompanied by a

territorial system, in 2015 or 20168. Enhanced taxpayer need for reliance on tax treaty networks


Action items now

1. Hold off on any discretionary repatriations of low-tax earnings to the US No sense incurring 35% US tax now if future rates are lower But see eBay’s $9b Q1 2014 taxable repatriation for acquisitions Exception for expiring US NOLs

2. Model impacts of US tax reform proposals GAAP ETR Cash tax payment rates Compare impact under status quo v. alternative structures

3. Assess all critical pressure points from OECD BEPS within entire corporate international structure Consider alternative structures to reduce BEPS impact


Possible strategic actions

Assess whether all legal entity management and control activities are properly managed and documented

Align operational substance with key entities Add employees or functions in-country, or move entities to

operations

Consider whether / how to collapse certain structures For example, significant interest in collapsing INR into IR Restructure hybrid instruments / hybrid entities Consider accompanying new tax rulings

Obtain APAs for principals / distributors / licensees Lock in one-sided TNMM / royalty rates as the appropriate method

Country-specific issues Re-negotiate / extend tax rulings as necessary


Speaker contact information

Eric RyanDLA Piper

2000 University AvenueEast Palo Alto, CA 94303

Office Phone: 650.833.2118Cell: 408.398.9912

[email protected]

Chris KotarbaDLA Piper

2000 University AvenueEast Palo Alto, CA 94303

Office Phone: 650.833.2156Cell: 650.810.3331

[email protected]

www.dlapiper.com

Circular 230 Notice: In compliance with U.S. Treasury Regulations, please be advised that any taxadvice given herein (or in any attachment) was not intended or written to be used, and cannot

be used, for the purpose of (i) avoiding tax penalties or (ii) promoting, marketing orrecommending to another person any transaction or matter addressed herein.

June 3, 2014 28OECD BEPS Update

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