OECD tackles Base Erosion and Profit Shifting
The OECD ‘Action Plan on Base Erosion and Profit Shifting’ (‘BEPS’) - issued on 19 July 2013 - identifies 15 key actions along with timelines, with most actions being addressed within two years. The scale of the plan is ambitious, and will result in a dramatic change in the landscape of tax planning in the international arena. An underlying theme is tackling the artificial separation of taxable income from the activities that generate it. Going forwards, the focus will be much more on the underlying substance and where value is really created within an international business.
The action plan highlights the huge changes in the way multinational enterprises (MNEs) operate in the 21st century – particularly the impact of the digital economy, and the impact this can play in tax avoidance. Other changes over the years which have also had an impact include the removal of trade barriers, the free movement of capital, exploitation of intellectual property and the way risk is managed. As international standards and bilateral tax treaties have not kept pace with these changing business models, they have been unable to tackle aggressive tax planning. Sweeping changes are proposed in many areas, and these will require cooperation at international level. The current mood in the G20 suggests that the political will to see this through will be forthcoming.
What actions have been proposed?
The list of the 15 key actions and time frame can be found in the newsletter below.
Implications for China and Hong Kong
As a G20 state, China has interest in adopting the BEPS initiatives as well as taking part in the discussion on the details of the action plan in order to protect its tax base. Over the past few years, China led tax developments in relation to indirect equity transfer, beneficial ownership, and transfer pricing practices towards these goals. In the area of transfer pricing, China has been advocating both its position on intangibles and its response to challenges to comparability analysis in developing countries (e.g. location savings and market premium concepts).
While the OECD action plan has ruled out formulary apportionment, i.e. apportionment of global profits based on the assets or turnover etc., there is still much room for the application of special measures beyond the arm’s length principle. It is very probable that China sees the BEPS as an encouragement to experiment more non-traditional methods such as profits split methods. Therefore, we expect more controversies and uncertainties and we recommend multi-national corporations with operations in China to take a closer look at their transfer pricing policies.
China’s determination and efforts to strengthen its cooperation with the international tax community has been reinforced with the signature of the Convention on Mutual Administrative Assistance in Tax Matters (the “Convention”) on 27 August 2013. In a nutshell, this Convention means that China will be joining a network of 56 countries, including the G20 countries, in the cooperation of tax administration in the world.
The Convention would focus and allow:
- Exchange of Information
- Assistance in recovery
- Service of documents
Although the implementation details need to be ironed out, where China may use its rights as allowed by the reservation clauses, we expect further discussions on:
- Automatic exchange of information, as it goes beyond the Exchange of Information Clauses in Tax Agreements and Tax Information Exchange Agreement;
- Convention allowing tax inspection and possibility to lead a tax examination abroad.
China has not yet clearly expressed its position to these extended measures but the signature of the Convention would provide China an additional channel to combat tax evasion on the profits shifted outside China.
Hong Kong will not be in a position to exert the same level of direct influence in shaping responses to BEPS as China. One of the important points in the action plan is a call for more tax transparency. Hong Kong has just passed the bill allowing Hong Kong tax authority to enter into standalone Tax Information Exchange Agreements (TIEAS) and to have a broader and more effective information exchange with its Comprehensive Double Tax Agreements (CDTAs).
There is undoubtedly pressure for Hong Kong to increase cooperation with other tax authorities in the Exchange of Information area. The focus on treaty shopping in the action plan will also have an implication for multi-national or Chinese enterprises using Hong Kong as a holding company to take advantage of its expanding CDTAs. To benefit the tax treaty, economic and physical substance needs to be maintained in Hong Kong.
Hong Kong and Chinese investors with overseas investments and/or operations will need to be aware of the more challenging tax environment overseas resulting from the BEPS.