Global Tax Policy and Controversy Briefing · 2014-07-08 · Global Director, Tax Controversy Services T: +1 202 327 5696 E: [email protected] at the end of January. The OECD then

Issue 14 | June 2014

Global Tax Policy and Controversy Briefing

“ We’re just pausing on some of the progress of the APAs. We just want to understand a bit more about what goes on. We want to test some propositions that have been put to us historically that say there is no taxing right here in Australia, because of certain structures. What I sometimes find is what looks good on the whiteboard doesn’t get translated directly on the ground.”

Chris Jordan,Commissioner, Australian Taxation Office

See page 8

Global Tax Policy and Controversy Briefing is published each quarter by EY.

Contributing EditorRob ThomasT: +1 202 327 6053 E: [email protected]

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Global updates — 6

BEPS-related developments — 12

14OECD releases discussion draft on tax challenges of the digital economy under BEPS Action 118OECD releases discussion drafts on neutralizing hybrid mismatch arrangements under BEPS Action 226Point of view: The OECD’s Discussion Drafts on Neutralizing the Effects of Hybrid Mismatch Arrangements30OECD releases discussion draft on preventing treaty abuse under BEPS Action 634Point of view: The OECD’s Discussion Draft on Preventing the Granting of Treaty Benefits in Inappropriate Circumstances38OECD releases draft country-by-country reporting template, provides second version requiring aggregate reporting40Point of view: The OECD’s Discussion Draft on Transfer Pricing Documentation and Country by Country Reporting43OECD releases Common Reporting Standard: a global FATCA-like regime45The minimum all treasury and finance professionals should know about FATCA48IRS releases Transfer Pricing Audit Roadmap53The outlook for global tax policy in 201460European Union update

68Brazil: Policy and controversy aspects of Brazil’s 2013 corporate tax reform72Japan: Tax policy reform: consumption tax increases on track, targeting corporate growth for future prosperity76Luxembourg: New Luxembourg Government announces main aspects of its fiscal policy78Nordics: Tax competition in the Nordics82Panama: Short-lived worldwide income tax regime: a strange week in tax history84United States: Five things businesses should know about Chairman Camp’s tax reform plan

66An interview with Michael Lennard

14

64 — 2014 VAT/GST rate changes

Themes and issues Country updates

It was not a surprise to find the early part of 2014 dominated by developments and news surrounding the 15-point Action Plan on Base Erosion and Profit Shifting (BEPS) that the Organisation for Economic Co-operation and Development (OECD) released in July 2013. As part of the its continuing efforts to maintain open lines of communication with the tax community, the OECD conducted webcasts on 23 January and 2 April and held regional meetings to focus on those items due to be finalized by September.

That open dialogue will be critical for the Action Plan’s ultimate success. The work of the OECD is proceeding swiftly, at a pace that OECD Centre for Tax Policy and Administration Director Pascal Saint-Amans has described as sometimes “frantic” and “crazy.” The work is resulting in the publication of BEPS discussion drafts that, when provided for comment (often for very short periods of time), have drawn many responses totaling thousands of pages. The OECD will then need to reflect on these comments and push rapidly forward in order to meet its first real deadline of September 2014.

This rapid pace is not the only issue raising concerns. For example, Robert Stack, Deputy Assistant Secretary for International Tax Affairs at the U.S. Department of the Treasury, has said, “Global tax administrators are looking for, in some cases, blunt instruments to take care of stateless income problems. The main challenge for the US is to get to the problem by pulling back from blunt instruments and moving to policies that reach the right technical results.” The web of international taxation is a difficult one to untangle and then reweave. Consequently, the most difficult stages of the BEPS reforms may occur after September, as countries seek to interpret the recommendations of the OECD and the compromise text.

One of the people who will have to align the OECD recommendations with his country’s tax system is Chris Jordan, Commissioner of the Australian Taxation Office (ATO). Our feature interview with him provides some interesting insights and perspectives from someone who

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only recently took over the helm of the ATO after a lengthy career in private practice. His forthright discussion of “over-engineered” governance processes and the cultural shifts that will be necessary to improve how the ATO does business is refreshing. His creation of an “integrated tax design unit” to better coordinate internal activities and decision-making processes shows that he is not shy about trying new ideas and is open to innovation. Nevertheless, some early indications of how his long-term vision to improve “customer service” will be balanced with his enforcement agenda may be reflected in the way he approaches digital e-commerce (which he touches on briefly) and how he handles the entire BEPS agenda. Whether Jordan represents a new breed of Tax Commissioner who embraces new and innovative approaches to tax administration remains to be seen, but his clear thought process and proactive agenda make his interview a must-read for anyone keeping an eye on global tax administration.

As noted, the OECD has released several discussion drafts of the BEPS Action Plan items, including one on transfer pricing and country-by-country (CbC) reporting

Global Tax Policy and Controversy Briefing4

Chris SangerGlobal Director, Tax Policy Services T: +44 20 7951 0150 E: [email protected]

Rob HansonGlobal Director, Tax Controversy Services T: +1 202 327 5696 E: [email protected]

at the end of January. The OECD then released, over just three weeks in March, discussion drafts on treaty abuse, hybrid mismatch arrangements and the digital economy. Each of these drafts is discussed in detail by our article contributors. One should keep in mind that these discussion drafts are a work in progress, albeit on an expedited timeframe. The recently proposed change to impose CbC reporting at an aggregate level instead of the entity level illustrates just how fluid some of these proposals may be during the discussion phase.

Exchange of information is another area of focus for the OECD, although it is not specifically part of the BEPS Action Plan. In early February, the OECD released what amounts to a global standard for the automatic exchange of financial account information in the form of a model Competent Authority Agreement (CAA) and Common Reporting Standard (CRS). In effect, the CAA and CRS outline a global reporting standard that bears a striking resemblance to the Foreign Account Tax Compliance Act regime in the US. Although the CRS is a model agreement with no independent legal force, there appears to be a significant amount of political support for its implementation. More than 40 jurisdictions have signed up for early adoption, and a letter of commitment to these new standards was signed by 44 jurisdictions in late March. The expectation is that these new standards could be formally adopted and implemented by the end of 2014 in several jurisdictions, which could result in new customer due diligence procedures for 2015 and various reporting requirements for 2016.

The European Commission (EC) is also active on various BEPS issues, specifically identifying hybrid financing structures as an area of concern. As Steve Bill tells us on page 54, the EC is working on an amendment to the Parent-Subsidiary Directive (PSD). This mechanism was designed by the European Union (EU) to eliminate tax obstacles for profit distributions between parent companies and subsidiaries based in different Member States, as well as to reduce the incidence of double non-taxation.

Under the amendment, Member States would have to include a symmetry principle for intra-EU dividends in their domestic law. In addition, another proposal would introduce a general anti-abuse rule into the revised PSD. According to the current proposal, the PSD should be translated into national law by 1 January 2015, leaving the Member States just six months for implementation. While all Member States seem to accept the anti-hybrid provision, several —particularly the Netherlands and Finland — have criticized the general anti-abuse rule. As all Member States must agree on the proposal before it is adopted, a possible compromise may be the adoption of the anti-hybrid provision without the general anti-abuse rule. If this compromise takes place, it would seem realistic that the PSD could be implemented by the end of 2014.

We are also pleased to highlight some of the more interesting data points from our annual Tax Policy Outlook publication, which in 2014 surveyed 61 countries. As an example, just 10 countries have announced reductions to statutory corporate income tax rates for 2014, while overall corporate tax burdens are expected to increase in 16 countries. The increase in only 3 of those 16 countries (France, India and Israel) can be attributed (at least in part) to a higher statutory rate, while the increasing tax burden in the other 13 countries is the result of expected “base broadening.” Many of these base broadeners might be described as BEPS-related, including limitations on the tax treatment of losses, tighter transfer pricing and thin capitalization rules, changes to withholding tax regimes, tougher controlled foreign company (CFC) rules and limitations on interest and business expense deductibility, including a rapidly growing focus on payments made to low-tax jurisdictions. The primary focus in protecting and enhancing the revenue base, however, is tax enforcement. Nearly 40% of the countries surveyed are looking to improve their tax enforcement efforts by requiring more disclosure and transparency and focusing on business “substance” in reviewing transactions and, more often, scrutinizing transactions using general anti-avoidance rules (GAARs).

Tax reform remains high on the policy agenda, and many countries have either put in place or are planning significant tax reforms in 2014. Brazil has restructured its system of worldwide income taxation for both corporations and individuals, while Panama enacted a new worldwide tax regime at the very end of 2013 only to repeal it in the opening days of 2014. Japan has adopted an earlier-than-planned repeal of the 10% corporate surtax it enacted in 2012 following the Fukushima disaster, reducing the top corporate rate from 38.01% to 35.64%. At the same time, Japan has increased its consumption tax (VAT) from 5% to 8% in 2014, and it is scheduled to increase further to 10% on 1 October 2015. France, too, has entered the reform debate in vigorous fashion, with new Prime Minister Manuel Valls announcing a tax and payroll stimulus package that, if passed, would result in significant corporate tax rate reductions.

Tax reform in the US, meanwhile, remains stalled under a cloud of uncertainty, even though House Ways and Means Committee Chairman Dave Camp’s highly ambitious Tax Reform Act of 2014 discussion draft lays the groundwork for continued tax reform debate as the US moves toward midterm elections.

With all this change, both at the international and the national level, we can expect the rest of this quarter and the next few to continue to be interesting and dynamic. The pre-emption of the BEPS project to date has led to much change that companies need to adapt to and can, at least in part, predict. As the debate moves forward and those Actions that are on a 2015 delivery plan come ever closer, we can expect to see yet more change. However, while countries still need to work together to deliver a coherent international tax regime that supports cross-border investment, while addressing the risk of unintended tax reductions, the themes of tax competition and the fight for foreign direct investment remain. These two objectives can be rationalized but are unlikely to lead to a simple tax world in the future. Continuing to monitor the developments in tax policy and controversy, and predicting outcomes where possible, remains the order of the day, month, year and potentially even decade.

Global Tax Policy and Controversy Briefing 5

Global updates

Portugal

Spain

United States

Canada

ChileColombia

Mexico

Panama

France

Portugal establishes an income tax reform committee.

Spain releases a report on a proposal to reform the Spanish tax system.

House Ways and Means Committee Chairman Dave Camp issues wide-ranging Tax Reform Act of 2014 discussion draft.

Canada and the US sign intergovernmental agreement to implement FATCA. Canada budget contains details of new consultation on tax planning by multinational enterprises.

Chile’s new president sends a substantial new tax reform package to Congress. Colombia issues

regulations on taxation of permanent establishments.

Mexico’s controversial tax reform package is signed by president and published.

Panama acts to repeal recently enacted law adopting worldwide income taxation system.

French Finance Bills enacted, but certain provisions are censored by the Constitutional Court. New French transfer pricing package entails a second, contemporaneous, documentation requirement.


German coalition agreement supports speedy enactment of a financial transaction tax.

Italy

Germany

Japan

South Korea

Hong Kong

Greece

Indonesia

Vietnam

Switzerland Russia

Norway

Japan releases 2014 Tax Reform Outline.

South Korea passes tax reform proposals including several changes to R&D incentives regime.

Hong Kong proposes 8.25% tax rate for captive insurers.

Italy increases 2013 and 2014 corporate income tax advance payments and imposes 2013 surcharge on financial service companies. Italy signs FATCA intergovernmental agreement with the US.

Greece establishes advance pricing agreement procedures.

Indonesian Tax Authority releases additional transfer pricing audit guidelines.

Vietnam releases circular on treaty benefit application.

Switzerland’s Federal Council presents final report regarding Corporate Tax Reform III.

Russia enacts major changes to the Profits Tax treatment of interest.

Norway reduces corporate tax rate and enacts interest deductibility restrictions.

Kenya

Kenya enacts new VAT act.

South Africa

South African Revenue Service issues draft notice of additional reportable arrangements.

India

India releases revised Direct Taxes Code 2013.


Chris Jordan, AO1 was appointed as Australia’s Commissioner of Taxation on 1 January 2013. He has broad and lengthy experience in tax policy and law development and implementation, having held influential roles in the private sector and as a government advisor to both Labor and Coalition governments. He was the Chair of the Board of Taxation from June 2011 to December 2012 and a member of the Board from its inception in 2000. He also served as Chair of the Business Tax Working Group from 2011 and as Chair of the New Tax System Advisory Board from 1999 to 2001 and was a member of the group that consulted with the mining industry on the resource rent tax from 2011 to 2012.

Chris has 30 years of experience in the tax profession: he started his accounting career with Arthur Andersen in 1979 and spent several years as a senior lecturer in taxation at Sydney’s University of Technology before working for KPMG for more than two decades. From 1995 to 2000, Chris was partner in charge of the New South Wales Tax and Legal Division of KPMG and from 2001 to 2012, chairman of partners for KPMG New South Wales.

Chris spoke with Alf Capito, EY’s Asia-Pacific and Australia Tax Policy Leader at EY’s Asia-Pacific Tax Symposium in Singapore on 12 November.

1. Australian Order.

An interview with Chris Jordan — Commissioner,

Australian Taxation OfficeIn

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Alf Capito: Chris, you’ve been in the Commissioner’s role for just under a year now, but of course, you’ve spent many years in the profession. What were your first impressions of the role?

Chris Jordan: The Australian Tax Office (ATO) is such a vast organization: 25,000 people over 60 sites, a AU$3.5 billion budget, and I suppose I’m still coming to grips with what it actually does. There are so many facets to it: it’s not just your large business compliance area that maybe you and I have more traditionally interacted with. It really is quite enormous. It constitutes about 15% of the Australian public service. What I’ve realized, though, is that it’s very good at implementing major new policy initiatives and it’s got a great end-to-end design process. It’s a leader in design in government, but there are areas that could be improved. I’m focusing on a longer-term vision: improving customer service and focusing on some significant cultural shifts within the organization.

Cultural changeAlf Capito: How did you find the culture? I would have thought that someone who’s come in from the outside might be at a risk of being rejected by the culture? How was your acceptance within the organization?

Chris Jordan: I keep saying surprisingly, but it was surprisingly positive! I think there was pent-up demand to see some change happening. I’ve been very fortunate in being able to ask the “why” questions. I think when people grow up with things, if they’ve been in an organization for many years, they sort of just get used to the way things are done. And to have someone coming in from the outside and challenging it — just in an open way, not in any sort of negative or critical way — has been refreshing to a lot of people. I was very fortunate that there was a capability review of the tax office shortly after I started. It was about a 6-month project, done through the Australian Public Service Commission and what it did was reinforce to me that it wasn’t just me being new to the public service, because I was often confused about “is this just a public sector type of matter or is it something within the ATO itself?” What this review did was point out quite clearly that a lot of the over-engineered governance processes were self-imposed by the tax office itself. People would approach things by trying to eliminate all risk. Now, we all know in our business lives that you cannot eliminate all risk, but what you can do is have a sensible and fit-for-purpose risk management framework. So as a general proposition, I did find a risk-averse, sharing-of-accountability culture with lots of meetings. Lots of people who were effectively playing with an issue because they were worried that, if they brought it to a close, they might not have covered everything and they might get it wrong.

So we’ve got to have a greater sense of purpose, a greater sense that time does cost money; it’s a cost to the ATO, but, equally important, it’s a cost to the person you’re dealing with. And these are some of the significant shifts in a cultural sense, understanding that you can’t hold on to things forever, you can’t

keep squeezing something. You have to make a judgement, you have to exercise common sense and ultimately, you have to make a decision and move on.

Alf Capito: To me that seems like a critical issue because in my experience, sometimes they just can’t seem to let go. There’s almost a fear that if they make a mistake, if they give some revenue away, they’ll be damaging their career. So how do you overcome that concept?

Chris Jordan: Cultural change takes a long time; it doesn’t happen overnight. There will be a group of people, probably, in the ATO that won’t make the change, but the overwhelming majority of people are saying, “We’re up for this.” I get people in the lifts, or buying a sandwich at the shop next door, tapping me on the shoulder and saying, “This is great! I haven’t felt more enthusiastic in many years about my job!” So I think what we’ve got to do is to say, “Look, people do make mistakes — I make mistakes, we all make mistakes. As long as they’re not the same mistakes and you’re only making new mistakes, then that’s okay!” You’re not doing the organization any good, you’re not doing the country any good, and you’re not doing yourself a great service by just holding on and wanting to know more and more.

In your area at EY, well, what do you do? You manage risk; that’s what an audit is about, that’s what the work is about, so we have to have a greater sense of managing risk rather than always trying to eliminate it. No set of facts are so complex that, 12 months later, a taxpayer still has no answer on them. It’s the process of decision-making that is overly complex, not necessarily the facts.

Alf Capito: I couldn’t agree more. Now you mentioned the “why” question. Of course, one of the really interesting developments is that you were appointed from outside the organization — and the previous commissioner probably would have stood for another term — so the question arises: Why did the government make the decision to have you appointed? There were business forums where the relationship between business and the ATO was very clearly stressed and strained. Given that, how are you trying to address the underlying issue of the problem that must have been there, which triggered your appointment?

Chris Jordan: That’s a very good question and it’s one that I’ve posed to the leadership group. There are three Second Commissioners who work below me as Commissioner, and there are about 35 National Program Managers, Deputy Commissioners and First Assistant Commissioners that effectively run the tax office, and that is the same question that I’ve posed to them. You have to ask: What is the symptom here? Don’t just look at the solution. It’s like going to the doctor — you keep getting sore throats and you keep going back and getting a prescription — well, why are you getting the sore throat? That’s the question I put to them. Why is it that the Inspector General of Tax had to come along? Why is it that an outsider was appointed? Why is it that the then-opposition, now government,

Alf CapitoTax Policy Leader — Asia-Pacific and Australia T: +61 2 8295 6473 E: [email protected]


is talking about more Second Commissioners, splitting the tax office and a new parliamentary oversight committee whose sole purpose is to scrutinize the tax office?

You have to address the symptoms of these responses before you can understand what the way forward should be. The tax office was probably becoming a bit isolationist and a bit inward-looking. It was taking a very black letter law approach to things: hence this long list of announced but un-enacted measures that the new government is just going through. I said we need to open the doors, open the windows and let the outside in, but we also need to let the inside out as a two-way flow. This is not the cultural aspects of the tax office, it’s not something that was generated by people who were in the tax office 20 years ago and have left; it’s the result of the present leadership. They must confront that and be able to move on and say right, okay, now how do we go forward?

And it’s got to be something that trickles down from the top. I can’t just send out an email and say, “Everyone change, go forth please!” It’s got to be embraced by the leadership, who must have their direct reports understand what cultural shifts are required, who then push it down to their team leaders. Being in an organization of around 25,000 people in many locations, it does require direct team leader to staff type interaction to generate over the longer term a change in attitude, a greater sense of purpose, a greater sense of time, and not to always default to be a protector.

People have used that word, “protecting.” Why don’t we think about facilitating and service? I know when I talk about customer service in the tax office, some people find it a little bit difficult, but that’s what it’s about. How do you want to be treated when you walk into a shop? You want to be treated with respect, you want to be treated as a customer; there’s someone there you know and they’re there to help you. And that’s the way we need to have people treating taxpayers.

Searching for certaintyAlf Capito: You mentioned the backlog of issues and perhaps one of the reasons might be that the government has to constantly step in to change the law, rather than the tax office facilitating a certain outcome for the business community. For example, the tax adviser profession has argued that the Tax Commissioner could be given statutory discretion in certain cases to be used mainly or essentially in favor of taxpayers to enable the tax office to make some accommodation within the law without constantly having to say, “We sympathize with you, we see the problem, but there’s nothing much we can do about it because you’ll have to go and see the government to change the law.” What’s your view on that sort of discretion?

Chris Jordan: That issue does polarize people. You have the lawyers on the one hand saying you have to have black letter law — a ruling’s not even good enough! Tax treatment has got to be in legislation: it’s got to be clear, it’s got to be written down in legislative form.

What I do know is that the present system isn’t working particularly well. We have a lot of complex business transactions that evolve. Things don’t stay static in business, so you might have a set of provisions that were created 10 or 20 years ago and the type of business for which they were originally designed has moved on significantly. So the type of transaction just

doesn’t fit neatly, or sometimes at all, within the provisions that are meant to deal with it. This issue of a relieving provision that the commissioner says looks like, sounds like, smells like, acts like a normal economic transaction that has a normal outcome — well, perhaps we should treat it like that because the alternative is to ask treasury to request the government to request a change in the law that may or may not happen.

One of the things I have done is create an integrated tax design unit within the ATO’s law design and practice group to better coordinate ATO activities. I think the ATO was a little bit of an issue here because many people within the organization who came across issues would request changes to the law. Treasury often found it difficult to prioritize — or sometimes even understand — the full ramifications of what was being asked, so in future there will be one, single ATO view. It will be coordinated through the integrated tax design unit; it will be done in plain language so everyone can understand what the problem is; it will set out a range of potential solutions; it will give some real-life examples with some diagrams and; it will explain that this is being asked because we cannot administratively deal with it in any other way.

I think there is room for greater discretion. Under the current system, while we could clear up all these measures now, in ten years’ time we could have another hundred measures.

Alf Capito: I couldn’t agree more, and obviously the governance around that would all be transparent.

Chris Jordan: Well, as long as I don’t have a line of people outside my office every morning wanting a special deal done! That would not work; that would be really difficult. It’s got to be a systemic thing; it’s got to be something of a general nature, and we have a look at it and say, “These provisions just don’t work in this area anymore; either they need to be changed, but in the meantime, this is how we need to apply it.”

Alf Capito: The other category of issues that were on that unlegislated list were where the government or the tax office thought the general anti-avoidance rules weren’t sufficient to fix the problem. It may well be that if Part IVA had been used in this set of circumstances, it would have avoided the problem. A good example of that might be the use of certain hybrid transactions where the tax office says, “Look, we’ve got to abolish 25902 and get rid of these interest reductions for integrity purposes.” Instead, the tax office could had have issued an alert on hybrids and said we’re going to apply Part IVA in these circumstances. Perhaps people wouldn’t then have gone down that path in the first place and you wouldn’t have needed to change the law. It seems that the tax office keeps Part IVA in a box and brings it out only when they really need it, almost to the point that they don’t want it to be used in fear that perhaps the courts might strike it down. But a lot of cases, had Part IVA been threatened or applied, may not have required a change in law.

Chris Jordan: There’s an ongoing debate around the use of specific avoidance provisions versus general anti-avoidance provisions and that debate will continue.

There’s probably not been a happy history with the success rate of Part IVA. I think it is a last resort-type provision; it’s not trotted out up front. I think we need to be able to be flexible but also have the opportunity to use the whole array of measures that potentially could be used. And I think the point that you made

2. Section 2590 of the Income Tax Act of Australia: Debt deductions in earning nonassessable nonexempt foreign income.



about issuing alerts is a very important one. My perception is that we [the ATO] are often slow at stating our position publicly and it’s something I’ve asked my senior people to get better at. Neil Olesen3 gave a speech recently where he said, instead of taking two years to issue a comprehensive ruling on a particular topic that covers every “if, but and maybe,” you might see a series of smaller, quicker alerts. I’m very, very happy with that because if we can say we’ve observed this (treatment), we don’t particularly think it operates in that way for these reasons, at least it puts people on notice. I constantly get U-turns thrown up when people are quite broad in their application, so I think we’ve got to react to that, and we’ve got to put notices and alerts out much more quickly in a much shorter, straightforward manner.

Alf Capito: The other thing that you’ve done is set up an independent appeals unit within the ATO. Can you tell us about why you did that and how you see that operating?

Chris Jordan: There was a lot of angst around large disputes in the large business area, so what I thought was logical was to move the review function out of compliance, put it in the law design and practice area. This will have people that have not been involved in the audit or in the dispute in the past in fact report to a different Second Commissioner, and undertake to not just have a review on the process but a review on the merits as well. Now, often people get very passionate on both sides; they might have been in a dispute for four or five years (which I think is way too long and should not happen going forward) and people get into their respective trenches. The taxpayers are in their trench, the tax office is in its trench, and they’re throwing reports over the top to each other. A big paper war — another position paper, another barrister’s opinion — and I thought, well, how can we break that? We can break it by having more alternative dispute resolution processes to get someone sitting in the middle of these two parties in dispute to see if they can come a little bit closer together and maybe have a settlement opportunity. Or, you can have an independent review by someone else within the tax office, someone who has got no particular bent on any of the issues, have a look at it, on merit, and make a recommendation.

There has been one process-independent review already completed and there are seven in line to be completed before Christmas. We have a feedback loop so that we find out from the people if it met expectations, and whether it was transparent. And after about six months, we’ll do a full review of it to see if we need to tweak it with a period. The fact that it’s someone else within the tax office looking at it, it’s the fact that it builds in some alternative dispute resolution processes and maybe builds in some external advice coming in as well. It just opens it up and says let’s have another look at this. My view is that if we can’t resolve something within two years, then we’re never going to resolve it. So we’ll stop playing with things and we won’t just let them drag on forever. If the court has to make a determination on it, so be it, but we’re not just going to sit there and continue the paper war.

Base erosion and profit shiftingAlf Capito: I think that’s a very welcome development; our brief experience with it has been quite a positive one so far. Now I know we spent some time during our plenary session here in Singapore talking about BEPS, but I can’t pass up this opportunity to ask you more around the BEPS space. It comes

down to this: even before there is any change in law going forward, the tax office seems to be taking a view that if you’ve got your arrangements set up appropriately, then that’s great, but we’re going to do an audit to make sure that you have got this transaction set up appropriately. So is it the case that it is quite difficult for companies to get APAs and sign-offs at the moment and how long do you see that being the case?

Chris Jordan: It’s in a fairly narrow area, in the digital e-commerce space, that we’re just waiting on some of the progress of the APAs. We just want to understand a bit more about what goes on. We want to test some propositions that have been put to us historically that say there is no taxing right here in Australia, because of certain structures. What I sometimes find is what looks good on the whiteboard doesn’t get translated directly on the ground. I use the term from my old days when I did due diligence on acquisitions or due diligence tax 101 was to check any structures that had been put in place, particularly if they’re a bit old, because what happens? Something’s been put in place five years ago, the tax manager changes, the CFO changes, no one really knows why it was there. So they do what they commercially would otherwise do and they don’t relate back, and so we’re finding a little bit of this just testing now as well. What was on the whiteboard, what was in the report that gets flopped on the table is not actually what happens on the ground! And that’s actually quite logical because what happens on the ground is the commercial result of you trying to get me to buy something in this country that you have that I want, rather than some artificially picture of boxes all around the place with arrows going over the top, down underneath and around the corner sort of thing.

Alf Capito: One area where I think the tax office has been a leader without anyone really knowing it at the local level is in the eyes of many of the tax authorities around the world, in terms of its audit techniques and its risk-differentiation methodology, the company risk reviews, the continuous audit approach. Certainly in my travels, the ATO is seen as a leader in that space. Do you see a role there, especially around this region, in training is the wrong word, but perhaps in mentoring and perhaps sharing some of those concepts with authorities around the region?

Chris Jordan: There is a role for the ATO to help in capability building and bringing up the standards. My primary focus of course is to have the citizens of Australia think well of the tax office rather than other revenue authorities thinking well of the Australian tax office. But the ATO has been a leader — it is a leader — and part of that is because we’re actually transparent, believe it or not! We publish a lot of our product and processes, and to the rest of the world, that’s unusual to actually have our compliance product up on our website, for example. We do a lot of that and it’s in that area that other revenue authorities think well of us. I think that there’s a larger role for “SGATAR” — a study group of Asian tax administrations — when you think of the size of the economies with China and Japan and Korea, Malaysia, Singapore and Australia, New Zealand and then Thailand, Indonesia, Philippines and so on. That’s a very significant grouping, and I think there’s more that we can do there that we can feed into the OECD body, the forum on tax administration. I think when we do training courses, like we do for the Chinese tax authorities, my view is why don’t we replicate them across the region? If you’ve got the material that’s relevant for China, why isn’t it relevant for maybe Korea or Japan or the Philippines or Thailand? So there is more we can do.

3. Second Commissioner at the ATO.


BEPS-related developments

1 January 2015: Irish rules will apply to circumvent the possibility of a “stateless” company.

Canada offered consultations on measures to prevent treaty shopping and tax planning by multinational enterprises.

A reform package for 2014 will likely include the introduction (for the first time in Chilean legislation) of a “substance-over-form rule.”

Payments to a related party (Mexico or abroad) are nondeductible, when these payments are not subject to tax or subject to tax at a rate of less than 75% of the Mexican income tax rate.

New anti-base erosion and anti-inversion international tax proposals included in 2015 Budget.

Ireland

Canada

“Web Tax” rules, which would require foreign groups selling advertising services and sponsored links online to obtain an Italian VAT registration in the case of sales to Italian companies.

Italy

Chile

Mexico

United States

Australia

China

Greece

India (under DTC)

Israel

New Zealand

Peru

Russia

Taiwan (gridlocked)

New or stronger CFC rules for 2014

On 19 March 2014, the UK Government published a position paper explaining its view on the various action points of the OECD BEPS project.

United Kingdom


The amount of deductible net interest, which will be calculated based on the adjusted taxable profit, will be reduced from 30% to 25% for 2014 onwards.

On 24 February 2014, the Austrian Parliament enacted the 2014 Tax Amendment Act, which includes, among other significant changes, a new “subject to tax” test for the deduction of interest and royalties paid to affiliated corporations.

In line with the plan for the “de-offshorization” of the Russian economy that had been presented in February, the Ministry of Finance published a Bill that would introduce rules relating to controlled foreign companies (CFC), tax residence of organizations, and taxation of profit from the “indirect” sale of immovable property.

The Dutch Government has announced a consultation on CbC reporting.

Finland

Austria

2014 will be the first full year under a general anti-avoidance rule (GAAR) within Greek tax law.

Greece2014: GAAR introduced related to the claiming of tax treaty benefits.

German government provides its view on patent boxes - that they provide unfair advantage to internationally operating businesses

Vietnam

Germany

Russia

Government releases for public consultation draft legislation relating to the thin capitalisation regime.

Australia

Netherlands

France

Implemented:• Limitation on deductibility of interest

accrued to low taxed related party lenders

• Requirement to provide accounting statements and consolidated accounts in case of tax audit

• Strengthening of transfer pricing rules and disclosure of foreign tax rulings

Abandoned:• Widening scope of GAAR from

“exclusively” to “mainly tax driven” • Mandatory disclosure of tax planning

schemes• Increase of penalties for the failure

to comply with transfer pricing documentation requirements

• Shift of the burden of proof to the taxpayer in the case of business restructuring

Budget 2014 addresses limitation on interest deductions for leveraged acquisitions, includes refinements to the hybrid share anti-avoidance legislation.

South Africa

Luxembourg issued an extension of the current corporate governance and substance rules.

Luxembourg


The Discussion Draft acknowledges that the proposals are in early-stage development and do not represent consensus views. It is anticipated that the final report on Action 1 will analyze a number of potential options, including options included in the current Discussion Draft and new options that may be proposed in response to the Discussion Draft.

The Discussion Draft was prepared by the Task Force on the Digital Economy (Task Force), a subsidiary body established in September 2013 to carry out the work of the OECD under Action 1. Action 1 proposes to “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.”

The document is organized into six substantive sections that roughly align with focus areas identified in Action 1 of the OECD BEPS Action Plan:

• Information and Communication Technology and Its Impact on the Economy (Section II)

• The Digital Economy, Its Key Features, and the Emergence of New Business Models (Section III)

• Identifying Opportunities for BEPS in the Digital Economy (Section IV)

• Tackling BEPS in the Digital Economy (Section V)• Broader Tax Challenges Raised by the Digital Economy

(Section VI)• Potential Options to Address the Broader Tax Challenges

Raised by the Digital Economy (Section VII)

OECD releases discussion draft on tax challenges of the digital economy under BEPS Action 1

On 24 March 2014, the Organisation for Economic Co-operation and Development (OECD) released a discussion draft in connection with Action 1 on addressing the tax challenges of the digital economy under its Action Plan on Base Erosion and Profit Shifting (BEPS). The document, “BEPS Action 1: Address the Tax Challenges of the Digital Economy,” (the Discussion Draft) contains a discussion of the key features and business models in a digital economy, the opportunities for BEPS that can arise in a digital economy and some potential options to address the tax challenges raised by the digital economy.

Channing FlynnGlobal Tax Technology Sector Leader T: +1 408 947 5435 E: [email protected]


The OECD issued the Discussion Draft to provide stakeholders with an opportunity to comment on the proposals before the OECD issues its final report under Action 1 by September 2014. Comments were to be submitted to the OECD no later than 14 April 2014 and a public consultation on the Discussion Draft is currently scheduled for 23 April 2014.

Information and communication technology and the emergence of new business modelsThe Discussion Draft first examines the evolution over time of information and communication technology (ICT), including emerging and possible future developments. Building on this discussion, the Discussion Draft provides examples of new business models and identifies the key features of the digital economy.

The Discussion Draft notes that advances in ICT have given rise to a number of new business models that although not always completely distinct from traditional business, can often be conducted over greater scale and distance (remotely). The Discussion Draft includes a description of the following examples of such new business models:

• E-commerce (including business-to-business, business-to-consumer, and consumer-to-consumer models)

• App stores• Online advertising• Cloud computing (including

infrastructure-as-a-service, platform-as-a-service, content-as-a-service, and data-as-a-service)

• Payment services • High-frequency trading• Participative networked platforms

The key features of the digital economy illustrated by the new business models are identified in the Discussion Draft as:

• Mobility, including mobility of intangibles on which the digital economy relies, mobility of users of the digital economy, and mobility of business functions resulting from a decreased need for local personnel to perform functions and a flexibility to choose the location of servers or other resources

• Reliance on data• Network effects (understood with

reference to where user participation, integration and synergies are important)

• Use of multisided business models (a business model in which the two sides of the market may be in different jurisdictions with interaction through an intermediary or platform increasing flexibility and reach)

• A tendency toward monopoly or oligopoly in certain business models

• Volatility (resulting from relatively low barriers to entry and rapidly evolving technology)

Identifying opportunities and tackling BEPS in the digital economy The Discussion Draft lists four core elements that it describes as associated with BEPS in the context of direct taxation. These are:

• Minimization of taxation in the market (source) country (through the minimization of functions assets and risks or other avoidance of a taxable presence, or in the case of a taxable presence, by shifting profits or maximizing deductions)

• Reduction or elimination of withholding tax at source

• Reduction or elimination of taxation at the level of the recipient (achieved through low-tax jurisdictions, preferential regimes, or hybrid mismatch arrangements) with entitlement to substantial non-routine profits often built up via intra-group arrangements

• Minimization of current taxation of low-tax profits at the level of the ultimate parent


In addition to the specific options presented to the Task Force to address BEPS in the context of the digital economy discussed below, the Discussion Draft discusses how the development of the other measures outlined in the BEPS Action Plan, and the OECD work on indirect taxation, are also expected to address such strategies. The Discussion Draft states that the comprehensiveness of the BEPS Action Plan should ensure that taxation is more aligned with where economic activity giving rise to the income takes place. The Discussion Draft goes on to state that this should restore taxing rights at the level of both the market (source) jurisdiction and the residence jurisdiction of an ultimate parent company.

Identification of the broader tax challenges raised by the digital economy The Discussion Draft lists four broad categories of policy challenges that it considers to be raised by the digital economy:

• Nexus• Attributing value to data• Characterization • VAT collection

The Discussion Draft describes the continued increases to the potential of ICT and digital technologies as impacting nexus and the ability to have significant presence without being liable to tax. For example, the reduced need for extensive physical presence in order to carry on business allows for movement of business functions to a new location that may be removed both from the market jurisdiction and the jurisdictions where related functions are taking place. The Discussion Draft states that these considerations raise questions as to whether the current rules are appropriate.

With respect to data, the Discussion Draft focuses on the questions of how to attribute value created from the generation of data through digital products and services and how to determine the share of profit attributable to these value drivers as raising cross-border tax challenges. Additionally, the Discussion Draft notes that the issue of how to characterize a person or entity’s supply of data in a transaction for tax purposes (e.g., as a free supply of a good, as a barter transaction, or some other way) also raises tax challenges.

Income characterization in the context of new business models similarly creates challenges when products and services are provided to customers in new ways. According to the Discussion Draft, income characterization difficulties raise questions with regard to the rationale behind existing income categories and consistent treatment among similar types of transactions.

The Discussion Draft notes that cross-border trade in both goods and services creates challenges for VAT systems. The Discussion Draft identifies two primary tax challenges related to VAT in the digital economy. First, the capability of private consumers to receive from online suppliers low value parcels treated as VAT-exempt in many jurisdictions. Second, the growth in the trade of services, particularly to private consumers, on which no, or a low amount of VAT is levied due to the complexity of VAT enforcement with respect to such services.

Summary of the potential options to address the broader tax challenges raised by the digital economy The Discussion Draft provides an overview of four potential options proposed to the Task Force to address the challenges of taxing the digital economy. The Discussion

Draft specifically notes that while the Task Force has had initial discussions on several options, the options are still in the process of being developed and it is important to receive input on them.

The first potential option presented to the Task Force and listed in the Discussion Draft would modify the exemptions to permanent establishment (PE) status under paragraph 4 of Article 5 of the OECD Model Tax Convention (relating to preparatory and auxiliary activities). The Discussion Draft states that several variations of this option are possible. One approach would eliminate paragraph 4 of Article 5 entirely. Another variation would eliminate just the enumerated exceptions of paragraphs (a)–(d) of Article 5(4) or make them subject to the overall condition that the character of the activity conducted be preparatory or auxiliary in nature, rather than a core activity, thus making such exceptions unavailable to businesses if such activities constitute one of their core activities or functions.

The second option, a variation on alternative PE thresholds, would establish an alternative nexus based on significant digital presence to address situations in which business are conducted “wholly digitally.” In such case, an enterprise engaged in certain “fully de-materialized digital activities” would have a PE if it maintained a “significant digital presence” in another country’s economy. Potential elements of a test for when a fully de-materialized digital activity would be conducted and for when a fully de-materialized business would have a significant digital presence are provided are provided in the Discussion Draft.


The third option is another variation on alternative PE thresholds and includes three broad alternatives: a “virtual fixed place of business PE” (creation of a PE when the enterprise maintains a website on a server of another enterprise located in a jurisdiction and carries on business through that website), a “virtual agency PE” (extension of dependent agent PE concept to contracts habitually concluded with persons located in the jurisdiction through technological means, rather than through a person), and an “on-site business presence PE” (creation of PE through economic presence within a jurisdiction where the foreign enterprise provides on-site services or other business interface at a customer’s location).

The fourth option provided in the Discussion Draft would impose a final withholding tax on certain payments for digital goods or services. The Discussion Draft notes that these types of options are intended to address the possibility of maintaining substantial economic activity in a market without being taxable in that market under current PE rules due to lack of physical presence.

Action 1 identifies the need to also address indirect taxation and the effective collection of consumption taxes (e.g., VAT, GST) with respect to the cross-border supply of digital goods and services. In this respect, the Discussion Draft identifies exemptions for imports of low value goods and remote digital supplies to customers as two areas where jurisdictions should focus their efforts.

In considering how best to evaluate the potential options, the Discussion Draft highlights the necessity of developing a framework that ensures the analysis can be done consistently and objectively. The Discussion Draft recommends the Ottawa framework principles, from the 1998 committee on Fiscal Affairs Report “Electronic Commerce: Taxation Framework Conditions,”1 of neutrality, efficiency, certainty and simplicity, effectiveness and fairness, and flexibility as a good starting point to establish such a framework. Specifically:

• Neutrality: Taxation should seek to be neutral and equitable between forms of electronic commerce and between conventional and electronic forms of commerce. Business decisions should be motivated by economic rather than tax considerations. Taxpayers in similar situations carrying out similar transactions should be subject to similar levels of taxation.

• Efficiency: Compliance costs for taxpayers and administrative costs for the tax authorities should be minimized as far as possible.

• Certainty and simplicity: The tax rules should be clear and simple to understand so that taxpayers can anticipate the tax consequences in advance of a transaction, including knowing when, where and how the tax is to be accounted.

• Effectiveness and fairness: Taxation should produce the right amount of tax at the right time. The potential for tax evasion and avoidance should be minimized while keeping counteracting measures proportionate to the risks involved.

• Flexibility: The systems for taxation should be flexible and dynamic to ensure that they keep pace with technological and commercial developments.

The Task Force considers that these principles are still relevant today and that supplemented as necessary can constitute a basis to evaluate the potential options to address the tax challenges of the digital economy.

ImplicationsThe Discussion Draft reflects the ongoing work of the OECD with respect to the tax challenges of the digital economy. This work is at its early stages, but the OECD considered it important to get input from stakeholders. Companies should evaluate how the issues and options discussed in the Draft may affect them, stay informed about developments in the OECD and in the countries where they operate or invest, and consider participating in the dialogue regarding the OECD BEPS project and the underlying international tax policy issues.


1. The Report was one of the outcomes of the 1998 Ministerial Conference on Electronic Commerce in Ottawa, Canada (Ottawa Conference).

OECD releases discussion drafts on neutralizing hybrid mismatch arrangements under BEPS Action 2

On 19 March 2014, the Organisation for Economic Co-operation and Development (OECD) released two Public Discussion Drafts in connection with Action 2 on hybrid mismatch arrangements under its Action Plan on Base Erosion and Profit Shifting (BEPS). The first document titled “BEPS Action 2: Neutralise the Effects of Hybrid Mismatch Arrangements (Recommendations for Domestic Laws)1” (the First Discussion Draft) makes recommendations for domestic rules and the second document titled “BEPS Action 2: Neutralise the Effects of Hybrid Mismatch Arrangements2 (Treaty Issues)” (the Second Discussion Draft) discusses the impact that such rules would have on the Model Tax Convention and proposes changes to the Convention to clarify treatment of hybrid entities. These Discussion Drafts are intended to provide stakeholders with proposals.

Alex PostmaGlobal and EMEIA Leader – International Tax Services T: +44 20 7980 0286 E: [email protected]

The OECD is keen on obtaining public comments on any issue raised in the Discussion Drafts. In this respect, each Discussion Draft identifies specific issues where comments are encouraged. Comments should be submitted by 2 May 2014.

The First Discussion Draft focuses on providing recommendations for domestic rules to be adopted by countries to neutralize the difference in tax treatments of hybrid mismatch arrangements. It describes previous reports issued by the OECD that discussed tax policy concerns with respect to hybridity including the 2012 report titled “Hybrid Mismatch Arrangements.” The First Discussion Draft also refers to work undertaken by the European Union (EU), such as the European Commission’s proposal to amend the Parent-Subsidiary Directive so that it would not apply to a profit distribution deductible by the subsidiary, and the ongoing work by the EU’s Code of Conduct Group to create a general framework for hybrid mismatch rules that would apply to arrangements within the EU involving hybrid entities.

The First Discussion Draft previews the proposed amendments to the OECD Model Tax Convention to address issues relating to hybrid mismatch arrangements within the Second Discussion Draft. The Second Discussion Draft includes rules affecting income derived by or through a fiscally transparent entity or arrangement, and coordination of the domestic law solutions to hybrid arrangements such that potential conflicts are avoided.

The remaining parts of the First Discussion Draft sets forth general recommendations to the design of domestic law and discusses three broad categories of hybrid mismatch arrangements. For each category, it provides detail descriptions of arrangements and examples, specific recommendations of domestic law to be adopted, technical tax discussions, application and scope of the rules.


1. http://www.oecd.org/ctp/aggressive/hybrid-mismatch-arrangements-discussion-draft-domestic-laws-recommendations-march-2014.pdf

2. http://www.oecd.org/ctp/treaties/hybrid-mismatch-arrangements-discussion-draft-treaty-issues-march-2014.pdf

First Discussion Draft – Recommendations for Domestic LawsThe First Discussion Draft defines hybrid mismatch arrangements generally as arrangements that utilize hybrid elements in tax treatment of an entity or instrument under the laws of two or more tax jurisdictions to produce a mismatch in tax outcomes of payments made under such arrangements. The Discussion Draft clarifies that its focus is on hybrid mismatch arrangements that would result in a shift of profit between jurisdictions or that permanently erode the tax base of a jurisdiction.

Hybrid element refers to the mechanics of a specific arrangement that will yield a mismatch. Therefore, cross-border mismatches resulted from, for example, payments of deductible interest to a foreign tax-exempt charity organization are not addressed. There are two categories of arrangements that contain hybrid elements: hybrid entities and hybrid instruments. Issues arising with respect to hybrid entities usually refer to the opacity of such entity for tax purposes. Issues arising with respect to hybrid instruments may further be categorized into hybrid transfers, where taxpayers in two jurisdictions take mutually incompatible positions with respect to the character and ownership rights of an asset, and hybrid financial instruments, where the incompatible treatments affects a payment made under the instrument.

The First Discussion Draft identifies two types of mismatch results. They are payments that are deductible under the rules of one jurisdiction but are not included under the laws of another jurisdiction (the so-called “D/NI” outcome) and payments that give rise to duplicate

deductions on the same expenditure (the so-called “D/D” outcome). Therefore, a mismatch occurs when a payment to which inconsistent tax treatments are applied.

Payment is defined in the First Discussion Draft as “an amount capable of being paid including (but not limited to) a distribution, credit, debit or accrual of money or money’s worth,” but it does not include payments made for tax purposes only or payments that do not create an economic relationship between the parties.

Finally, the payment that is made through a hybrid arrangement that causes a mismatch must result in erosion to the tax base of one or more jurisdictions where the arrangement is structured.

Criteria for a potential ruleThe First Discussion Draft states that for a rule created to address mismatches that arise from the use of hybrid arrangements to be effective, it must:

• Operate to eliminate the mismatch without requiring the jurisdiction applying the rule to establish that it has “lost” tax revenue under the arrangement

• Be comprehensive• Apply automatically• Avoid double taxation through rule

coordination• Minimize the disruption to existing

domestic law• Be clear and transparent in their

operation• Facilitate coordination with the

counterparty jurisdiction while providing the flexibility necessary for the rule to be incorporated into the laws of each jurisdiction

• Be workable for taxpayers and keep compliance costs to a minimum

• Be easy for tax authorities to administer

Design recommendationsThe First Discussion Draft classifies the recommendations based on the particular hybrid techniques that produce BEPS outcomes. In this respect the recommendations target three categories of hybrid mismatch arrangements:

• Hybrid financial instruments (including transfers),; where a deductible payment made under a financial instrument is not treated as taxable income under the laws of the payee’s jurisdiction

• Hybrid entity payments, where differences in the characterization of the hybrid payer result in a deductible payment being disregarded or triggering a second deduction in the other jurisdiction

• Reverse hybrid and imported mismatches, which cover payments made to an intermediary payee that are not taxable on receipt. There are two kinds of arrangement targeted by these rules:• Arrangements where differences

in the characterization of the intermediary result in the payment being disregarded in both the intermediary jurisdiction and the investor’s jurisdiction (reverse hybrids)

• Arrangements where the intermediary is party to a separate hybrid mismatch arrangement and the payment is set off against a deduction arising under that arrangement (imported mismatches)


For each of the categories listed above, the First Discussion Draft makes recommendations for changes in domestic laws and linking rules — rules that link the tax treatment of an entity, instrument or transfer in one jurisdiction to the tax treatment in another jurisdiction — that specifically target the mismatch in tax outcomes under the particular hybrid arrangement. The linking rules, to be applied if domestic law fails to address the mismatch, are divided into primary responses and defensive rules with respect to each category of hybrid mismatch arrangement. Primary responses generally refer to domestic rules in the payor’s or investor’s jurisdiction. Defensive rules generally refer to domestic rules in the payee’s or subsidiary jurisdiction and are applied in the event of the absent of primary responses. Page 18 of the First Discussion Draft provides a summary of recommendations for easy reference.

Hybrid financial instruments and transfersThe First Discussion Draft defines a hybrid financial instrument as any financing arrangement that is subject to either different tax characterizations under the law of two or more jurisdictions such that a payment will have different tax treatments (e.g., a loan in one jurisdiction and equity in another), or different manner in which tax will be assessed on the instrument (e.g., deduction in one jurisdiction while the other jurisdiction gives an exemption). The different tax characterizations will result in a D/NI outcome. Below is an example of a hybrid financial instrument:

In addition, the First Discussion Draft defines a hybrid transfer as a particular type of collateralized loan arrangement or derivative transaction that the counterparties to the same arrangement in different jurisdictions would both treat themselves as the owner of the loan collateral or subject matter of the derivative. Similar to hybrid financial instrument, the difference in characterization will result in a D/NI outcome. Examples of various hybrid transfer arrangements, such as a “collateralized loan repo” arrangement, are provided in the Discussion Draft to illustrate the common elements in those arrangements. Such example is reproduced below.

In this respect the First Discussion Draft suggests that ownership of an asset for tax purposes should be determined according to the beneficial ownership of the cash flows associated with that asset and the mismatch should be neutralized by the linking rule for hybrid financial instrument, as discussed below.

The First Discussion Draft recommends jurisdictions to enact a rule whereby a dividend exemption is only granted under domestic law to the extent the payment is not deductible by the payor. The Discussion Draft states that such rule would eliminate mismatches in the first place. The First Discussion Draft also calls for changes to rules related to withholding tax rate relief granted at source. It states that relief should be proportional to the net taxable income derived under the arrangement.

Equity/dividend

Debt/interest

Parent Holder (Country A)

Subsidiary Issuer (Country B)

Example: Payment by Issuer is treated as payment of deductible interest by Country B. Payment received by Parent is treated as exempt dividend income by Country A. The result is an interest deduction in Country B with no corresponding income inclusion in Country A.

Obligation to pay purchase price

Rights to buy Target in the future

Capital gain Divi

dend

Divi

dend

Interest

Target collateral (Country B)

Buyer/Holder(Country B)

Seller/Issuer(Country A)

Example: Country A treats the arrangement as loan from Holder to Issuer secured by shares of Collateral. Deduction for interest expense is permitted in Country A on the difference between sale and purchase price. Dividend income from Collateral is exempt from tax in Country A. Country B treats the arrangement as purchase and sale of Target shares. Dividends from Target and capital gain on Target shares are exempt from tax in Country B. The result is an interest deduction in Country A with no corresponding income inclusion in Country B.


The First Discussion Draft next describes the hybrid financial instrument linking rule. Under the primary response in the linking rule, the payor jurisdiction would deny a deduction for any payment made under a hybrid financial instrument to the extent the payee does not oblige an inclusion of the payment as ordinary income. Under the defensive rule, the payee jurisdiction would require an income inclusion as ordinary income to the extent the payor jurisdiction allows for a deduction (or equivalent relief) of the payment made under the hybrid instrument.

The First Discussion Draft recommends the rules above to only target mismatches attributable to hybrid financial instruments, and to the extent of the mismatch. That is, the mismatch has to result from the hybrid instrument itself, and not the surrounding circumstances affecting the parties involved. In this respect, the rule only neutralizes the mismatches derived from that instrument irrespective of whether in the end the taxpayer may not have increased tax liability because of the application of the hybrid financial instrument rule.

The First Discussion Draft recommends that the hybrid financial instrument rule be applied to any mismatch that arises between related parties, including persons “acting in concert.” In this respect, the First Discussion Draft established that two persons are related if the first person has a 10% or more investment in the voting rights or value of a second or a third person has a 10% or more investment in vote or value in both.

For purposes of the related party rule, a person who acts together with another person (acting in concert) in respect of ownership or control of any voting rights or equity interests will be treated as owning or controlling all the voting rights and equity interests of that person. Two persons will be treated as acting together if they are members of the same family, one person acts in accordance

with the wishes of the other in respect of ownership or control of such rights or interests, they have entered into an arrangement to that end, or ownership or control of any such rights or interests are managed by the same person or group of persons.

Hybrid entity payments The First Discussion Draft defines a hybrid entity payment as a technique to exploit differences in the treatment of an entity or arrangement across two jurisdictions to produce D/D or D/NI outcomes from payments made by that entity.

A D/D or double deduction outcome usually involves the use of a hybrid subsidiary that is treated as transparent in the investor’s jurisdiction and not transparent in the jurisdiction where the entity is established or operates. The hybrid entity can be wholly owned, partially owned (e.g., an entity that is treated as a partnership in one jurisdiction and as a corporation in another) or certain other structures. Below is one of the examples of such arrangement.

A double deduction technique can also be achieved by structures where a single entity can be regarded as resident in more than one jurisdiction (e.g., dual consolidated companies). Such entity can be consolidated with affiliated groups in different jurisdictions or could surrender losses to more than one affiliated group.

A D/NI outcome is usually accomplished by having a payment made by a hybrid entity to its investor that is deductible in the payor’s jurisdiction but disregarded in the investor’s. Some tax consolidation structures can also give rise to D/NI outcomes. The First Discussion Draft exemplifies these mismatches with arrangements where disregarded payments are made by a hybrid entity to a related party and payments made by a PE to a related party.

Interest

Investor(Country A)

Payor Affiliate(Country B)

Payor(Country B)

Bank

Example: Country A treats Payor as transparent. Deduction is allowed for interest paid by Payor in country. Country B treats Payor as an entity. Deduction for interest paid in Country B may reduce Payor Affiliate’s country B taxable income through country B loss sharing or fiscal unity regimes. The result is a deduction for interest expense in both Countries A and B.

Inte

rest

Investor(Country A)

Payor Affiliate(Country B)

Payor(Country B)

Example: Country A treats Payor as transparent. Interest income of Investor and interest expense of Payor are not recognized as income and expense, respectively, in Country A. Country B treats Payor as an entity. Deduction for interest paid in Country B that may reduce Payor Affiliate’s country B taxable income through country B loss sharing or fiscal unity regimes. The result is a deduction for interest in Country B with no corresponding income inclusion in Country A.


The First Discussion Draft establishes that the most direct way of addressing D/D outcomes would be to prevent double deductions from being used against any income that was not subject to tax in both jurisdictions (dual inclusion income). However, the implementation would be complicated as it would not only require parallel rules in both jurisdictions designed to restrict the use of the deduction, but also add compliance and exchange of information issues.

Therefore, the First Discussion Draft recommends the following linking rule for deductible hybrid payments (i.e., payments that generate D/D outcomes). The primary response would deny the duplicate deduction arising in the investor’s jurisdiction to the extend it exceeds the taxpayer’s dual inclusion income for that period (with excess deductions being able to be carried forward). To prevent stranded losses, the excess duplicate deduction could be allowed in the investor jurisdiction, so long as the taxpayer can establish that the deduction for the hybrid payment is not being offset against the income of any person in the subsidiary’s jurisdiction.

The defensive rule would deny the dual deduction in the subsidiary jurisdiction to the extent it exceeds the dual inclusion income for the same period. Again, the First Discussion Draft recommends allowing carrying forward the excess unused deductions. Similar to the primary response, to prevent stranded losses, the excess duplicate deduction could be allowed in the subsidiary jurisdiction, so long as the taxpayer can establish that the duplicate deduction for the hybrid payment is not being offset against the income of any other person in the subsidiary’s jurisdiction.

With respect to disregarded hybrid payments (i.e., payments that generate D/NI outcomes), the primary response would provide that the deduction allowed in the payor’s jurisdiction for a disregarded payment should not exceed the taxpayer’s dual inclusion income for the same period. The defensive rule, would require the payee to include, as ordinary income, any

disregarded payments to the extent the payor’s deductions for such payment in the payor jurisdiction exceed the payor’s dual inclusion income for that period.

Imported mismatches and reverse hybridsThe First Discussion Draft last analyzes the mismatches that arise through the use of imported mismatch structures including mismatches that arise from the use of reverse hybrids. These mismatches give rise to D/NI outcomes. The First Discussion Draft, however, acknowledges that sometimes using a reverse hybrid will not result in a mismatch, because in certain jurisdictions, the permanent establishment rule will affect the sourcing of the payment.

With respect to imported mismatches, the First Discussion Draft distinguishes between imported mismatches using a hybrid instrument and imported mismatches using a hybrid entity.

Below is an example of imported mismatches using a hybrid instrument.

Below is an example of imported mismatches using a hybrid entity.

Inte

rest

inco

me

Inte

rest

expe

nses

Inte

rest

expe

nses

Divi

dendInvestor

(Country A)

Payor(Country C)

Intermediary(Country B)

Example: In Country A, payment from Intermediary is treated as dividend and is exempt under Country A law. In Country B, Intermediary’s payment to Investor is treated as interest expense. Such interest expense offsets interest income received from Payor. In Country C, interest paid to Intermediary is deductible under Country C law. The result is a deduction for interest in Country C with no corresponding income inclusion in either Country A or B.

Inte

rest

Investor(Country A)

Payor(Country C)

Intermediary(Country B)

Example: Country A treats Intermediary (a reverse hybrid entity) as an entity. Interest income of Intermediary is not recognized as income by Investor in Country A. Country B treats Intermediary as transparent. Investor is not treated as having a PE in Country B. Country B does not impose tax on interest income of Intermediary. Country C treats Intermediary as transparent. Deduction for interest paid by Payor is allowed in Country C. The result is a deduction for interest in Country C with no corresponding income inclusion in either Country A or B.


The First Discussion Draft states that Reverse hybrid and imported mismatch arrangements have a number of structural similarities, such as:

• The arrangement will typically include at least three different tax jurisdictions (the payor jurisdiction, the intermediary jurisdiction and the investor jurisdiction).

• The intermediary jurisdiction may have little incentive to apply a hybrid mismatch rule to the payment.

• The hybrid element that gives rise to the mismatch is a product of the investment structure between investor and intermediary. There is no hybrid element operating between payor and the intermediary and, accordingly, these structures can be used to generate D/NI outcomes in respect of almost any cross-border payment regardless of the terms under which the payment is made, or the relationship between the payer and intermediary.

• The structure of the arrangement can make it difficult for the payor to know the nature and extent of the mismatch unless it arises within the confines of a controlled group.

The mechanical difference between reverse hybrids and other types of imported mismatches turns on the nature of the hybrid mechanism and the mismatch in tax outcomes that is attributable to that hybrid mechanism.

• In respect of reverse hybrid structures, the hybrid mechanism is the direct consequence of the hybrid tax treatment of the intermediary under the laws of the intermediary and investor jurisdiction and the resulting mismatch is a straight D/NI outcome in relation to a payment made to that entity.

• In respect of other types of imported mismatches, both the hybrid mechanism and the mismatch is indirect, that is to say, the payment is offset or reduced by tax relief arising under another hybrid mismatch arrangement embedded in the arrangement.

The difference between reverse hybrids and imported mismatch arrangements could therefore be thought of as a difference between direct and indirect mismatches engineered through the investment structure.

The First Discussion Draft recommends that the investor and intermediary jurisdictions to implement comprehensive anti-hybrid mismatch rules to ensure the resulting mismatch could not be exported into a third jurisdiction. Such a solution where all countries had a harmonized response would generate compliance and administration efficiencies as well as certainty of outcomes for taxpayers.

The linking rule recommended by the First Discussion Draft calls for a primary response to be implemented in the investor’s jurisdiction that would make changes to its controlled foreign corporation (CFC) or foreign investment fund (FIF) rules, or specific changes to domestic laws, that would target areas such as income of residents accrued through offshore investment structures and changes that would be effective to tax on a current basis. In addition, the Discussion Draft calls for a secondary rule that would apply to the intermediary jurisdiction and would deny transparent or partially transparent treatment to an entity of the intermediary jurisdiction if the controlling investor treats the intermediary as a reverse hybrid where income of the intermediary is not taxed under neither the investor’s nor the intermediary’s jurisdiction.

The defensive rule would apply in the payor jurisdiction and would deny a deduction for a payment to an offshore non-inclusion structure (i.e., reverse hybrid or imported mismatch) to the extent the payment results in no-taxation or is offset by an expenditure incurred under a hybrid mismatch arrangement and the taxpayer is member of the same group as the parties to the arrangement that results in the mismatch.

The First Discussion Draft also states that information reporting requirement also should be enacted in the intermediary jurisdiction to facilitate tax compliance and enforcement.

Second Discussion Draft – treaty issuesThe Second Discussion Draft focuses on the changes that should be made to the OECD Model Tax Convention in addressing Action 2. The Discussion Draft specifies that it complements the First Discussion Draft and it is intended to ensure that hybrid instruments and entities are not unduly used to obtain treaty benefits. Similarly, the document notes that special attention is to be given to possible discrepancies between the Convention and domestic laws that would have been modified under the recommendations of the First Discussion Draft.


The first change concerns dual-resident entities. In this respect, the Second Discussion Draft suggests that the recommendations should be included in Action 6 (Preventing Treaty Abuse), as strategies that affect the different definition of residence under the Model Tax Convention and domestic laws are better addressed in the Action for Treaty Abuse.

The second change proposed would to address the use of transparent entities to unduly benefit from Treaty provisions. In this respect, Article 1(2) of the Convention is modified to include a rule for fiscally transparent entities whereby income derived by or through an entity or arrangement that is treated as wholly or partly fiscally transparent under the tax law of one of the Contracting States will be considered income of a resident 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.

Such change would include additions to the Commentary. The Commentary focuses on the application of the rule to partnerships but suggests that the Committee of Fiscal Affairs is willing to examine the application of that rule to entities other than partnerships at a later stage.

The Second Discussion Draft next comments on the necessary coordination between the contents of the First Discussion Draft and how the suggested domestic law changes may affect specific Articles of the Convention. With respect to rules providing for the denial of deductions under domestic law, the Second Discussion Draft notes that other

than Articles 7 and 24 (which apply to business profits and non-discrimination), nowhere in the Convention are deductions addressed.

With respect to the elimination of double taxation that is suggested with the dividend exemption disallowance when the dividends are deductible in the source state and the special withholding rule recommended, the Second Discussion Draft notes that no Article in the Convention would be in conflict.

Article 23(1) as it is worded in the Model Convention would not create problems to jurisdictions that adopt the recommendations made in the First Discussion Draft because it specifies that a credit method will apply to dividends. However, the OECD notes that a number of jurisdictions depart from that and agree on an exemption method, and provides general comments on how to resolve the problem.

Likewise, Article 23(2) is regarded as consistent with the recommendations in the First Discussion Draft. The only issue noted is circumstances under which the parties to the treaty either supplement or depart from the basic credit approach of the Convention of Article 23(2).

Finally, the First Discussion Draft seems to note concerns on potential application of anti-discrimination provisions in the Convention. The Second Discussion Draft acknowledges the concerns and states that those concerns are more related with how the recommendations in the First Discussion Draft will affect nonresidents, so the concerns would not appear to raise concerns about possible conflict with the Convention.

ImplicationsThe two Discussion Drafts are the first drafts of the output to be produced under Action 2 of the OECD BEPS project. The Discussion Drafts contains detailed descriptions and examples of various hybrid mismatch arrangements and related recommendations on changes to domestic law and treaty provisions. Most notably, the application of the rules discussed generally would exclude unrelated parties, except in cases of structured transaction. On the other hand, the implementation of these rules could require a multinational corporation to document the tax treatments of each cross-border intercompany transaction in two or more jurisdictions, which could significantly increase compliance cost.

Companies should evaluate how these proposed changes may affect them, stay informed about legislative and treaty developments in the OECD and in the countries where they operate or invest, and consider participating in the dialogue regarding the BEPS project and the underlying international tax policy issues.


Webcast

OECD hosts a second webcast update on the BEPS projectOn 2 April 2014, the Organisation for Economic Co-operation and Development (OECD) hosted its second webcast on the Base Erosion and Profit Shifting (BEPS) project. A replay and the slides for the webcast can be found on the OECD website.1 The webcast provided an update on the current activity of the OECD with respect to its July 2013 “Action Plan on Base Erosion and Profit Shifting.” The discussion focused on progress and deliverables related to the Actions that have a September 2014 delivery date.

As in the first webcast held in January 2014, the featured speaker was Pascal Saint-Amans, who leads the OECD’s tax work. Other senior members of the OECD secretariat participating in the webcast included Raffaele Russo, who is leading the BEPS project; Marlies de Ruiter, who has responsibility for the tax treaty, transfer pricing and financial transactions work; Achim Pross, who has responsibility for the international cooperation and tax administration work; and Joe Andrus, who leads the OECD’s transfer pricing unit.

Saint-Amans opened the webcast by referencing the five discussion drafts that the OECD has released in the past two months on four of the Actions: Action 13 on transfer pricing and country-by-country (CbC) reporting (discussion draft released on 30 January 2014), Action 6 on treaty abuse (discussion draft released on 14 March 2014),

Action 2 on hybrid mismatch arrangements (two discussion drafts released on 19 March 2014) and Action 1 on the digital economy (discussion draft released on 24 March 2014).

Saint-Amans briefly mentioned the other Actions with 2014 delivery dates, indicating that the work on both Action 5 on harmful tax practices and Action 15 on a new multilateral instrument is well underway. He noted that because these Actions involve intergovernmental matters there will not be a public consultation process with respect to them. He also reported that the work related to the Actions with 2015 delivery dates has begun and that discussion drafts in these areas are expected to be released in the second half of 2014. He emphasized the importance of stakeholders taking part in the BEPS discussion by submitting comments on OECD drafts and participating in the scheduled public consultations.

While the OECD activity on transfer pricing documentation and CbC reporting was the last topic covered during the webcast, the developments discussed in that area are most significant. Andrus highlighted the interest in this area, noting that the OECD received more than 1,300 pages of comments on the discussion draft on transfer pricing documentation and CbC reporting.

Read more in a detailed EY Global Tax Alert at

ey.com/BEPS


1. http://www.oecd.org/tax/beps-webcasts.htm

Point of view: The OECD’s Discussion Drafts on Neutralizing the Effects of Hybrid Mismatch Arrangements

These two Discussion Drafts set forth ambitious proposals for domestic law and treaty provisions with respect to the tax treatment of specified hybrid transactions and arrangements. They derive from tax policy concerns associated with certain cross-border transactions and arrangements that give rise to disparate tax treatment under the domestic tax laws of the two or more countries involved. However, we would note that the proposal advanced by the OECD in the Discussion Drafts seems to have broader implications for tax sovereignty and these deserve careful consideration.

EY’s point of view on the OECD’s Discussion Draft on Preventing the Granting of Treaty Benefits in Inappropriate Circumstances (“Discussion Draft”) is best illustrated in our comment letter to the OECD:

Jose Antonio BustosInternational Tax Services T: +44 20 7951 2488 E: [email protected]


“The proposal is a construct of domestic laws that would condition the local tax treatment of a particular arrangement based on the tax treatment of the other side of the arrangement in another country. While tax treaty provisions often are negotiated based on the applicable domestic law tax treatment in the treaty partner, what the OECD is advocating here is a system of domestic laws that would operate unilaterally and automatically but would be conditioned on tax policy choices made in another country.

We urge the OECD to act cautiously so as to ensure that its proposals to address hybrid mismatch arrangements are appropriately integrated with the relevant domestic law rules of countries and with the proposals for domestic law and tax treaty changes that are being developed in connection with other aspects of the OECD’s Action Plan for Addressing Base Erosion and Profit Shifting.

Implications of the complexity of the proposed approach for addressing hybrid mismatch arrangements The Discussion Drafts set forth a proposed construct for the treatment of hybrid transactions and arrangements that is exceedingly complex. The construct involves a set of primary and secondary rules and defensive responses, with different rules for each of the several categories of hybrid arrangements that are covered.

This construct seems more complicated than any domestic law regime of any country in place today. Moreover, this construct envisions the global adoption of rules that must then mesh very precisely across the two or more countries involved in any particular transaction or arrangement.

It does not seem possible that countries could adopt and interpret this construct in a completely consistent way. Indeed, the proposal leaves key concepts and definitions open with the idea that these

details are to be filled in by each country. Moreover, each country would need to incorporate the proposed construct for the treatment of hybrid arrangements into its existing domestic law, including what in some cases are significant rules on hybrids that are already in place. While some countries might choose to replace their existing rules with respect to hybrid arrangements with this new OECD regime, it seems likely that many countries would instead layer the new regime on top of their existing rules.

Countries also would have to address a whole range of collateral consequences associated with the treatment of hybrid arrangements. This would require the meshing of the proposed regime for hybrids with many elements of each country’s domestic law tax rules for financial transactions. Examples of some of the kinds of collateral consequences that would have to be addressed under each country’s own tax system include:

• The impact on the debt-equity analysis of other debt

• The implications under earnings stripping rules

• Characterization as equity for other tax purposes

• The implications under rules regarding multiple classes of stock

• Withholding tax treatment • Foreign exchange gain or loss

consequences such as amount and timing

• Foreign tax credit implications

In addition, presumably each country would need to adapt the proposed construct for hybrids to its own overall customs and practices with respect to the tax law. This would include matters like preferences for detailed and specific rules versus more conceptual approaches and availability of rulings or other advance clearance procedures.

In considering the OECD’s proposed approach for the treatment of hybrid mismatch arrangements, it must

be acknowledged that what would result almost certainly would not be coordinated country to country as is intended in the abstract. This means that advancement of the proposal necessarily would involve substantial uncertainty and significant risk of double taxation. These implications should be taken into account as alternatives are considered, including the potential for addressing the tax policy concerns with respect to hybrid arrangements under the proposals under development in connection with other action areas in the OECD’s BEPS Action Plan.

Importance of interaction with work under other BEPS actions There is significant overlap between this Action 2 on addressing hybrid mismatch arrangements and several other aspects of the OECD’s BEPS Action Plan. The overlap is perhaps most pronounced in the case of Action 4 on limiting interest deductibility. Other action areas where there is real potential for overlap include Action 3 on strengthening CFC rules, Action 5 on harmful tax practices, and Action 6 on addressing treaty abuse. The work on Action 6 and some of the work on Action 5 is being done simultaneously with the work on hybrids, but the work on Actions 3 and 4 will not begin in earnest until after recommendations with respect to hybrids are delivered and recommendations in those areas are not expected to be delivered until a year after the delivery of the hybrids recommendations.


We believe that some of the issues with respect to hybrids could be dealt with more naturally under these other Actions. The work on Action 4 will focus on issues with respect to leverage and financing. In order to address those issues in a comprehensive way, hybrid financing arrangements should be included within the scope of that project. Moreover, addressing hybrid arrangements as part of that work would be necessary to ensure that the recommended approach with respect to the treatment of leverage takes into account all aspects of a business’s leverage profile. Alternatively, addressing hybrid financing arrangements separately only under Action 2 would seem to be a piecemeal approach. And addressing such arrangements under both Actions without appropriate coordination would adversely affect the recommended approaches under each of these Actions.

Ideally, work on these other Actions would be completed first, before turning attention to the work on hybrid mismatch arrangements. The other Actions are simpler than Action 2 in the sense that the focus is on the country’s domestic law rules only or, in the case of Action 6 on addressing treaty abuse, is on bilateral agreements between two countries. This would seem to be easier to manage than the proposed construct with respect to hybrid mismatch arrangements, which is centered on each country’s domestic law rules but requires specific and granular coordination of another country or countries’ domestic law rules with the rules of the first country.

If the work in these other areas were to be completed first, the OECD could then assess the extent to which issues with respect to hybrids remain. Any remaining issues could be dealt with using hybrid specific rules in a more targeted way. Approaching it from the other direction, which would require that the subsequent work on interest deductibility, CFC rules and harmful tax practices be designed around the proposed hybrid regime, would be difficult and would seem to risk making those rules more complex than otherwise would be necessary.

Giving primary focus to the work under Action 4 on interest deductibility also would facilitate a more comprehensive approach for addressing inconsistencies between countries’ tax treatment of financial transactions. The proposed construct for hybrid mismatch arrangements is aimed at addressing asymmetries in tax treatment that result in what the OECD views as double non-taxation. However, in the interests of fairness and equal treatment, the OECD similarly should address asymmetries in tax treatment that result in double taxation.

Thus, where a thin capitalization regime or other limitation on interest deductibility causes interest expense to be non-deductible in one country, there should be a corresponding adjustment of the income inclusion in the other country. This would help to reduce instances of effective double taxation, although it is not expected that such coordination rules would completely eliminate the potential for double taxation in this area. We urge the OECD to include in its work on Action 4 and the deductibility of interest consideration of approaches for accomplishing a coordinated and symmetrical approach to the treatment of leverage and interest expense. The ability to develop balanced and symmetrical rules regarding the appropriate location of debt and the associated interest expense is a further reason to favor interest deductibility rules overall as the first defense against hybrid mismatch arrangements and to look to hybrid specific rules under Action 2 only as a backstop where necessary to address hybrid arrangements that are not fully captured in such leverage rules.

We would recommend that the implementation work with respect to the proposed construct on hybrid mismatch arrangements be deferred until the work on developing recommendations with respect to these other Actions is completed. This would allow for appropriate coordination of the recommendations, including what is likely to be a significant narrowing of the

required reach of the rules on hybrids due to many of such arrangements being directly addressed through the rules on leverage that will be recommended for example. In order to avoid exacerbating complexity and increasing both uncertainty and the risk of double taxation, coordination of the solutions in all these Action areas will be critically important.

The need for a narrow approach The complexity of the proposed hybrid mismatch arrangement approach and the need for coordination with the work on other Actions, most particularly the recommendations for limiting interest deductibility being developed under Action 4, provide significant support for use of the “bottom up” approach set forth in the Discussion Drafts. The reach of the proposed treatment of hybrids should be narrowly targeted, with only specified categories of hybrid mismatch arrangements covered. This would allow time to consider the implications in practice of the proposed approach. It also would allow time to evaluate the impact that the work done under the other Actions has on the continued use of such arrangements and to determine the extent to which hybrid-specific rules are needed once the rules developed in other areas of the Action Plan have been put in place.

The initial scope of rules addressing hybrid mismatch arrangements should focus on related party transactions. Moreover, for this purpose, the scope of the “related party” concept should be limited to situations involving a control relationship. Therefore, the threshold for related party status should be set at more than 50% rather than at the 10% level proposed in the Discussion Drafts. We further believe that the use of the concept of “acting in concert”, which is subjective and can be highly contentious, is not advisable in this context where clarity and certainty of scope is essential.


In considering any extension of the proposed rules to cover certain arrangements between third parties, it is our view that the concept of a “structured transaction” is not one that can be readily defined at the OECD level. Rather, this is more naturally a concept to be determined consistent with each country’s domestic law. Therefore, we urge the OECD to leave the treatment of hybrid arrangements between unrelated parties to be addressed in countries’ domestic law. Any new rules in this area should be implemented on a prospective basis and should be clear and targeted so as to minimize disruptions to the capital markets.

This initial narrow coverage of the recommended construct for hybrid mismatch arrangements could be expanded, contracted or adjusted as appropriate, after the OECD and member countries assess the experience gained and evaluate the new landscape with respect to hybrid arrangements in light of the domestic law and tax treaty changes implemented in connection with the work under other Actions.

The need for coordination with domestic law anti-abuse rules The OECD’s proposed construct with respect to the treatment of hybrid mismatch arrangements starts from the base of the relevant countries’ domestic law treatment of the arrangement in question. Even with the narrow approach we recommend, it is necessary that the treatment of a hybrid transaction or arrangement in one country is known and fixed in order to determine the treatment that should be applied in the other country. Any uncertainty or change in the treatment in the first country could mean that the treatment in the second country does not lead to the intended overall result. Indeed, the result could be unintended double taxation if one country’s treatment is changed and the other country’s treatment cannot be changed because of statute of limitations issues or lack of coordination or other reasons.

Because the key to the OECD’s proposed construct on hybrid arrangements is coordination of the treatment of the arrangement in two or more countries, domestic law GAAR provisions should be made inapplicable to hybrid arrangements that are covered by such construct. The construct is based on a system of primary and responsive actions. After-the-fact application of a domestic law GAAR in one country would have implications for the appropriate responsive action, but it may well be too late for the tax treatment of the arrangement to be changed in the country that is in the responsive posture. Therefore, a rule protecting against application of domestic law GAAR provisions should be an integral part of the proposed approach on hybrids.

The applicability of domestic law GAAR provisions also must be addressed in the context of transition. With the implementation of the OECD’s proposed approach to hybrid arrangements, taxpayers may well choose to refinance existing financial arrangements rather than to keep in place a hybrid arrangement that is targeted under the new regime. A taxpayer may refinance a disfavored hybrid instrument into a straight debt instrument for example. In this regard, one of the intended results of the proposed hybrid construct is to discourage use of such instruments in favor of other instruments that do not have hybrid characteristics. A transaction that is undertaken to replace a disfavored hybrid instrument with another form of financing should be protected against any potential challenge that could be brought under a domestic law GAAR based solely on the fact that the refinancing is driven by the enactment of new rules on the tax treatment of hybrid arrangements. Therefore, a rule protecting such refinancings against application of domestic law GAAR provisions also should be an integral part of the recommended construct for treatment of hybrid mismatch arrangements.

Need for coordination with other aspects of domestic law Just as it is essential that the proposed approach for the treatment of hybrid mismatch arrangements be coordinated with the domestic tax law of the affected countries, it also is critically important to ensure that the new construct does not interfere with other regulatory regimes at a domestic or multilateral level. As noted in the Discussion Drafts, a key focus in this regard is ensuring that any new rules with respect to the treatment of hybrids do not apply in a manner that undercuts the regulatory capital requirements applicable to regulated financial services businesses. The ability of a global financial institution to use new forms of capital as mandated by the regulators and to bring in capital from the market only at the top holding company level as favored by the regulators and then to push the capital down to the group entity where it is needed should not be impeded by recommended changes in the tax treatment of hybrid arrangements.

Therefore, EY encourages the OECD to continue to work with the financial services industry and with the relevant industry regulators so that the interaction of the recommended approach for the tax treatment of hybrid mismatch arrangements and the applicable regulatory capital rules does not lead to inappropriate and unequal results across financial institutions with different global profiles.”


OECD releases discussion draft on preventing treaty abuse under BEPS Action 6

The Discussion Draft is one of a series of such drafts that the OECD is releasing this spring in connection with the BEPS Action Plan. The recommendations proposed in the Draft include incorporating in tax treaties both “limitations on benefits” (LOB) rules similar to those found in US tax treaties and broad anti-abuse rules similar to the “main purpose” tests found in UK tax treaties

Detailed discussionThe 14 March 2014 Discussion Draft under Action 6 focuses on concerns about the potential for benefits of tax treaties to be granted to a taxpayer in inappropriate circumstances and provides recommendations for addressing these concerns. The OECD issued the Draft to provide stakeholders with an opportunity to comment on the proposals before the OECD issues its final recommendations under Action 6 by September 2014. Comments were to be submitted to the OECD on or before 9 April 2014 and the OECD had a public consultation on the Draft on 14-15 April 2014.

The Discussion Draft is organized into three sections that align with the three areas of focus identified by Action 6 of the OECD BEPS Action Plan related to preventing treaty abuse:

• Development of model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances

• Clarification that tax treaties are not intended to be used to generate double non-taxation

• Identification of tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country

The Discussion Draft proposes changes to the OECD Model Treaty and the related Commentary and recommendations regarding domestic law provisions.

Barbara AngusInternational Tax Services T: +1 202 327 5824 E: [email protected]

On 14 March 2014, the Organisation for Economic Co-operation and Development (OECD) released a Discussion Draft in connection with Action 6 on treaty abuse under its Action Plan on Base Erosion and Profit Shifting (BEPS). The document titled BEPS Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances1 (the Discussion Draft or the Draft) contains proposed tax treaty provisions and related commentary together with proposed domestic law provisions to address treaty shopping and other potential treaty abuse.


1. http://www.oecd.org/ctp/treaties/treaty-abuse-discussion-draft-march-2014.pdf

Treaty provisions and domestic rules to prevent the granting of treaty benefits in inappropriate circumstancesIn considering how best to prevent the granting of treaty benefits in inappropriate circumstances, the Discussion Draft distinguishes two situations: (1) cases where a person tries to circumvent limitations provided by the treaty itself and (2) cases where a person tries to circumvent the provisions of domestic tax law using treaty benefits.

Cases where a person tries to circumvent limitations provided by the treaty itselfThe Discussion Draft describes “treaty shopping” as involving the attempt by a person who is not a resident of a Contracting State to attempt to obtain benefits that a tax treaty grants to a resident of that State. The Draft briefly reviews the prior work done by the OECD with respect to treaty shopping and notes that countries use a variety of approaches to address instances of treaty shopping that are not addressed by provisions in the OECD Model Treaty. The Draft proposes a series of recommended additions or changes to tax treaties.

The Discussion Draft’s first recommendation is the addition to the preamble of tax treaties of a clear statement that “the Contracting States, when entering into a treaty, wish to prevent tax avoidance and, in particular, intend to avoid creating opportunities for treaty shopping.”

The Discussion Draft’s second recommendation is the inclusion in tax treaties of a specific anti-abuse rule that is based on the LOB provisions included in treaties concluded by the United States and some other countries. The Draft includes proposed language for a LOB rule and further states that detailed commentary would explain the main features of the proposed rule.

The Discussion Draft also notes that the OECD Focus Group working on this issue also considered whether a LOB rule should include a so-called “derivative benefits” provision. The Draft states that the Group recognized that such provision would be an appropriate way of dealing with cases where taxation of an item of income in the two treaty countries is comparable to the taxation of the same item of income if it had been received directly by the shareholders of the company that received that item of income. However, the Group also noted that such a provision could result in the granting of treaty benefits in situations that could give rise to BEPS concerns, such as where a treaty-benefited payment is taxed at a more favorable rate in the country where the recipient company is located than it would be in the country where the shareholders are located. The Discussion Draft includes a specific request for comments on possible ways to address such cases if a “derivative benefits” provision were included in the LOB rule. It also requests examples of situations that should be covered under a “derivative benefits” provision.

The Discussion Draft’s third recommendation is the inclusion in tax treaties of a general anti-abuse rule (GAAR) that is based on a main purpose test. Under this rule, treaty benefits would be denied when one of the main purposes of arrangements or transactions is to secure a benefit under a tax treaty and obtaining such benefit in these circumstances would be contrary to the object and purpose of the relevant provisions of the tax treaty. The Draft indicates it is intended that detailed Commentary would explain such a rule and include examples. The Draft includes a specific request for comments on what the Commentary should cover.

The Discussion Draft includes several explanatory points that could be included in the Commentary. The Draft makes clear that it is intended that the main purpose test would supplement the LOB rule. A benefit that would be denied under the LOB rule would not then be subject to analysis under the main purpose test. Conversely, a benefit that would be allowed under the LOB rule would be denied if the main purpose test is not satisfied.

The Discussion Draft further states that a treaty country may deny the benefits of the treaty if it is reasonable to conclude, having considered all the relevant facts and circumstances, that one of the main purposes of an arrangement or transaction was to gain a benefit under a tax treaty. Moreover, the Draft states that conclusive proof of such a main purpose is not required under this test. The Draft also notes that obtaining treaty benefits need not be the sole or dominant purpose of an arrangement but rather it is sufficient for purposes of the test that obtaining the treaty benefit is at least one of the main purposes.

The Discussion Draft sets forth two examples of situations where treaty benefits would be disallowed under the main purpose test and two examples where treaty benefits would not be disallowed under the main purpose test. The Draft requests comments on these examples and on additional examples that could be included in the Commentary in order to illustrate cases in which the main purpose test would or would not be satisfied.


In addition, the Discussion Draft discusses other situations where a person may seek to circumvent specific limitations or conditions with respect to particular treaty benefits, stating that although the GAAR-type approach of the main purpose test would be useful in such situations, targeted specific treaty anti-abuse rules generally would provide greater certainty for both taxpayers and tax administrations. The Draft identifies a series of areas where specific treaty anti-abuse rules could be helpful, including:

• Splitting-up of contracts to avoid permanent establishment thresholds

• Hiring-out of labor to obtain the benefits of Article 15

• Transactions intended to avoid dividend characterization

• Dividend transfer transactions• Transactions that circumvent the

application of article 13(4) (related to taxation of capital gain from immovable property)

• Tiebreaker rules for determining the treaty residence of dual-resident persons

• Triangular cases involving a permanent establishment in a third country

The Draft includes recommendations for specific anti-abuse provisions with respect to some of these situations and notes that some of the situations will be dealt with in the work under other BEPS Actions.

Cases where a person tries to abuse the provisions of domestic tax law using treaty benefitsThe Discussion Draft also discusses what it describes as tax avoidance risks that are not caused by tax treaties but may be facilitated by tax treaties. These are situations where there is an attempt to use a tax treaty benefits to avoid provisions of domestic law. The Draft lists a series of strategies that fall into this category:

• Including thin capitalization and other financing transactions

• Dual residence strategies• Certain transfer pricing strategies• Arbitrage transactions that take

advantage of either mismatches within a country’s domestic laws or mismatches between the domestic laws of two countries related to the character or timing of income or deductions

• The characterization of entities• The treatment of taxpayers

The Draft notes that many of these transactions will be addressed through other items on the BEPS Action Plan and states that the main objective of the treaty work with respect to these types of transactions is to ensure that treaties do not prevent the application of specific domestic law rules that would otherwise prevent such transactions.

The Discussion Draft notes that the current Commentary already addresses some of these situations, making clear that treaties do not prevent the application of various domestic law provisions and providing a general discussion regarding the interaction between tax treaties and domestic anti-abuse rules. However, the Draft reiterates the recommendation, described above, to include a treaty GAAR provision.

In order to prevent interpretations of the provisions of tax treaties in a manner intended to circumvent of a country’s domestic anti-abuse rules, the Discussion Draft recommends the addition of a provision like the US “savings clause,” which confirms a country’s right to tax its residents without regard to the provisions of any tax treaty (other than those provisions that are clearly intended to apply to residents).

Clarify that tax treaties are not intended to be used to generate double non-taxationThe Discussion Draft further recommends inclusion of specific language clarifying that tax treaties are not intended to be used to generate double non-taxation. The Draft notes that the Commentary on Article 1 of the OECD Model Treaty has since 1977 included a statement that tax treaties should not help tax avoidance or evasion and that this statement was further strengthened in 2003. However, in order to provide clarification, the Draft recommends stating clearly in the title of treaties that the prevention of tax evasion and avoidance is a purpose of tax treaties. The Draft also recommends inclusion of a preamble that expressly provides that the countries entering into the treaty “intend to eliminate double taxation without creating opportunities for tax evasion and avoidance,” and that refers specifically to treaty shopping as an example of such avoidance that should not result from treaties.


Tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another countryThe final section of the Discussion Draft discusses tax policy considerations relevant to a country’s decision whether to enter into, modify or terminate a tax treaty with another country. The Draft notes that a clear articulation of these considerations would be useful to countries in justifying their decisions not to enter into tax treaties with certain low or no-tax jurisdictions. The Draft also recognizes that there are many non-tax factors that can lead to the conclusion of a tax treaty between two countries and that a country has a sovereign right to decide to enter into tax treaties with any jurisdiction.

The Discussion Draft proposes changes to the introduction to the OECD Model Tax Treaty discussing these policy considerations. As a main objective of tax treaties is the avoidance of double taxation in order to reduce tax obstacles to cross-border economic activity, the Draft identifies the existence of risks of double taxation resulting from the interaction of the tax systems of the two countries involved, as the primary tax policy concern that should be considered. As such, where a country levies no or low income taxes or where elements of a tax system could increase the risk of non-taxation, other states should consider whether there are risks of double taxation that would justify, by themselves, a tax treaty. Another consideration referenced is the risk of excessive taxation from high withholding taxes. Additionally, the Draft mentions the willingness and ability of a prospective treaty partner to implement effectively the provisions of tax treaties concerning administrative assistance (e.g., the ability to exchange tax information), as being a key aspect that should be taken into account when deciding whether or not to enter into a tax treaty.

ImplicationsThe Discussion Draft is the first draft of the output to be produced under Action 6 of the OECD BEPS project. The use of a LOB provision is consistent with the historic approach of the United States in its treaties. The use of a main purpose test is consistent with the practice of the United Kingdom in its treaties. Moreover, each of these approaches has been adopted by some other countries. The Discussion Draft’s approach of recommending both approaches in combination raises issues regarding the potential uncertainties that could be created for businesses engaging in cross-border transactions.

Companies should evaluate how the proposed changes may impact them, stay informed about treaty developments in the OECD and in the countries where they operate or invest, and consider participating in the dialogue regarding the BEPS project and the underlying international tax policy issues.


Point of view: The OECD’s Discussion Draft on Preventing the Granting of Treaty Benefits in Inappropriate Circumstances

Christian EhlermannInternational Tax Services T: +49 89 14331 16653 E: [email protected]

EY’s point of view on the OECD’s Discussion Draft on Preventing the Granting of Treaty Benefits in Inappropriate Circumstances (“Discussion Draft”) is best illustrated in our comment letter to the OECD:

“EY is concerned that the recommendations in the Discussion Draft with respect to the incorporation of anti-abuse rules in tax treaties go too far and would interfere with the proper functioning of tax treaties for their intended purposes.

In our comment letter, we therefore urged the OECD to reconsider its recommendations and strike to an appropriate balance that allows tax treaties to achieve the objective of facilitating cross-border trade and investment.

Limitation on Benefits Test The Discussion Draft proposes a two-prong approach to addressing potential treaty abuse, recommending the incorporation in tax treaties of both a more objective test in the form of a limitation on benefits (LOB) provision and a more subjective test that reflects a general anti-abuse rule in the form of a main purpose test.

LOB provisions are structured as a series of alternative mechanical tests that are intended to be relatively objective. However, mechanical tests by their nature cannot cover every circumstance that can arise. Thus, such tests – even multiple alternative tests – may not allow treaty benefits in situations where such benefits would be appropriate. In order to reduce the risk of inappropriate denial of access to treaty benefits, the mechanical tests of an LOB provision must be as broad as possible and must be supplemented with an effective rule allowing the discretionary provision of treaty benefits when the mechanical tests otherwise would not achieve the right result.

LOB provisions should include the full range of alternative mechanical tests in order to cover the range of circumstances that can arise. The Discussion Draft’s formulation of an LOB provision should be expanded to include additional mechanical tests. For example, a headquarters company test should be added, as well as a test that addresses the special circumstances of collective investment vehicles.


The OECD’s work on the Model Tax Convention and the related Commentary has been critically important to the ongoing expansion of the global network of bilateral tax treaties. These tax treaties serve to reduce or eliminate double taxation which, if unrelieved, would be a significant barrier to cross-border trade and investment. Whilst there is a need to protect against the granting of tax treaty benefits in inappropriate circumstances, it is important to ensuring that this does not stop tax treaty benefits being granted in appropriate circumstances.

The mechanical tests in an LOB provision should not include conditions that make application of a test unrealistic in practice. In this regard, the LOB provision in the Discussion Draft includes restrictions on intermediate ownership in several of the tests. Given the complex organizational structures of global businesses, restrictions of this type on ownership through intermediate entities would render these tests inapplicable in many cases. We believe that these restrictions are not necessary to serve the policy objectives of the particular tests and recommend that their inclusion be reconsidered.

As noted above, even a series of mechanical tests would not capture all situations where treaty benefits are appropriate. For this reason, LOB provisions typically include a discretionary benefits provision under which the competent authority can make a determination to grant treaty benefits in an appropriate case. Given what is at stake, it is essential that the discretionary benefits provision operates effectively in practice. We believe that the OECD should include work on improving the operation of discretionary benefits provisions as an element of its work on Action 14 with respect to improving the mutual agreement procedure under treaties.

The global nature of business today and the complexity of tiers of ownership in corporate groups mean that a so-called derivative benefits test is an essential element of an LOB provision. However, the Discussion Draft cites concerns that such a test could apply to cover arrangements that involve what is viewed as BEPS activity and provides an example that is intended to illustrate these concerns. The example involves a transfer of

royalty-generating intangible property by a parent company, which is in a country that has a treaty with the country where the royalty is generated, to a subsidiary in a third country that also has a treaty with such country but that taxes royalties at a preferential tax rate.

This example does not involve an arrangement that should be viewed as raising issues with respect to qualification for treaty benefits. Any concerns with respect to the particular arrangement described do not seem to involve a concern about treaty shopping because the same treaty results would have applied if the intangible property had remained in the parent company. Any issue with respect to the transfer of the intangible property to the subsidiary, which seems to be a focus of the concern expressed in the Discussion Draft, would seem to be a matter for the parent company country that could be dealt with under its domestic law. It would not seem to be a concern of the source country to be dealt with by denying treaty benefits in this narrow case.


We do not believe that this example and the concern referenced provide sufficient justification for not including a derivative benefits test in the LOB provision set forth in the Discussion Draft. To the contrary, we believe that inclusion of a derivative benefits test that allows consideration of comparable benefits in a third-country treaty is essential to the functioning of an LOB provision.

Treaty-based GAAR Provision – Main Purpose Test The Discussion Draft recommends inclusion in tax treaties of a general anti-abuse rule that would apply in addition to all other limitations and qualifications and could deny treaty benefits where the other limitations and qualifications, including the recommended LOB provision discussed above, all are satisfied. The Draft would deny treaty benefits “if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the main purposes of any arrangement or transaction that resulted directly or indirectly in that benefit.”

An exception to this denial of benefits would apply if “it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention.” The Discussion Draft notes the intent to supplement the main purpose test with detailed commentary explaining the functioning of the test and providing examples.

We are concerned that inclusion of this “main purpose” test would create significant uncertainty regarding the availability of treaty benefits that would seriously erode the functioning of treaties. The test is broad and subjective and the exception incorporated in the test is vague and subjective. Businesses will not know whether they qualify for benefits of a treaty until after the fact, potentially long after the fact.

Similarly, a treaty country will not know how its treaty partner is interpreting and applying the test, either currently

or in the future, with the potential for significant deviations from the intended or expected implementation of the treaty and substantial imbalances between the countries.

The Discussion Draft notes that this main purpose test is intended to “provide a more general way to address treaty shopping avoidance cases, including treaty shopping situations that would not be covered by the specific anti-abuse rule in the recommended limitation on benefits provision, such as certain conduit financing arrangements.” The reference to “certain conduit financing arrangements” The reference to “certain conduit financing arrangements” is the only indication of the purpose for or intended aim of the main purpose test. The examples provided in the Discussion Draft to illustrate the application of the test all are arrangements that involve conduit features or accommodation parties.

We would suggest that the concerns underlying these types of arrangements could better be addressed through a targeted rule aimed at conduit financing arrangements or other transactions in which qualification for treaty benefits depends on an accommodation party. Indeed, the OECD has experience with more targeted rules and with addressing conduit companies in particular that it could draw on to craft an appropriately tailored rule that it could recommend. The OECD’s recent work on the beneficial ownership concept could also be leveraged here.

A more targeted rule would create significantly less uncertainty and would cause substantially less collateral damage than the proposed main purpose test. The particular examples provided in the Discussion Draft are not helpful in explaining the reach of the broader main purpose test. As an illustration, the example in paragraph 27 of the Discussion Draft involves a loan that was transferred to a new intermediate company in exchange for promissory notes. The example concludes that the proposed provision would deny treaty benefits “if

the facts of the case show that one of the main purposes” for transferring the loan was for the intermediate company to obtain treaty benefits with respect to the interest. However, the example does not come to a conclusion based on the stated facts. Moreover, it is not clear if the result would be different if the loan instead were transferred in exchange for an equity interest in the intermediate company. In other words, the reach, if any, of the proposed main purpose test beyond conduit type arrangements is not clear.

In this regard, it is important to remember that this main purpose test is being proposed in combination with a robust LOB provision. The Discussion Draft recognizes that the LOB provision “will address a large number of treaty shopping situations based on the legal nature, ownership in, and general activities of, residents” of a treaty country. Therefore, the main purpose test is intended to operate only as a form of backstop to the application of the LOB provision. The main purpose test is much too broad for the intended purpose of backstopping the recommended LOB provision and the specific aim of capturing certain conduit financing arrangements that might not be caught by the LOB provision. A much more narrowly targeted rule would be better suited to this objective.

While we appreciate the inclusion of an exception from the denial of treaty benefits for situations where “it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions” of the treaty, this exception is overly vague and subjective. The two examples illustrating this exception provide little guidance because there is no clear analysis or principles that support the conclusion that treaty benefits are available in those cases.


• The first positive example in paragraph 33 involves a decision to build a plant in a treaty country. The explanation focuses on the main purpose for building the plant which is related to business expansion and lower local manufacturing costs. However, these factors are true of all three countries under consideration for location of the plant and the company in the example chose the one country that had a treaty with the parent jurisdiction. The example cites the general treaty objective of encouraging cross-border investment as the rationale for concluding that the treaty benefits are appropriate.

• The second positive example in paragraph 33 involves a collective investment vehicle that holds dividend-paying investments in corporations in a country with which its home country has a treaty. The example here too cites the general treaty objective of encouraging cross-border investment and concludes that treaty benefits are appropriate unless the investment is part of an arrangement or relates to another transaction undertaken with a main purpose of obtaining treaty benefits.

These examples would be more useful if they included clearer guidance that could be extrapolated to other situations in order to evaluate the potential availability of the exception from the denial of treaty benefits.

If it is concluded that it is necessary to include a main purpose test as part of the recommended approach to addressing treaty abuse, we urge the OECD to make modifications to the test to make it more workable and to reduce the uncertainty that would be created by this subjective test. A formulation that looks to “the” main purpose instead of “one of the main purposes” would be easier to apply and would provide more certainty. In

addition, the presence of active business operations of the group in either the residence country or the source country should be a presumptive rebuttal of any main purpose inquiry. The inclusion of such an exception would help to reduce some of the subjectivity of the main purpose test.

The discussion of the treaty-based general anti-abuse provision in the Discussion Draft also in several places references the use of domestic law general anti-abuse rules to override treaties. We found this discussion especially troubling. Moreover, with the recommendation of an LOB provision in tandem with a treaty-based general anti-abuse rule, it appears that there could be situations where a transaction would have to run the gauntlet of the application of the LOB provision and the treaty-based general anti-abuse rule plus unilateral application of a domestic law general anti-abuse rule. We urge the OECD to take the opportunity to recommend unequivocally that anti-abuse rules with respect to tax treaty benefits must be included in the treaty itself.

Targeted specific anti-abuse rules Finally, the Discussion Draft recommends the use of targeted specific anti-abuse rules to address qualification for particular treaty benefits. In this regard, the Discussion Draft notes that although the main purpose test will address these situations, “targeted specific anti-abuse rules generally provide greater certainty for both taxpayers and tax administrations.” We agree that more specific rules provide greater certainty than do more general rules.

We believe that the use of targeted specific anti-abuse rules that support particular treaty provisions is a better approach than the main purpose test. Such rules could be used to supplement and backstop the LOB provision which applies more generally. Indeed, such

rules could be used to address the conduit financing arrangements that have been identified as the target of the main purpose test. We urge the OECD to consider replacing the recommendation for a treaty-based general anti-abuse rule with an approach that uses targeted specific anti-abuse rules in tandem with an appropriately crafted LOB provision.

One of the areas where a targeted specific rule is recommended is the determination of residence for treaty purposes in the case of dual-resident entities. The Discussion Draft proposes the elimination of the tie-breaker rule currently contained in the OECD model and its replacement with a rule that would require affirmative competent authority action. Under the proposed rule, a dual resident entity generally would not be entitled to any treaty benefits unless the competent authorities affirmatively agree to treat it as resident of one country or the other.

The question of residence is a fundamental one and most of the benefits of a treaty turn on it. Leaving a determination as to residence to the competent authorities does not seem practical or appropriate given the resource constraints of the competent authorities, the significant other responsibilities of such competent authorities, and the difficulties that competent authorities can have in reaching agreement.

The issues associated with reforming the current tie-breaker rule for treaty residence determinations are necessarily intertwined with Action 14 on improving the functioning of the mutual agreement procedure. We urge that potential modifications to the tie-breaker rule be separated from the work on addressing treaty abuse and instead be examined as part of the work on Action 14 where any modifications can be coupled with approaches designed to facilitate resolution by the competent authorities.”


The proposals described in the Discussion Draft are being developed pursuant to the OECD Base Erosion and Profit Shifting (BEPS) Action Plan, which was issued 19 July 2013. These proposals were released in draft form to provide an opportunity for stakeholders to comment.

As reflected in the July 2013 white paper, the OECD is proposing a common approach to transfer pricing documentation that would involve two tiers of information: a master file with comprehensive information about the global operations of a multinational corporation (MNC) group and local country files with transactional information relevant to each country. For that reason, the Discussion Draft is in the form of a proposed revision to the documentation chapter of the OECD Transfer Pricing Guidelines and it contemplated that the new CbC reporting template would be included in the transfer pricing master file. However, the OECD specifically requested comments on whether the template should instead be provided to tax authorities as a separate document.

The Discussion Draft noted that the information in the CbC reporting template “may be helpful in risk assessment processes.” However, it further noted that such information “should not be used as a substitute for a detailed transfer pricing analysis” and that such information “would not constitute conclusive evidence that transfer prices are or are not appropriate.”

Also included were a form of template and descriptions of the data sources to be used for the template. The Discussion Draft further notes that the OECD will consider “whether information relevant to other aspects of tax administration and the BEPS Action Plan should also be included in the common template.”

Importantly, the OECD described the proposed CbC reporting template and transfer pricing documentation guidance as an initial draft that does not necessarily reflect consensus views of the OECD working groups. It is noted that the draft reflects limited consideration of the issues since the July release of the BEPS Action Plan and that “stakeholder comments are essential.”

Chris SangerGlobal Director – Tax Policy Services T: +44 20 7951 0150 E: [email protected]

On 30 January 2014, the Organisation for Economic Co-operation and Development (OECD) released the much-anticipated draft of its proposed template for country-by-country (CbC) reporting to tax authorities in its Discussion Draft on Transfer Pricing Documentation and CbC reporting). The OECD Discussion Draft also elaborates on the OECD’s White Paper on Transfer Pricing Documentation, which was released on 30 July 2013. In the CbC reporting template, reporting at the entity level was proposed and the volume of data required for each entity seem to go well beyond the high-level risk assessment exercise that was originally intended. Businesses made their concerns known, with more than 1,200 pages of formal comments and equally robust engagement with all stakeholders. Ten weeks later, the OECD announced that reporting would only be required on an aggregated basis.


OECD releases draft country-by-country reporting template, provides second version requiring aggregate reporting

Form of template changed significantly after business inputThe draft CbC reporting template would have required information with respect to each entity in an MNC group, arranged by the entity’s country of organization. The entities covered would have included the ultimate parent and all entities that are considered to be “associated enterprises” of the parent under the OECD Transfer Pricing Guidelines. Each permanent establishment that has a separate income statement for regulatory, financial reporting, internal management or tax purposes would have been considered to be an entity and would have be reported under the country in which it is situated.

Only 10 weeks or so after the discussion draft was published, the OECD’s tax group used an early April webcast to announce significant changes to the template. Joe Andrus, who leads the OECD’s transfer pricing unit,1 highlighted the interest in this area, noting that the OECD received more than 1,300 pages of comments on the discussion draft on transfer pricing documentation and CbC reporting. He reported that the responsible OECD working group had productive meetings during the week of 24 March and had reached tentative decisions on several important modifications to the proposals in the discussion draft. The tentative decisions, which he noted are only tentative because they have not yet been reviewed by the OECD Committee on Fiscal Affairs, include the following key points regarding the CbC template and the master file/local file approach to transfer pricing:

• The template will be modified to require reporting of aggregated information by country rather than requiring entity-based reporting.

• The template will include a list of all group entities by country together with the business activity codes for their major activities.

• The financial data required to be reported on the template will be back and will include revenue, earnings before tax, cash tax, current tax, stated capital and accumulated earnings, employee head count, and tangible assets.

• The six columns of intercompany transaction information included on the draft template will be eliminated and this transactional information will be included only in the transfer pricing documentation local file.

• The data used to populate the template will be permitted to be sourced from either statutory accounts or financial statement reporting packages, applied consistently across the group and from year to year.

• The template will not be part of the master file and rather will be a standalone document.

• Information on the 25 highest paid employees as proposed in the discussion draft to be included in the master file will be eliminated.

• It will be clearly stated that the information in the master file is intended to be high-level information.

Andrus further noted that there are issues that remain under consideration and will

be discussed at the May meeting of the OECD working group. These issues include the process for delivery to tax authorities of the CbC template and transfer pricing master file and the language and translation requirements with respect to these documents.

ImplicationsThe G8 leaders in their June 2013 communique explicitly committed to the development of a template for reporting to tax authorities of CbC information. Moreover, increased transparency is a key objective of the OECD BEPS Action Plan. It is expected that many countries would act on OECD recommendations that are issued in this area. Therefore, companies should closely monitor developments with respect to the draft CbC reporting template.

While the OECD has indicated that the template is intended to be used for high-level risk assessment purposes, the initial draft contemplated very detailed reporting. The news that the template will now capture aggregated data is to be welcomed. But, whatever the form (and recognizing that the scope of the template may well continue to change), companies should begin to consider how to prepare for a new reporting requirement of this type. Consideration should be given to existing financial reporting systems and the availability of data sources that could be used to provide information of the type and in the form contemplated in the draft template.


1. Joe Andrus will be succeeded by Andrew Hickman in May 2014: http://www.oecd.org/tax/head-transfer-pricing-andrew-hickman.htm.


Point of view: The OECD’s Discussion Draft on Transfer Pricing Documentation and Country by Country Reporting

Chris SangerGlobal Director – Tax Policy Services T: +44 20 7951 0150 E: [email protected]

The OECD’s Discussion Draft on Transfer Pricing Documentation and Country by Country Reporting (“Discussion Draft”) was the first discussion draft issued under the auspices of the BEPS project. As the vanguard of seven such drafts this year, many hoped that it would provide some indication of how assertive the OECD planned to be on the BEPS project as a whole.

In this regard, it was a wakeup call as, despite the action item identifying the need for consideration of the burden on business, the Discussion Draft as released in its original form did not reflect an appropriate balance between the provision of relevant information to tax authorities and the burdens for business. This original draft clearly demonstrated the need for business to engage in the debate and to help inform the development of the proposals; and indeed the benefit of, and the wisdom of the OECD in, opening such drafts for discussion and debate.

The paper generated over 1,200 pages of responses and, with the OECD’s April update webcast announcing some preliminary changes to the original draft, we are already seeing the benefits of that engagement.

Changes to reflect the purpose of the country-by-country reporting templateAccording to the OECD, the country-by-country reporting template should be used for high-level transfer pricing risk assessment purposes and should not be considered to be a substitute for detailed transfer pricing analysis. As noted by EY in our comment letter to the OECD,1 we felt that the country-by-country reporting template should be a separate document and should not be included in the transfer pricing documentation master file. This would be consistent with the template’s use as a high-level risk assessment tool only.

One of the most commonly heard objections from business about the original Discussion Draft was that the country-by-country reporting template should provide flexibility as to the data sources to be used to populate it, so that MNC groups could use the data that is most readily available within their own systems. It is therefore to be welcomed that the revised approach (although currently remaining provisional) mentioned on the OECD’s April update webcast now centers upon aggregated reporting at the country level.

Many comment letters to the OECD (including EY’s) noted that the scope of the country-by-country reporting template should be narrowed and modified to focus on its intended objective of transfer pricing risk assessment and that the template should not be used as an information-gathering instrument for other BEPS action points. Again, it is to be welcomed that (according to the latest OECD webcast)2 the template is likely to be significantly scaled back. Of course, scope creep is always a possibility in the development of tax policy and regulation and all stakeholders will be carefully monitoring whether this Action Plan item suffers that fate over time.

A further point noted by EY and other comment letter authors was that, in order to maintain confidentiality and limit the burden, the country-by-country reporting template should be required to be delivered only to the parent company’s home country and should then be shared with other countries under tax information exchange relationships.


1. http://www.oecd.org/tax/transfer-pricing/comments-discussion-draft-transfer-pricing-documentation.htm

2. http://www.oecd.org/tax/beps-webcasts.htm

Other suggestions for changeIn addition to the suggestions on the country-by-country reporting template, there are a number of other areas where EY has suggested changes:

• Master file vs. local file With regard to the Transfer Pricing master file / local file

combination, it is EY’s view that the master file should only contain information that is relevant for all entities. Information that is only relevant for a single entity or a group of entities should either be included in the local (country) file, or can be shared through treaty mechanism. This applies for example to information on APAs and MAP matters.

• General risk assessments Successful outcomes of any major change initiative

benefit from collaboration and give and take. Clarity and transparency regarding the risk assessment policies applied by tax authorities could assist taxpayers in the preparation of relevant documentation and would help reduce administrative burdens for both taxpayers and tax authorities. In this regard, tax administrations should share at least their general risk assessment policies with taxpayers.

• Use of safe harbors, materiality and focus The use of “materiality” and focusing on “important

transactions” can reduce the administrative burden for taxpayers, as can the use of safe harbors.

• Allow sufficient flexibility to adapt documentation to circumstances

In terms of the guidance provided by the OECD on transfer pricing documentation, it is important that the taxpayer is provided with the flexibility to adapt to specific facts and circumstances, with the taxpayer providing an explanation regarding the particular adaptation.

• Provide sufficient lead time Finally, even at the revised aggregated level of presentation,

given the significant effort that companies would have to expend to prepare the documentation in the format and detail proposed by the OECD, clear rules with regard to the timing of implementation should be established. Companies should be provided sufficient lead time in order to be able to develop the new systems and processes needed in order to comply with the new rules.

Engaging with stakeholdersA final thought relates not so much to technical composition as it does to process and protocol. The OECD discussion drafts are open for comment for very short periods and, as shown by the changes announced in the webcast, engagement really can make a difference. However each window of opportunity to engage may be extremely short and requires focused resource. Companies would be best advised to identify where they have the most interest and focus their efforts accordingly.


OECD releases Common Reporting Standard: a global FATCA-like regime

Julian SkingleyEMEIA Financial Services T: +44 20 7951 7911 E: [email protected]

Paul RadcliffeEMEIA Financial Services T: +44 20 7951 5816 E: [email protected]

On 13 February 2014, the Organisation for Economic Co-operation and Development (OECD), at the request of the G8 and the G20, released a model Competent Authority Agreement (CAA) and Common Reporting Standard (CRS) designed to create a global standard for the automatic exchange of financial account information.1 The publication of the CAA and CRS is a significant structural step in governments’ efforts to improve cross-border tax compliance. This follows a raft of tax compliance legislation such as the US Foreign Account Tax Compliance Act (FATCA) and active campaigns for voluntary disclosures and legal procedures, most recently in Germany and Italy.

The aim is to reduce tax evasion by taxpayers using offshore financial accounts held both directly and indirectly through enhanced information reporting.

The good news for financial institutions is that the OECD has modeled the CRS on FATCA, which means it should be possible to leverage existing and planned FATCA processes and systems. However, the data required is different, and the volumes are likely to be significantly greater under the CRS.

The standard has no direct legal force but it is expected that jurisdictions will follow the model CAA and CRS closely when implementing bilateral agreements.

There is significant political will to implement this standard with over 40 jurisdictions signing up to early adoption. The expected timeframe could see jurisdictions seeking to sign agreements in 2014, with new customer due diligence procedures required in 2015 and reporting in 2016.

Although there is further detail to come, financial institutions may wish to consider the impact of the CRS on their FATCA compliance, as well as the best way to engage with prospective competent authorities.

Building on FATCAThe CAA and CRS are based heavily on the FATCA Model 1 Intergovernmental Agreement (Model 1 IGA) with certain amendments to remove US specificities and build on work already performed as a result of FATCA.

The CAA and CRS reflect the approach described in the OECD report of

18 June 2013 (A Step Change in Tax Transparency). Reporting financial institutions will report financial account information on certain account holders to their national tax or other competent authority. These will, in turn, provide information to other competent authorities in a partner jurisdiction under a systematic and periodic transmission of “bulk” taxpayer information — an “automatic exchange” of information. The information to be exchanged will cover all types of investment income. This will include interest, dividends, income from certain insurance contracts and other similar types of income as well as account balances and sales proceeds from financial assets.

Structure of the standardThe CAA is a base agreement. It sets out general definitions, the obligations of the jurisdictions to obtain and exchange information, and the procedures for collaborating on compliance and enforcement. The annex to the CAA is the CRS, which describes the due diligence requirements for identifying and reporting on specific types of accounts under the agreement, and provides additional definitions.

The overall process for obtaining customer classifications is broadly the same as the Model 1 IGA but the nature of those classifications is based on residency rather than citizenship or nationality. This is because the OECD has recognized the investment in FATCA by the financial industry and should mean financial institutions can leverage a significant amount of the work already performed when complying with this new standard.


1. Section 2590 of the Income Tax Act of Australia: Debt deductions in earning nonassessable nonexempt foreign income.

Expected timing for adoption of the standardThe CAA and CRS were formally submitted by the OECD to the G20 Finance Ministers and Central Bank Governors meeting in Sydney on 22-23 February 2014. In a joint statement issued 19 March 2014, numerous countries (referred to collectively as Early Adopters) committed to the early adoption of the OECD’s new standard for the automatic exchange of information between tax authorities, also known as the CRS. Specifically, Early Adopters recognized tax evasion as a global problem requiring a global solution, and welcomed the CRS as way to work in close cooperation to tackle cross-border tax evasion.

The Early Adopters’ “ambitious but realistic” implementation timetable is as follows:

1 January 2016: Accounts opened prior to this date will be treated as pre-existing accounts. Accounts opened on or after this date will be treated as new accounts. New account opening procedures to record tax residence will need to be in place from this date.

31 December 2016: Due diligence procedures for identifying high-value, pre-existing individual accounts must be completed.

31 December 2017: Due diligence procedures for identifying low-value, pre-existing individual accounts and for entity accounts must be completed.

30 September 2017: The first exchange of information in relation to new accounts and pre-existing individual high-value accounts will take place by this date.

30 September 2017 or 30 September 2018: Information about pre-existing individual low value accounts and entity accounts will either first be exchanged by 30 September 2017, or 30 September 2018, depending on when financial institutions identify them as reportable accounts.

Adoption of the standard by partner jurisdictions will be in two phases. A competent authority will need to implement the CRS into local law. This local law would require financial institutions to collect and report data of account holders. At this stage many

authorities are expected to provide guidance on local interpretation. Further, jurisdictions will need to agree to the CAA to facilitate the automatic exchange of information. This may be done bilaterally, through existing treaties or through the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, a multilateral tax information exchange instrument.

Further guidance on interpretationIndependently of the adoption of the CAA and CRS, the OECD will continue to develop the commentary to accompany the CRS as well as the technical solutions to implement the actual information exchanges. The commentary will be of crucial importance in terms of providing sufficient guidance and explanation to allow financial institutions to interpret the CRS. It is currently expected that this commentary will be released in time for the September G20 Finance Minister meetings.

A significant concern will be whether jurisdictions will take different positions in terms of interpretation. The industry hope is that any such differences are few and far between. An additional concern, given the potential number of adopting jurisdictions, will be how financial institutions will track such differences. One possible route could be for the OECD commentary to record any differences in interpretation. This approach would allow financial institutions to look to one point of reference.

The OECD Background Information Brief released at the same time as the CAA and CRS acknowledges this concern and states that the standard will be a “living system” and so may need to “evolve over time.” Helpfully the OECD also notes that, “the OECD, working with G20 jurisdictions, will seek to ensure that the standard remains a single standard also over time and that as much as possible it continues to be interpreted and operated consistently across different jurisdictions.”

It is also worth noting that the CAA is only a model and, before coming to an agreement, jurisdictions are able to negotiate amendments to it. Therefore, financial institutions need to make a judgment regarding the point at which the requirements are incorporated into

their operations, given that may preempt external legal milestones.

Implications• Implementation timelines are likely to

be very tight.• OECD commentary is not due to be

released until around the middle of 2014.

• FATCA programs can be leveraged but there are differences that may require additional processes/procedures in order to comply.

Next steps• The approach adopted by financial

institutions will be influenced by, among other things, the extent to which they consider that the anticipated timetable for implementation of the OECD proposals may change. Currently, the anticipated timeline appears ambitious. In any event, as the CRS is a model agreement, the requirements are subject to change, both in terms of the final agreements that are entered into and the interpretation, local legislation and guidance provided at a country level.

• Financial institutions will need to decide the best time to initiate a change program to ensure it can satisfy the requirements of the CRS, taking into account, in particular, the time required for implementing changes to its customer classification processes.

• However, financial institutions may want to take steps now to understand the key differences and similarities between the CRS and FATCA, and the corresponding impact on their approach to FATCA compliance. For example, there may be opportunities to reduce effort by combining FATCA planned activities with the CRS, such as the review of high-value accounts.

• Financial institutions may also wish to consider the best approach to engaging with prospective competent authorities to help ensure that businesses can comply with the CRS in a way that minimizes cost and disruption.


The minimum all treasury and finance professionals should know about FATCA

This short article is designed to assist treasury and finance professionals to develop baseline knowledge around what FATCA may mean for their enterprise. The article is available as an online podcast in seven languages at ey.com/FATCA.

In 2010, the US Government decided it needed new rules to deal with its concern that American individuals and companies might not be properly reporting all monies held outside of the US. It worried that money was being held in foreign bank accounts that it was unaware of and that those individuals and companies might not pay the right US taxes.

FATCA was developed and regulations were issued in 2013. Most of these regulations will come into effect on 1 July 2014.

Under these FATCA regulations, the US is requiring foreign financial institutions (FFIs) to:

• Register with the Internal Revenue Service (IRS)

• Review their list of existing customers and redocument them

• Create and comply specific onboarding procedures for new customers

• Report on “US account holders”

• Monitor changes in the circumstances of their customers

• Withhold 30% tax on non-cooperating customers in some circumstances


Some parts of FATCA apply to US financial institutions and other entities that are US withholding agents. FFIs are affected the most.

So when is a company an FFI?

In the simplest terms, every non-US entity is an FFI unless it is not. In other words, an entity is not an FFI if it falls under one of FATCA’s exceptions. Entities in non-financial groups are generally not FFIs. But some may be. Therefore, it must be determined whether your group is a non-financial group or an FFI.

A group of companies qualifies as a non-financial group if 25% or less of the group’s income consists of so-called “passive income,” such as interest dividends and royalties, and no more than 25% of the assets are producing, or held for the production of, passive income.

In addition, no more than 5% of the income of the group may be produced by a company that does qualify as an FFI.

That’s right: even if your group of companies can qualify as a non-financial group, there may still be entities within the group that will qualify as FFIs. Examples of such FFIs within a non-financial group include:

• Insurance companies that offer annuity contracts or cash value insurance contracts. For instance, a company that issues certain types of life insurance contracts to its employees will be a financial institution under FATCA. On the other hand, insurance companies that solely offer pure protection insurance, such as flood insurance, business interruption insurance or product liability insurance, should not be FFIs under FATCA.

• Non-US retirement funds and pension plans will be FFIs if they do not meet certain specific exemptions for retirement plans and exemption schemes. These exceptions could be difficult to meet, and each entity should make the appropriate assessment of the rules.

• Securitization vehicles set up to issue debt will be FFIs.• Entities that issue credit cards or payment cards that can be

preloaded with funds in excess of US$50,000 to be spent at a later date, such as prepaid credit cards or “e-money,” can be considered an FFI. However, if the entity does not perform any other banking-type activities that would cause it to be an FFI, the entity could qualify for a “deemed-compliant category” as a “deemed-compliant credit card issuer.”

• Holding companies, treasury centers and captive finance companies may be FFIs and subject to FATCA. However, if the holding treasury center or captive finance company is part of a non-financial group and its activities are restricted to those described in the FATCA regulations it may qualify for an exemption.

If an FFI in a non-financial group is organized in a country that has signed a FATCA Intergovernmental Agreement (IGA) with the US, there may be certain exemptions and exceptions that would exempt it in addition to those mentioned above. But no matter where the FFI is organized, you must confirm that it fits within an exemption or it must comply with FATCA.

As of late March 2014, 26 countries had concluded IGAs with the US, although the IGA with Switzerland is awaiting confirmation following a referendum. In addition, three British Crown Dependencies have signed IGAs.

So as a company, you need to determine first whether you are a non-financial group and second that none of the entities within your group qualify as FFIs. If you have FFIs in your group, you need to make sure they are either exempt or they are compliant with the actions that the FATCA regulations require from FFIs.

Unfortunately, that is not all that you need to consider. Even if you are a non-financial group of companies and you have no FFI in your group, you may still be subject to FACTA reporting and withholding in a number of instances, for example:

FATCA The minimum all treasury and finance professionals should know

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財務/経理プロフェッショナルが最低限知っておくべきこと

金融和财务专业人士必知的FATCA规则


• If you have a bank account anywhere you will need to certify your FATCA status to your bank on a Form W-8 (or W-9 for your US entities) or on another document required by the bank and possibly to other counterparties and payors, known as withholding agents. This will likely apply to most if not all the entities in your group. If the entity does not or cannot fill out this form, there is a risk that FATCA withholding of 30% may apply to certain payments made to you. Not only is this cash flow negative, but the refund process, which is not always available, will add administrative burden to your operations.

• In certain cases, this certification could require that you have to disclose the direct or indirect US owners, if any, of your company.

• If an entity is not an FFI and is an “excepted non-financial foreign entity” (NFFE), it will not have to disclose its owners. Excepted NFFEs include:• non-financial publicly traded corporations and their non-

financial subsidiaries and affiliates• NFFEs engaged in an active trade or business

• However, if a non-financial foreign entity does not meet the criteria for an excepted NFFE, it should be treated as a “passive NFFE.” Passive NFFEs are subject to withholding unless they certify to their payors that the entity to which the payment is being made does not have any US owners who own more than 10% of the entity directly or indirectly or who control the company. If they cannot certify this, the entity must provide the required information concerning each substantial US owner or controlling US person to the payor.

• One of your entities may be making US-source “withholdable” payments to non-US entities such as interest, dividends, premiums for insurance contracts or annuity contracts, investment advisory fees, custodial fees, payments made under swaps, futures, and other hedging transactions and/or bank or brokerage fees from US sources. These payments could be subject to FATCA reporting and withholding. Non-financial companies should look closely at their operations to determine if they are making US-source payments to non-US entities. In fact, as a payor of withholdable payments, you also need to ask questions to make sure the payee is FATCA-compliant and obtain the forms discussed above. Failure to do so could make you liable for failing to withhold tax.

All of the previous points taken into account, there are three main areas you should focus on when making your assessment of what to do next:

First• Examine your corporate footprint• Define and review your organizational footprint• Review entities within the corporate footprint and identify

each legal entity’s FATCA classification (e.g., FFI, excepted NFFE, passive NFFE, US withholding agent)

• Identify documentation to be provided to payors for each entity

Second• Analyze your payment streams• Identify business units making and processing payments

and review any FATCA implications, which typically includes accounts payable, treasury, shareholder relations, trust department and any other function involved in payment processing and determination of income (e.g., procurement, legal and business units)

• Review impact on intercompany transactions as well as third-party payments

Third• Determine your current information and withholding

compliance capabilities if you have current US tax reporting and withholding responsibilities because you are already a US withholding agent

• Review current information reporting and withholding capabilities

• Identify process and procedure gaps under current laws; if you are not complying with current requirements, you will have difficulty complying with FATCA

Stop press: IRS eases enforcement for compliance with FATCA until 2016 for taxpayers making a good faith effort to complyIn Notice 2014-33, the IRS has announced that it will treat calendar years 2014 and 2015 as a transition period for purposes of enforcing and administering implementation of FATCA by all withholding agents (including foreign financial institutions).

The Notice specifically provides that it does not otherwise affect the timelines provided in the final and temporary FATCA regulations for due diligence, reporting or withholding, and will not modify the starting date for an FFI to implement new

account opening procedures for accounts maintained by the FFI that are held by individuals. Also, it does not appear that the cut-off date of 30 June 2014, will be moved for purposes of defining a “grandfathered obligation.”

Implications: Notice 2014-33 does NOT extend the effective date of either FATCA or the conforming regulations. However, similar to the years 1999 — 2001, when the current chapter 3 regulations initially became effective, so long as a withholding agent or FFI makes a good faith effort to comply with its US withholding and reporting obligations, it will not be subject to withholding tax liabilities or penalties for failing to withhold or report in 2014 or 2015.

Read more at www.ey.com/FATCA

EY has sought to provide you this practical summary of the FATCA regulations to give you an initial high-level overview of how these may impact you. The information we provide is necessarily simplified and limited by the nature of this presentation. Therefore, we do urge that you seek professional assistance in making any assessment or determination of the way in which your company will need to comply with the FATCA regulations.

If you would like to learn more about FATCA or keep up to date with the ever-changing regulations and guidance, please visit our FATCA portal at ey.com/FATCA, where this short article is available as a podcast in seven languages.


Rob HansonGlobal and Americas Director – Tax Controversy Services T: +1 202 327 5696 E: [email protected]

On 14 February 2014, the Internal Revenue Service (IRS) issued the Transfer Pricing Audit Roadmap (Roadmap), which provides best practices and helpful reference materials for Large Business & International (LB&I) employees regarding the administration of transfer pricing audits. The Roadmap, organized around a basic 24-month audit timeline, breaks down a transfer pricing audit into three phases: planning, execution and resolution, under the rubric of the IRS Quality Examination Process (QEP).

IRS releases Transfer Pricing Audit Roadmap


From an institutional perspective, the Roadmap represents an effort to formalize the continuous involvement of transfer pricing specialists in transfer pricing audits, from inception to completion. Overall, the Roadmap emphasizes coordination within LB&I, including the exam team and transfer pricing specialists, and the taxpayer, and encourages constant communication among all three groups of stakeholders. Further, opening with the statement that “Transfer pricing cases are

usually won and lost on the facts,” the Roadmap seems to emphasize fact gathering as a means of building a case not only for exam, but for successful litigation. Accordingly, taxpayers are well-advised to ensure that their transfer pricing documentation is robust and presents a factual picture consistent with its tax returns and financial statements.

The following chart provides more detail on the three phases.

Detailed discussionInvolving transfer pricingAs part of the 1 October 2010 reorganization that created the LB&I division, the Transfer Pricing Operations (TPO) group was created.1 The TPO is headed by an executive and encompasses both the Advance Pricing and Mutual Agreement (APMA) Program and the Transfer Pricing Practice (TPP). The TPP is a group of transfer pricing specialists — including economists,

lawyers, international examiners and other experts — assembled to assist the field team with transfer pricing enforcement. In the past, transfer pricing cases were handled primarily by international examiners, who were trained in more general international tax issues and typically did not have in-depth knowledge of US transfer pricing rules. In September 2012, the TPP began actively participating in field audits.

QEP phases

Planning

Execution

Resolution

Transfer pricing audit stages and timeline

Cycle time in months

Non-cycle time 1st to 2nd 3rd 4th 5th 6th 7th to 15th 16th 17th 18th 19th 20th to 23rd 24th

Pre-examination analysis

Opening conference, transfer pricing orientation

Preparation of initial risk analysis, exam plan and key milestones

Fact finding and additional IDRs, functional analysis

Mid-cycle risk assessment

Issue development and preliminary reports

Pre-NOPA issue

presentation

Resolution discussion

Final NOPA and case closing

Transfer Pricing Audit Roadmap


1. The TPO is national in scope and is divided into three territories — East, Central and West.

Planning phase: pre-examination analysis1. Preliminary assessmentThe initial planning phase of the Roadmap can last up to 6 months and starts before the 24-month audit cycle begins. During this phase, examiners are instructed to review the taxpayer’s returns, with particular emphasis being placed on Forms 5471, 5472, 8833, 8858, 8865, and 926, as well as schedules UTP and M-3. Examiners are also encouraged to familiarize themselves with the taxpayer’s business operations (e.g., review of 10-K information) and to perform preliminary economic analyses (e.g., conduct key financial ratio analysis). Essentially, this phase of the exam involves reviewing the information already at the IRS disposal, including prior audit cycle results, reports and Appeals Case Memoranda, as well as internal IRS tools to conduct industry analyses. Also during this phase, the examiner prepares the mandatory information document request (IDR) and initial examination contact letter, both of which are issued simultaneously.2 Finally, the Roadmap makes the first of many references to TPP involvement throughout the document, noting that a member of the TPP and/or an economist will participate in the preliminary assessments, and the level of involvement of a TPP member can range from advisor to lead examiner.

2. Internal Revenue Code Section 6662(e)3 documentation review

In this step of the planning phase, examiners review and analyze the Section 6662(e) documentation and note areas that require further development, confirmation or inquiry. Examiners will determine whether the documentation provided meets the requirements established in the Regulations, and

are instructed to coordinate with the economist and the TPP on the initial assessment and hypothesis.

3. Planning meetingsAlong with discussing general items such as timeframes and key milestones, the preliminary planning meeting should be used as an opportunity for examiners to identify the key taxpayer personnel who will be responsible for assisting the exam team with the transfer pricing audit and to request data and records relevant for the transfer pricing audit. The Roadmap also instructs TPP members to discuss the IDR process (e.g., response times, taxpayer input) with the taxpayer during this meeting and specifically mandates APMA notification with regard to challenged transactions involving treaty partners.

4. Opening conferenceThe opening conference, which kicks off the 24-month audit cycle, provides a forum for the audit team to discuss the general aspects of the audit process (e.g., review of the Roadmap as applied to the case, IDR response time and delays, Notice of Proposed Adjustment (NOPA) issues and resolution processes) with the taxpayer.

5. Taxpayer orientationsWithin 30 days of the opening conference, there will be a financial statement/books and records orientation meeting. The goal is to address all topics financial and can include, among other things, a reconciliation from geographical trial balance to the consolidated financial statement in the 10-K, reviewing segmented financial statements and roll ups to the consolidated financial statement, mapping from the tax return to trial balance to general ledgers, reviewing work papers for book/tax differences and gaining an overview of the taxpayer’s accounting practices

and policies. Soon after the financial statement/books and records orientation meeting is held, there should also be a transfer pricing orientation meeting. In that meeting, the examiner’s goal is to, among other things:

• Gain more insight into the taxpayer’s intercompany transactions

• Determine the functions performed, assets employed and risks assumed among controlled parties

• Identify who is responsible for tax planning

• Understand the value chain(s) associated with the intangible, services or tangible goods

• Gain an understanding of the taxpayer’s transfer pricing methodology

6. Preparation of initial risk analysis and audit plan

The last step of the planning phase includes the preparation of the risk analysis and audit plan, both of which are approved internally and then provided to the taxpayer. This period also serves as an opportunity to request additional information from the taxpayer.

Execution phase: fact findingThe execution phase typically spans across a 14-month period. This phase is comprised of two main steps: fact finding and issue development.

1. Fact finding Fact finding involves the issuance of any necessary additional IDRs; interviews of relevant taxpayer employees; and plant tours and site visits. The purpose of this step is to give the audit team the ability to perform in-depth functional analysis, identifying all significant economic activities connected to the transactions under review. The examiner should also perform a comparability analysis.


2. Taxpayers are required to respond within 30 days from receipt of the initial examination contact letter.

3. All “Section” references are to the US Internal Revenue Code of 1986, as amended, unless otherwise stated. The Regulations promulgated thereunder are referred to as “regulations” and cited as “Treas. Reg. Section.”

The Roadmap instructs the audit team to meet with taxpayer in order to confirm the material facts developed during the examination. Particularly, a written statement summarizing the material facts from the exam team’s perspective should be provided to the taxpayer and the taxpayer should be requested to provide a written confirmation or explanation of differences between its position and the IRS. This interactive process is anticipated to have a significant impact on case resolution.

As an important side note, the Roadmap also directs audit teams to coordinate any discrete legal issues found with Field Counsel, Associate Chief Counsel International, the TPP and the International Practice Network.4

2. Issue developmentHere, the economist on the case is tasked with performing an economic analysis consistent with the working hypothesis, in consultation with various team members, including the examiner, the TPP member and field counsel. In addition to a strong and coherent economic analysis, an effective presentation of the position is required, which will include an explanation of the background and facts used in developing hypothesis. This write-up, along with the preliminary economist’s report, will form the basis of the draft NOPA, which will be submitted to the taxpayer for discussion of inaccuracies and points of disagreement. The ultimate goal being to have an agreed set of facts presented in the final NOPA, the Roadmap notes that the process can be an iterative one, based on repeated rounds of receiving the taxpayer’s input and then redrafting. During this phase, the audit team should also consider the applicability of Section 6662 penalties, as well as prepare a mutual agreement procedure report if applicable.

Resolution phaseThe resolution phase usually occurs during the last 7 months of the audit cycle. This phase is composed of three main steps: issue presentation, issue resolution and case closing/revenue agent’s report (RAR).

1. Issue presentationPrior to finalizing the NOPA, the audit team will meet with the taxpayer to discuss the government’s findings on all transactions at issue. The audit team should work to understand the taxpayer’s position, determine whether the taxpayer agrees with the facts as stipulated by the IRS and establish whether the taxpayer would agree to any issues.

2. Issue resolutionThe audit team and the taxpayer will meet to determine whether a resolution of the issues raised is possible. The Roadmap suggests discussing pre-Appeals resolution opportunities on issues left unresolved at the examination level. Once all issues are fully developed and resolution efforts have been concluded, a final NOPA will be issued. For all agreed issues, a discussion of Rev. Proc. 99-32 election and its ramifications is appropriate.5

3. Case closing/RARIn the last step, the audit team will prepare a RAR/30 day letter for all unresolved issues, hold the Appeals pre-conference meeting and attend the post-Appeals meeting.

Implications The Roadmap is a toolkit for conducting transfer pricing audits, from the identification of issues, to the formulation of a working hypothesis, to the resolution of the issues. The process relies heavily on open and active communication between the taxpayer and the exam team.

With an emphasis on the involvement of TPP members in every step of the audit, taxpayers should be prepared for scrutiny by professionals with sophisticated transfer pricing knowledge. Further, having robust documentation of transfer pricing methodologies is extremely important, as the Roadmap itself approaches the audit with the maxim that cases are “won or lost on the facts.” With this in mind, it is reasonable to expect that the meticulously detailed steps set forth in the Roadmap could be designed to generate reports, notes and stipulated facts that could potentially form the basis of case development for litigation, in the event that issues are unable to be resolved at the Exam or Appeals levels.

The Roadmap points out that transfer pricing audits can take a much as two to three years. As such, the Roadmap is constructed on a two year framework. While the two year framework is not mandatory, the Roadmap seems to emphasize issue development over currency.

Taxpayers would be well-advised to take advantage of the Roadmap, which emphasizes cooperation not only among various groups within LB&I, but also with the taxpayer. Coupled with LB&I’s new IDR Directive, taxpayers should have the opportunity to frame their transfer pricing methodology in a compelling manner, clearly addressing the basis for their business decisions and the resulting financial outcomes and effective tax impact.


4. To assist in the development of in-house transfer pricing experts, the IRS has established internal knowledge management tools, including internal communication networks where examiners and other personnel can exchange their experiences and observations. One of these networks is the International Practice Network, a knowledge development network for international issues (including transfer pricing).

5. Rev. Proc. 99-32 discusses the Service’s position regarding adjustments that may be made to conform the accounts of taxpayers to reflect allocations made under Section 482, and avoid the tax consequences that might otherwise result from those conforming adjustments.

Webcast

Webcast: which transfer pricing issues will dominate 2014?That’s the question that was posed to approximately 2,000 EY transfer pricing professionals around the world recently. During our recent BorderCrossings webcast, three of EY’s most experienced transfer pricing professionals addressed the question and provided predictions and insights. During a wide-ranging discussion about how transfer pricing trends, issues and events worldwide could affect your global compliance, controversy and planning in the months ahead, the following topics were covered:

• Transfer pricing aspects of the OECD’s Base Erosion and Profit Shifting (BEPS project, including a discussion of the 2014 timeline, expected discussion drafts and possible OECD approaches)

• Efforts by the Brazil, Russia, India, China and South Africa (BRICS) and other developing countries to shape global transfer pricing compliance strategies

• Trends in transfer pricing enforcement in the US, Canada, the European Union and other OECD countries

• An update on the merged US Advance Pricing and Mutual Agreement (APMA) program, including a discussion of the key proposed changes to the US mutual agreement process and the advance pricing agreement (APA) process reflected in Notice 2013-78 and Notice 2013-79, respectively

Join the conversation and access the webcast at:

ey.com/transferpricingin2014


Taxes around the world are on the rise. But these rises may be a bit less obvious than in the past. Governments are generally making fewer changes to headline corporate, personal and indirect tax rates in 2014 compared with 2013 and 2012. Instead, more are putting legislative changes in place that will adjust and expand the tax base for 2014 and beyond, often at the net expense of taxpayers.

Overall, just 10 countries of the 61 we surveyed have so far announced reductions to statutory corporate income tax (CIT) rates for 2014. Conversely, our respondents1 expect corporate tax burdens to be higher in 16 countries, although the increase in just three of those (France, India and Israel) can be attributed in part to a higher statutory rate. The higher burden forecast for the others stems from changes that broaden their tax base.

Rob ThomasContributing Editor – Tax Policy and Controversy Quarterly Briefing T: +1 202 327 6053 E: [email protected]

Recent findings by the Organisation for Economic Co-operation and Development (OECD) align with our survey respondents’ observations. The OECD’s latest annual revenue statistics2 publication concluded that tax revenues in nearly all member countries had rebounded from the depth of the global economic crisis and that the tax revenue to GDP ratio in 2012 of 34.6% reached a five-year high due to some combination of real economic growth, higher tax rates in some countries and base-broadening legislation in others. Broadly speaking, our respondents report that the same overall trends are also occurring across personal and indirect taxes.

In addition to using tax as a lever for deficit reduction, we see many countries in 2014 that appear eager to take the initiative on a global effort to combat BEPS, acting in advance of detailed recommendations pending this year and next by the OECD. For example:

• The Australian Government has introduced legislation requiring the Australian Taxation Office (ATO) to publicly report the gross income, taxable income and tax payable of all companies with annual income of AU$100 million or more.

• The French Government will disallow the tax deduction of interest accrued to related parties if the French taxpayer cannot justify (at the request of the French tax authority) that the lender is liable to CIT on such interest that amounts to at least 25% of the CIT that would have been due if the lender had been established in France. This new rule applies to fiscal years ended as of 25 September 2013.

The outlook for global tax policy in 2014

Chris SangerGlobal Director, Tax Policy services T: +44 20 7951 0150 E: [email protected]


1. EY’s tax policy leader in each country

2. “Tax revenues continue to rise across the OECD,” OECD, www.oecd.org/newsroom/tax-revenues-continue-to-rise-across-the-oecd.htm, 17 December2013.

• Mexico’s 2014 tax reform package contains a number of measures that could be described as inspired by Base Erosion and Profit Shifting (BEPS). They include a measure allowing the Mexican tax authorities to apply conditions to the application of existing tax treaties, a modified provision concerning the piercing of the corporate veil for tax purposes, and a series of new rules regarding tax-related crimes through which officers in corporations and even legal and tax advisors may be found liable and subject to imprisonment.

• In the area of general anti-avoidance rules (GAAR), Chile has announced a substance-over- form approach for 2014, while Vietnam and Greece both have a new GAAR for 2014.

It will be a challenge for companies to stay up to date with tax changes around the globe in 2014. All countries are trying to both expand and protect their tax base. Many are either making or planning wholesale tax reform. And at the supranational level, not only will the OECD BEPS project undoubtedly drive change, but similar activity by the European Commission will also require close attention.

CIT: rates and burden in 2014Our study of tax policies for 2014 indicates that while many countries continue to lower statutory CIT rates, a greater number of countries are actually increasing the overall CIT burden by expanding the tax base. Examples include:

• Increased tax enforcement, including more demands for disclosure and transparency, renewed focus on audit activities, and new or amended GAAR

• Changes to R&D tax incentives• Refinements to incentives designed to encourage capital

investment• Changes to withholding taxes• Tighter transfer pricing regulations and oversight• Limits on interest and business expense deductibility, including

a growing focus on payments made to low-tax jurisdictions• Decreases to the statutory CIT rate• Limitations to the tax treatment of losses• Tougher controlled foreign company (CFC) rules• More stringent thin capitalization rules

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Globally, Finland had the largest decrease (24.5% to 20%, an 18.4% decrease), while Israel had the largest increase (25% to 26.5%, a 6.0% increase) in the CIT rate.

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Countries decreasing their statutory CIT rates outnumber those that are increasing them by a ratio of more than three to one. Of the 61 countries surveyed, 10 countries already have or will lower their statutory CIT rates in 2014, while only 3 (France, India and Israel) have passed legislation to increase them. Chile’s recently elected President, Michelle Bachelet (who took office in March 2014), has promised a major overhaul to the Chilean tax system, including a gradual rise in the corporate tax rate from 20% to 25% — although there are currently no specific proposals in this area.

For 2014, Israel reports the largest percentage increase in the top CIT rates (an increase from 25% to 26.5%, a 6% increase), while Finland reports the largest percentage decrease, with the 2014 rate reduction from 24.5% (2013) to 20% (2014) representing a decrease of 18.4%.

Japan elected to repeal a temporary surcharge on corporate tax one year earlier than planned, resulting in a statutory CIT rate of 35.64% (down from 38.01% in 2013). This reduction gives Japan the third-highest effective corporate tax rate among the G20,3 below the US (39%)4 and France, where recent changes have increased the effective tax rate from 36.1% to 38% in 2014, albeit temporarily.5 It is understood that Japan’s Prime Minister, Shinzō Abe, would like to reduce the CIT rate further in future years, although he has made no specific proposals.

Russia and Saudi Arabia (both 20%) have the lowest effective CIT rate of the G20 nations, followed by the UK (21%). The UK will equal Russia’s and Saudi Arabia’s rates in 2015, when the main and small profits rates for companies will be unified at 20%. Many other countries may now see a rate of around 20% as a medium-term target.

The downward trend for rates, however, obscures the increasing corporate tax burden.6 In all, 16 of the 61 countries forecast an overall increase in 2014. This increase builds on findings in our 2013 policy outlook, in which 15 of 60 countries forecast an increase. In contrast, just 11 of the 61 countries project a decreasing tax burden overall for 2014, a 39% drop from 2013, when 18 of 60 countries surveyed then, projected a decline.

3. Japan is fourth if the taxation of foreign companies in India is taken into account; foreign companies in 2014 will pay an effective tax rate of 43.26%, including surcharge and education CESS, while the ETR for domestic companies is 33.99%.

4. When the federal rate is combined with the average of state rates.

5. The initially proposed 1% tax on EBITDA (earnings before interest, taxes, depreciation and amortization) has been replaced by an increase of the temporary additional contribution to CIT from 5% to 10.7%, which applies to companies (or tax consolidated groups) with an annual turnover exceeding €250 million. The increase would apply to fiscal years ending between 31 December 2013 and 30 December 2015. The maximum CIT rate would thus amount to about 38% instead of the current 36.1%.

6. The total tax burden is a subjective point of view of the EY tax policy leader in each country and is not based upon actual data.

16reportedhigher

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11reported

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30reported

no change 16reportedhigher

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7reported

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34reported

no change13

reportedhigher

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3reported

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42reported

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CIT burden

PIT burden

VAT/GST/sales tax burden


VAT and other indirect taxesWe also see many governments taking steps to expand the base of goods, services and other activities subject to indirect taxation. As in the case of corporate income taxes, this phenomenon is characterized by a dwindling volume of standard rate changes when compared with prior years. In fact, none of the 61 jurisdictions surveyed has so far announced a standard rate VAT decrease for 2014. Three countries (France, Japan and Luxembourg) report a standard rate increase (and Japan’s increase amounts to a 60% rise), while 13 of the 59 report a higher overall projected indirect tax burden as a result of base expansion via other means. Again, both the number of overall indirect tax burden increases (13 of 60)8 and decreases (3 of 60) remain consistent with 2013 data.

China is one example of a jurisdiction aiming to broaden the tax base via greater use of a VAT, although some changes in the short term may actually lower the overall indirect tax burden. China has converged VAT and business tax (BT), which allows for input tax credit under VAT that would not have been available under the BT system. Since the launch of the VAT pilot program in 2012, the overall tax burden has been reduced by over RMB90 billion (approximately US$15 billion) as of June 2013.9 After the nationwide expansion of VAT reform beginning August 2013, the tax burden was reduced by more than RMB10 billion (approximately US$1.6 billion) in the first month, with a yearly prediction of RMB120 billion (approximately US$20 billion).10 This indicates what a long-term strategy VAT represents for China.

Tax competition in the Nordics

It is worth noting that four Nordics countries (Denmark, Finland, Norway and Sweden) appear to be actively engaged in their own round of intense tax competition. Denmark (25% to 24.5%),7 Finland (24.5% to 20%) and Norway (28% to 27%) have all recently passed CIT rate reductions, while Sweden’s rate is already low at 22%. These Nordic nations also conform to the simultaneous trend of broadening the tax base; all four, for example, have announced new restrictions to interest/business expense deductibility in either 2013 or 2014.

No change

No

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LuxembourgFrance Japan

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19.6% 15%

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None of the 61 jurisdictions surveyed have so far announced a standard rate VAT decrease for 2014. Japan’s increase from 5% to 8% represents a 60% increase.

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7. In 2013, a bill was adopted under which the standard corporate tax rate will gradually be reduced from 25% to 22%.

8. Hong Kong does not impose VAT or GST.

9. “State Administration of Taxation: ‘Camp changed by’ the reduction of over 90 billion yuan,” China News, www.chinanews.com/gn/2013/08-16/5171830.shtml, 16 August 2013.

10. “Real advance camp changed to increase the pilot reform,” Xinhua, http://news.xinhuanet.com/fortune/2013-09/27/c_125461243.htm, 27 September 2013.

VAT/GST rates


Personal income taxesGovernments are also seeking to raise more revenue from their wealthiest citizens by broadening the base of taxation. Only two countries surveyed — Mexico and Sweden — have announced increases to top marginal rates of personal income tax (PIT) in 2014,11 while just two — Guatemala and Norway — will decrease their highest rates. Chile, meanwhile, has proposed a reduction

in the top marginal rate of PIT from 40% to 35% in 2014, but the proposal has not yet passed into law. Even while tax rates are projected to remain largely unchanged, 15 countries do anticipate an increasing tax burden for personal taxpayers (a figure identical to that of 2013), compared with 7 countries projecting a lower personal income tax burden for 2014, a dramatic fall from the 2013 results, where 16 of 60 countries anticipated a reduced burden.

How countries are adjusting their corporate tax base in 2014Our data shows that there are a number of common ways in which countries are choosing to adjust their corporate tax bases in the year ahead.That said, not all countries are moving in the same direction as the common trend. As an example, many countries are using more generous R&D and other business incentives to attract foreign direct investment. Argentina, for instance, unveiled a significant update of its software promotional regime12 for 2014, which contains a range of tax benefits that includes tax credits, income tax reductions and tax exemptions. Australia, meanwhile, has proposed that companies with aggregate assessable income of AU$20 billion or more would no longer

be eligible to access the 40% nonrefundable tax offset for R&D activities. In Norway, the initial depreciation rate available to certain assets is increased in 2014. In Finland, though, long-term (i.e., usage time of at least 10 years) movable fixed assets must now be depreciated using straight-line depreciation, asset by asset, instead of over their economical usage time — currently 25% per year on a pooled basis. So while the types of measures identified around the world may be largely consistent, their use can be very different, depending on the particular country and its overall objectives.

Across the 61 countries surveyed (all of which levy corporate income taxes), we identified the following common measures that countries will be using in 2014 to continue to adjust the corporate tax base (shown in order of prevalence).

-9.7%

3.5% 16.7%

-3.6%

2

2

31% 47.8%

58%

30%

28% 47.2%

60%

35%

No change

Norway

Sweden Mexico

Guatemala

57countries reported

no change

reporteddecrease

reportedincrease

Mex

ico

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ayGlobally, Guatemala had the largest decrease (31% to 28%, a 9.7% decrease), while Mexico had the largest increase (30% to 35%, a 16.7% increase) in the PIT rate.

11. This statistic ignores the top marginal rate of 75% for France, which is described as a special surcharge and is borne by the employing entity.

12. “Argentina issues additional regulations regarding Software Promotional Regime,” EY, www.ey.com/GL/en/Services/Tax/International-Tax/Alert--Argentina-issues-additional-regulations-regarding-Software-Promotional-Regime, 23 September 2013.

Personal income tax rates


The outlook for global tax policy in 2014 covers a total of 61 countries. All countries, as well as daily EY Global Tax Alerts, can be accessed at:ey.com/2014taxpolicyoutlook

24

12 12 11

10 9 6

16 13Changes to (or focuses on) tax

enforcement, including disclosure, substance requirements, GAAR

Changes to R&D incentives Changes to interest/business expense deductibility (including

payments to low–tax jurisdictions)

Changes to other business incentives (i.e., non–R&D)

Changes to withholding taxes Significant transfer pricing changes

Decreasing the statutory CIT rate Changes to the tax treatment of losses

Changes to CFC rules/thin capitalization

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A lighter side to tax: Sweden’s tax code helped influence disco fashion, ABBA member says

The disco era is forever linked with flared slacks, sequined jumpsuits and platform shoes. But now Sweden’s ABBA, the disco supergroup that rivaled the Bee Gees as the dancing kings and queens of 1970s entertainment, has revealed another surprising influence on disco fashion: tax.

In what may become a case study for economics professors worldwide, ABBA member Björn Ulvaeus revealed in the recently published According to ABBA: The Official Photo Book that the singing group’s flamboyant outfits were influenced heavily by Swedish tax rules. Those rules in the 1970s and 1980s only allowed the cost of costumes to be deducted if they couldn’t be worn on the street under normal standards.

“In my honest opinion, we looked like nuts in those years. Nobody can have been as badly dressed on stage as we were,” Ulvaeus admits in the book. Of course, this is a group that once sang in the song “Money, Money, Money” about working all day and working all night to pay the bills and not having a single penny left.

According to a report in the UK’s Guardian newspaper, Ulvaeus himself was “wrongly accused of failing to pay 85m kronor (about US$13 million) in Swedish taxes between 1999 and 2005, and went on to successfully appeal against the decision.”

“After the court decision, Ulvaeus said, “I am of course very happy that I have been informed in writing that I have always done the right thing concerning my taxes” according to the Guardian report.

The winner takes it all, indeed.

Ryan Donmoyer Ernst & Young LLP (United States) – Washington, DC


Progress towards adoption of several major tax proposals, all of which have been on the EU Council’s table for several years, remains painfully slow despite the efforts of the Lithuanian presidency. This concerns in particular energy taxation, the Common consolidated corporate tax base (CCCTB), the financial transaction tax (FTT) and the revision of the Savings Tax Directive.

The ambitious goals of the proposed revision of the Energy Tax Directive appear to have been significantly watered down and, whilst technical work is continuing, it seems increasingly unlikely that there will be agreement on restructuring the Community framework for the taxation of energy products and electricity but rather a simple increase in the current minimum rates.

Detailed technical work is also continuing on the proposal for a CCCTB but, given the outright opposition of a number of Member States,

it is difficult to see any prospect of it being adopted unless the precedent set with the FTT is followed, namely that a reduced number of Member States seek to reach agreement under the enhanced cooperation rules. Even this will not be easy, however, since it will certainly prove far more difficult in this case to reach unanimous agreement that the conditions have been fulfilled to enable enhanced cooperation to be launched. On the other hand, the concept of a consolidated corporate income tax base with an agreed key for apportioning taxable income between countries applying the consolidated base would seem to be a solution to the issue of internal base erosion and profit shifting (BEPS). It could therefore be the case that the CCCTB and BEPS streams of activity converge or move in parallel at some point. Whether this would accelerate work on the CCCTB or slow down work on BEPS, however, is an academic point.

Steve Bill, OBETax Policy and Controversy T: +44 7768 035826 E: [email protected]

European Union update


FTTWith regard to the proposal for an FTT, technical work has been continuing but the initial political pressure to achieve progress weakened somewhat during the German election campaign in the latter half of 2013. The Coalition Agreement has however committed the new German Government to work for the speedy implementation of a broad-based, low-rate FTT and at the Franco-German summit on 19 February, Chancellor Angela Merkel and President François Hollande expressed the hope that a revised proposal would be agreed ahead of the European parliament elections in May 2014, even if “imperfect.” This seems to imply that Germany and France may seek to champion a two-stage approach along the lines which has been publicly suggested recently by EU tax Commissioner Algirdas Semeta. In such a scenario an EU FTT would, in the first stage, have a much narrower scope than that initially proposed by the Commission and supported by Germany, possibly being limited to equities and applied on an issuance basis. It is difficult to predict what a broader second stage might look like as it will require a number of participating Member States to accept the taxation of transactions such as equity derivatives which they currently seem reluctant to include.

Savings Tax Directive The situation in respect of the proposed amendments to the Savings Tax Directive1 has been somewhat different. In this case, the technical discussions concerning the extension of the scope of the Directive have been concluded, but despite the express wish of the European

Council that the proposal be adopted by the end of 2013, two Member States (Austria and Luxembourg) continued to block adoption on the grounds that the same scope must be applied by all the major European financial centers in order to avoid a flight of capital out of the EU. To this end, Luxembourg has called upon the Commission to speed up its negotiations with the third-party countries concerned (Switzerland, Andorra, Monaco, Lichtenstein and San Marino). We understand that the Commission intensified its efforts to carry forward negotiations with these countries. The finishing line was finally reached on 20th March when all Member States reached agreement. “After six long years of deadlock, we finally have agreement on the Savings Tax Directive,” said Commissioner Semeta a few days later.2 “This was a strong signal that every single Member State is now committed to tax transparency and that the EU will continue to lead by example when it comes to tax good governance.”

Amending the Parent-Subsidiary DirectiveIn addition to these four major proposals, the Commission has recently put forward (in November 2013) proposals to amend the Parent-Subsidiary Directive3 (PSD) by including a “linking rule” based on the symmetry principle in respect of intra EU dividends arising from hybrid loan arrangements (in line with action 2 of the OECD’s BEPS action plan) and a more detailed general anti-abuse rule (GAAR). Discussions have commenced under the Greek presidency but it has become clear that whereas most, if not all, Member States seem to accept the anti-hybrid provision, a number of Member States

(led by Finland and the Netherlands) are opposed to the idea of a harmonized GAAR. A likely compromise therefore might well see the anti-hybrid provisions being rapidly adopted and the general anti-abuse rule provision being jettisoned.

The European Parliament on 2 April 2014 voted4 to back the European Commission’s proposal to revise the EU Parent-Subsidiary Directive. Despite the backing of the European Parliament, the amendments remain at this stage a proposal. The next stage of the process is that the proposal will need to be approved by the Council of Ministers, which is effectively the agreement of the Member States. In this respect, it should be noted that approval would need to be unanimous, and as noted, some Member States have expressed reservations about the proposals.

In the event the amendments are approved, it would then be up to individual Member States to implement domestic (or treaty based) law to put this into effect. The proposal is that such changes would need to be put into effect by 31 December 2014 at the latest. However, how the proposals would interact with the domestic law of Member States is itself a source of much debate.

Exchange of informationWork has also continued on the Commission’s proposal to extend the scope of mandatory automatic exchange of information in the field of Direct Taxation. In this, as in other areas, the EU is seeking to increase overall levels of synergy with the OECD, which is in the process of developing a global Common Reporting Standard for information exchange.5

1 http://ec.europa.eu/taxation_customs/taxation/personal_tax/savings_tax/index_en.htm

2 http://europa.eu/rapid/press-release_SPEECH-14-302_en.htm?locale=en

3 See http://www.ey.com/GL/en/Services/Tax/International-Tax/Alert--European-Commission-proposes-amendments-to-Parent-Subsidiary-Directive-by-introducing-anti-hybrid-clause-and-general-anti-abuse-provision

4 http://europa.eu/rapid/press-release_STATEMENT-14-92_en.htm

5. http://www.ey.com/GL/en/Services/Tax/International-Tax/Alert--OECD-releases-Common-Reporting-Standard


Country-by-country reporting off the agenda until 2018The European Parliament and the Council have reached an agreement on a Commission proposal to improve transparency on social and environmental matters. Certain large companies have to disclose non-financial information on policies, risks and results regarding environmental matters, social and employee-related aspects, aspects for human rights, anti-corruption and bribery issues, and diversity on board directors. Country-by-country (CbC) reporting requirements in relation to taxation were not included, however, and in that regard the Commission has to report back on CBCR on tax matters by 2018. In this, as in other areas, the EU is seeking to increase overall levels of synergy with related OECD, including the ongoing development of a CbC reporting template and the development of a global Common Reporting Standard for information exchange.6

VATIn the area of EU VAT legislation, the Commission has succeeded in getting adopted all the necessary implementing provisions in respect of the 1 January 2015 change in the place of supply rules for B2C supplies of broadcasting, telecoms and e-commerce. However the Council has yet to adopt the related rules concerning the treatment for VAT purposes of advance payment “vouchers.” If no progress is made in this domain there is a real risk of double or non-taxation occurring after that date, particularly in respect of supplies of telecoms services due to conflicting national rules.

Standard VAT returnIn line with its Strategy for reforming the EU VAT System, in October 2013 the Commission put forward proposals for a Standard VAT return. The intention is to simplify rules and reduce administrative burdens for businesses by introducing a uniform set of requirements for businesses when filing their VAT returns, regardless of the Member State in which they do it. If adopted, the standard VAT return — which would replace national VAT returns — would ensure that businesses are asked for the same basic information, within the same deadlines, across the EU.

Non legislative actionsIn October 2013 the Commission set up a High Level Expert Group addressing Taxation of the Digital Economy.7 Its mandate is to examine the best ways of taxing the digital economy in the EU, weighing up both the benefits and risks of various approaches, to identify the key problems with digital taxation from an EU perspective and to present a range of possible solutions. The Commission will then develop any necessary EU initiatives to improve the tax framework for the digital sector in Europe in both the direct and indirect tax spheres. The group has already met twice and is required to present a report before 1 July 2014.

State aidAs part of its state aid modernization program8 launched in May 2012, the Commission published in January 2014 a draft notice aimed at providing practical guidance in relation to state aid and requested comments by 14 March.9 The Notice contains a chapter dealing with “fiscal state aid,” which

covers cooperatives, undertakings for collective investment, tax amnesties, tax settlements and administrative tax rulings, depreciation/amortization rules, flat-rate tax regimes for specific activities, anti-abuse rules and excise duties. The Commission aims to adopt the final Guidance Notice in the second quarter of 2014. It will replace the 1998 Commission Notice on the application of state aid rules to measures relating to direct business taxation.

Harmful tax practicesThe EU’s Code of Conduct Group is continuing its work on “harmful tax practices” and has focused on preferential innovation regimes, such as the UK and Cyprus patent boxes.10 Both the Group and the December ECOFIN Council meeting failed to reach any agreement in this area, however, and ECOFIN has therefore invited the Commission to reconsider all existing preferential IP regimes several of which the Code of Conduct Group has in the past determined were not harmful.

The review will test the existing regimes in Belgium, Cyprus, France, Hungary, Ireland, Malta, Netherlands, Spain and the UK against the criteria developed for identifying potentially harmful measures. It will almost certainly focus on the criteria concerning economic substance and OECD principles, in particular, differentiating acceptable incentives that encourage genuine economic activity, from those that purely facilitate profit shifting. The intention is to reach a conclusion by mid-2014.

6 http://www.ey.com/GL/en/Services/Tax/International-Tax/Alert--OECD-releases-Common-Reporting-Standard

7 http://www.ey.com/GL/en/Services/Tax/International-Tax/Alert--European-Commission-to-form-Expert-Group-to-address-challenges-for-tax-systems-related-to-digital-economy

8 http://ec.europa.eu/competition/state_aid/modernisation/index_en.html

9 See http://www.ey.com/GL/en/Services/Tax/International-Tax/Alert--European-Commission-invites-comments-on-notice-regarding-state-aid-definition-with-specific-examples

10 http://www.ey.com/GL/en/Services/Tax/International-Tax/Alert--European-Commission-scrutinizes-Member-States--tax-schemes-under-State-Aid-criteria


How do you remain at the forefront of global tax?A little application.Now you can access EY Global Tax Guides on your tablet. With information on more than 150 jurisdictions, the world of tax is at your fingertips.

Download your EY Global Tax Guide app via the App Store or ey.com/TaxGuidesApp.


2014 VAT/GST rate changes

BurundiA new intermediary rate of 10% for basic foodstuffs was included in the budget.

Ghana1 January 2014: VAT rate increased to 15% (from 12.5%).

Kenya2 September 2013: reduced VAT rate of 12% was abolished.

Tanzania1 July 2013: VAT exemption for tourist services was abolished.

Tunisia1 January 2014: VAT exemption for services rendered by health care establishments to nonresidents was abolished.

Zambia1 January 2014: standard rate VAT applies to pre-booked tourism tourist packages (previously 0%).

Zimbabwe1 January 2014: certain food products are removed from the zero rate schedule.

Barbados1 October 2013: VAT on hotel accommodation and direct tourism services reduced to 7.5% (from 8.75% and 17.5% respectively).

Curaçao1 May 2013: higher TOT rate of 9% applies on luxury and/or unhealthy goods and services.

1 May 2013: new TOT exemptions introduced for “primary necessities of life.”

Dominican Republic1 January 2015: standard VAT rate will be decreased to 16% (from 18%).

Puerto Rico1 July 2013: various taxable services excluded from B2B exemption and therefore subject to sales and use tax.

Turks and Caicos Islands1 October 2013: introduction of GST on professional services was cancelled.

Honduras1 January 2014: GST rate increased to 15% (from 12%).

Albania1 April 2014: VAT exemption will apply to medical services and supply of medicines.

Belgium1 January 2014: many services performed by lawyers are taxed at 21% (previously exempt).

Croatia1 January 2014: reduced VAT rate increased to 13% (from 10%).

1 January 2014: new reduced rate of 13% applies to most newspapers and magazines.

Jordan10 July 2013: the special tax rate on mobile phones was increased to 16% (from 8%).

10 July 2013: the special tax rate on mobile phone subscriptions was increased to 24% (from 12%).

Canada1 July 2014: Nova Scotia will reduce the provincial component of its HST rate to 9% (from 10%).

1 July 2015: Nova Scotia will reduce the provincial component of its HST rate to 8% (from 9%).

BrazilIPI rates modified for certain building materials, furniture and appliances.

Mexico1 January 2014: VAT rate of 11% applicable in Mexico’s border region was abolished, resulting in a 16% VAT rate across the country.

Paraguay1 January 2014: agricultural products and cattle are now subject to a 5% VAT rate (previously exempt).

Peru1 November 2013: rates for the VAT withdrawal system have been modified.


Japan1 April 2014: consumption tax rate will increase to 8% (from 5%).

1 October 2015: consumption tax rate will increase to 10% (from 8%).

Pakistan4 October 2013: withholding rates for wholesalers and dealers have been reduced.

South Korea1 January 2014: cosmetic surgery now liable to VAT.

Vietnam19 June 2013: 5% tax rate applies to sales, rent and hire purchase of social housing.

Cyprus1 January 2014: standard VAT rate increased to 19% (from 18%), and reduced VAT rate increased to 9% (from 8%).

Czech Republic1 January 2016: a uniform VAT rate of 17.5% is planned.

France1 January 2014: standard VAT rate increased to 20% (from 19.6%), and intermediary VAT rate increased to 10% (from 7%).

France (continued)1 January 2014: Reduced rate of 5.5% extended to certain supplies previously subject to the 7% VAT rate.

1 January 2014: intermediary VAT rate (10%) extended to intermediate housing.

France — Corsica1 January 2014: standard VAT rate increased to 10% (from 8%).

Greece13 August 2013: VAT on restaurant services reduced to 13% (from 23%).

IrelandReduced VAT rate of 9% on tourism and hospitality services (due to expire and revert to 13.5% on 31 December 2013) has been retained.

Italy1 October 2013: standard VAT rate increased to 22% (from 21%).

Lithuania1 January 2015: a reduced 9% VAT rate will apply to certain tourist accommodation services.

Luxembourg2015 - exact date to be confirmed: standard VAT rate will increase to 17% (from 15%), reduced VAT rate will increase to 8% (from 6%), and parking rate will increase to 14% (from 12%).

Moldova1 January 2014: reduced VAT rate of 8% reintroduced for certain products.

Montenegro1 July 2013: standard VAT rate increased to 19% (from 17%).

Netherlands1 January 2014: reduced rate (6%) on rebuilding, renovation and repair of owner-occupied dwellings further extended to 31 December 2014.

PolandTemporarily increased VAT rates of 23% (standard rate) and 8% (reduced rate) will continue to apply until the end of 2016.

Portugal — Azores1 January 2014: standard VAT rate increased to 18% (from 16%), intermediate VAT rate increased to 10% (from 9%), and reduced VAT rate increased to 5% (from 4%).

Romania1 September 2013: reduced VAT rate (9%) applies to bread, wheat and flour.

Russia1 October 2013: sale of goods related to certain sporting events are taxed at the zero rate (previously 18%).

Serbia1 January 2014: certain goods and services that were taxed at 0% are now taxed at standard rate (20%).

1 January 2014: reduced VAT rate increased to 10% (from 8%).

Spain1 January 2014: standard rate VAT applies to digital newspapers and e-books.

Ukraine1 January 2014: VAT reinstated on imports of natural gas.

19 December 2013: proposed decrease of standard VAT rate to 17% (from 20%) has been postponed until 2015.

Cook Islands1 April 2014: standard VAT rate will increase to 15% (from 12.5%).

Indirect tax in 2014: Our annual review of global indirect tax developments and updates details changes in value-added tax (VAT), excise and customs duties in more than 100 countries, including changes in tax rates, the introduction of new taxes and additions to the growing network of free trade agreements. These multilayered developments are shaping the global tax landscape as governments continue to rely on indirect taxes to raise revenues and as they strive to improve and enhance indirect tax systems to make them work in our rapidly changing world.Read our full report at www.ey.com/IndirectTax2014.


Over the last five years, the United Nations (UN) group on taxation has been expanding its work beyond tax treaties. In 2013, it issued a manual on the application of the arm’s-length principle, and it is now moving into the tax issues raised by resource-rich developing countries and, importantly, the base erosion and profit shifting area. In 2013, the composition of the Committee was changed with new faces coming into the group, although the chair remained unchanged, as did the secretary, Micheal Lennard. The expectation from many is that the UN will play an increasingly important role in the international tax arena in the future.

Michael joined the UN in 2006 as the Chief of International Tax Cooperation in the Financing for Development Office. Since then he has overseen the development of the UN Model Double Tax Treaty and has worked work extensively on the UN Practical Transfer Pricing Manual for Developing Countries. He also previously worked for the OECD and the Australian Taxation Office.

Jeffrey Owens, Senior Policy Adviser to EY’s Global Vice-Chair of Tax, met with Michael to discuss a broad range of current issues. These include how Michael sees the Committee developing during its next four-year mandate, what comes next for the UN’s work on transfer pricing and how the UN will contribute to current political debate on BEPS and other tax issues.

The full interview transcript can be accessed at: www.ey.com/Lennardinterview

An interview with Michael Lennard — Secretary, United Nations Committee of Experts on International Cooperation in Tax Matters

Michael Lennard: We need to make sure developing countries play more of a role in setting (those) standards, standards that will work for them.

Jeffrey Owens: What are, from your perspective, some of the priority issues that the committee is looking at in the area of tax treaties?

Michael Lennard: I think, without choosing a favorite between one’s children, there are a few which really stand out as important issues. One is the treatment of services. The treatment of services is very different in the UN Model than it is in the OECD Model. ... I think the fact that in the UN there’s a clear majority in favor of treating services PEs as having been achieved a little bit more easily than goods permanent establishments, and that’s a minority, very much a minority, in the OECD.


Jeffrey OwensSenior Policy Adviser to the Global Vice Chair — Tax T: +44 20 7951 1401 E: [email protected]

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About the UN Committee of Experts on International Cooperation in Tax MattersUnder UN resolutions, the Committee has a mandate to:• Keep under review and update as necessary the United Nations Model Double

Taxation Convention between Developed and Developing Countries and the Manual for the Negotiation of Bilateral Tax Treaties between Developed and Developing Countries

• Provide a framework for dialogue with a view to enhancing and promoting international tax cooperation among national tax authorities

• Consider how new and emerging issues could affect international cooperation in tax matters and develop assessments, commentaries and appropriate recommendations

• Make recommendations on capacity-building and the provision of technical assistance to developing countries and countries with economies in transition

• Give special attention to developing countries and countries with economies in transition in dealing with all the above issues

The Committee comprises 25 members nominated by governments and acting in their expert capacity. The members are appointed by the Secretary-General for a term of four years, are drawn from the fields of tax policy and tax administration, and are selected to reflect an adequate equitable geographical distribution, representing different tax systems.

The Committee meets annually for five working days in Geneva and submits its report to ECOSOC at its substantive session.

The Committee formulated its working methods during its first session. The Committee creates, as necessary, ad hoc subcommittees composed of experts and observers who would work throughout the year to prepare and determine the supporting documentation for the agenda items for consideration at its regular session.

The Committee has relied heavily on its subcommittees and working groups for its work, especially in relation to updating the UN Model. The subcommittees and working groups focus during the year on certain issues related to the UN Model and then present options, including specific wording for review and adoption by the Committee during its annual sessions. The subcommittees have also been instrumental in taking forward the Committee’s work on revision of the Manual for the Negotiation of Bilateral Tax Treaties between Developed and Developing Countries and on drafting of the UN Transfer Pricing Manual for Developing Countries, as well as in implementing other aspects of the Committee’s mandate such as in the areas of new and emerging issues affecting international cooperation in tax matters and capacity building.

As they fulfill their mandates, the subcommittees and working groups are dissolved by the Committee. There are currently seven subcommittees and one working group.

Jeffrey Owens: Do you think we’ll eventually reach a situation where we no longer have a UN Model and an OECD Model, but we have one model which is broadly endorsed by the international community, and which allows countries to set out their positions?

Michael Lennard: Philosophically yes, because really both models are seeking to say there are options, these are the options, and each of the options has pros and cons.

Michael Lennard: Another big issue is redrafting the Commentary on Article 9, the arm’s-length principle. But the arm’s-length principle is not in play in the redraft.

Jeffrey Owens: We’re sure of that?

Michael Lennard: Well, one can never be entirely sure. I mean even the OECD BEPS Action Plan suggests that sometimes the arm’s-length principle might even have to be departed from. But the work is actually changing the commentary on Article 9, bringing it up to date, reflecting some of the issues identified in the 2013 Manual. On some of those issues there is a feeling among some Committee members that it [Article 9] actually paid a bit too much deference to the OECD Transfer Pricing Guidelines.


BrazilPolicy and controversy aspects of Brazil’s 2013 corporate tax reform The enactment of Provisional Measure 627 (PM 627/13)1 of 12 November 2013 represents the broadest and deepest reform to Brazil’s corporate income tax system since the enactment of Decree-Law 1.598 of 26 December 1977.2 In fact, it can be argued that PM 627/13 is an even broader redesign of the system as compared to 1977’s changes, as it addresses not only all fundamental aspects of the recognition of income, losses and capital gains from domestic sources (as did Decree-Law 1.598/77), but effectively restructures Brazil’s taxation of worldwide income of corporations and individuals (amendments to Law 9.249/95 and to Law 7.713/88).

Julio AssisTax controversy leader – Brazil T: +55 11 2573 3309 E: [email protected]

In addition, PM 627/13 also changes certain base definitions of revenue-based social contributions (i.e., PIS and COFINS), among other measures.

Background: back to 1976Decree-Law 1.598 was enacted by military President Ernesto Geisel as a reform of Brazil’s corporate income tax, triggered by the statutory accounting reform instituted under Brazil’s Law of Corporations 6.404 of December 16, 1976. Law 1.598 was substantially amended by Law 11.638 of 28 December, 2007, which provided the foundation for the convergence of Brazilian statutory accounting to International Financial Reporting Standards (IFRS). Hence, the same need for a broad and deep reform of Brazil’s corporate income tax law that arose

in 1976 to 1977, surfaced once more in 2007 to 2008. The complexity of the accounting reform, in fact, was even greater in 2008 than in 1977, in light of the inherent intricacies of IFRS convergence. Therefore, the corporate income tax reform needed since 2008 has required a great degree of engagement and collaboration between the tax administration, taxpayers and their intermediaries.

Six years later, the 2013 reform was enacted through a provisional measure, which is required to be urgently reviewed and possibly amended by the National Congress. In developing the tax reform, the Brazilian Tax Authority engaged with multiple organizations3 that it deemed representative of the private sector, of taxpayers, and of the accounting profession in Brazil.


1. Updated by National Congress and Senate (PLC 2/2014); thus, subject to President approval before the enactment.

2. Decree-Law 1.598/77 is the foundation for all corporate income tax rules in Brazil. It is the statutory authority for the National Tax Code (Código Tributário Nacional or CTN, Law 5.172 of October 25, 1966), particularly Chapter III, Section IV, articles 43-45 on Federal Income Taxation. The CTN is a statute of higher authority, “Complementary” to Constitutional Law, as ratified in Brazil’s Federal Constitution of October 5, 1988, article 153, III, §2.

3. The Financial Accounting Statements Committee (CPC), the Securities Exchange Commission (Comissão de Valores Mobiliários – CVM), Regional Accounting Board (Conselho Regional de Contabilidade – CRC), National Confederation of Industry (Confederação Nacional da Indústria – CNI), National Confederation of Commerce (Confederação Nacional do Comércio – CNC), National Confederation of Financial Institutions (Confederação Nacional das Instituições Financeiras – CNF), and GETAP (Grupo de Estudos Tributários Aplicados).

The transitory tax regime of 2007The statutory accounting reform of Law 11.638/07 (and the related enactment of numerous detailed convergence rules by the Financial Accounting Statements Committee – Comitê de Pronunciamentos Contábeis or CPC, totaling 46 so far) redefined the fundamental concepts of recognition of revenues, gains, expenses and losses, as well as balance sheet and consolidation accounting methods.

The effect of these changes for tax purposes was acknowledged by Law 11.638/07 in Article 1. Under Article 1, Law 11.638/07 introduced a new §2 and a new §7 under Article 177 of Law 6.404/76, to state that all statutory accounting changes caused by the application of the new accounting rules would not alter the base of any taxes or have any other tax effects. This is what is commonly referred to as Brazil’s “tax neutrality” principle in the context of IFRS convergence.

This principle caused the Brazilian tax authority to enact the so-called “Transitory Tax Regime” (Regime Tributário de Transição or RTT) in 2009 under PM 409/08 (later converted into Law 11.941/09). The RTT provided the rules for taxpayers to “reconstruct” their statutory accounting to determine and report the differences between the old and the new accounting rules. It also required taxpayers to ascertain the corporate income tax base with tax adjustments on corporate “net income” adjusted to match the old accounting rules. Specific compliance and reporting obligations were established to control and demonstrate these accounting differences.

The RTT approach was originally scheduled to last for a period of two years only, which was intended as the

term during which a new regime would be developed and legislated. Its extension for over six years raised several issues, as it effectively required companies to keep two sets of statutory accounting records (one of which under the pre-2008 accounting principles that were no longer in force for any purpose other than the application of tax law). Several questions existed as to how to apply the tax neutrality principle, which caused many issues and differences of interpretation.

For the RTT to end, Brazilian corporate income tax law had to address all accounting realization events, which were greatly refined with the IFRS convergence. It also had to determine which realization events to recognize for tax purposes, when such recognition would occur (and how), as well as how to treat for tax purposes future refinements of the statutory accounting rules in conformity with IFRS. This is what is contemplated in the vast majority of the articles of PM 627/13, a complete redefinition of Brazil’s corporate income tax base.

The new rules: key changes to the recognition of domestic-source incomeThe new rules generally aim to turn into “book to tax” differences most of the items that under RTT were treated as “pre-IFRS to post-IFRS” statutory accounting differences.4 In this sense, PM 627/13 seeks to preserve most of the key definitions of taxable income embedded in Decree-Law 1.598/77, and it also mandates that future statutory accounting changes shall not alter tax bases before the enactment of further amendments to the tax law (Article 54), which tends to be a positive approach.

PM 627/13 also eliminates the parallel transactional accounting established

under the RTT, which is a welcomed change. In the earlier drafts of the PM, the tax authority intended to create a parallel and permanent transactional accounting record that would remain under the pre-2008 accounting rules. That option was later acknowledged as unfeasible.

PM 627/13 curbs what are perceived by the Tax Administration as “abusive transactions,” which historically allowed the recognition of tax-deductible goodwill in certain corporate reorganizations involving related parties and in some transactions involving like-kind exchanges. Nonetheless, it is clear that an inside basis step-up remains available on qualified purchases and business combinations, and that such step-up also includes goodwill. This is another item that, as per the earlier drafts of the PM, was going to be eliminated by the Tax Administration. Yet, the tax authority, through its engagement with the private sector, decided to retain the inside basis step-up for economic policy reasons. The tax authority determined that the inside basis step-up fosters private investment and facilitates true acquisitions and business combinations.

Finally, PM 627/13 maintains the dividends exemption declared out of statutory (post IFRS) income historically granted under Article 10 of Law 9.249/95 (exception for fiscal year 2014 in which the exemption will be only granted for taxpayers who elect to adopt the new system as from 2014). It also maintains the use of such statutory accounting for purposes of determining and declaring interest on shareholders’ equity and equity accounting gains, in a move that limits the application of the “tax neutrality” principle for prior years, and in an effort to reduce the significant controversy and litigation that would be triggered by the application of Normative Instruction (NI) 1.397/13.


4. From a compliance perspective and considering Brazil’s electronic reporting systems, this change means the end of the Corporate Income Tax Return DIPJ, the end of the FCONT obligation which reconciles pre- and post-IFRS accounting to produce the so-called “RTT differences,” as well as the non-application of the “parallel” transactional recordkeeping under pre-IFRS accounting rules established under IN 1.397/13. Instead, it requires only the use of the Public System of Digital Recordkeeping (SPED) along with a new electronic version of the Income Tax Registry “LALUR” (EFD or “eLALUR”) to demonstrate book-to-tax differences and tax calculation. This preserves the full traceability of all data and adjustments that is critical to Brazil’s enforcement system and compliance environment.

Mandatory adoption in 2015 versus elective adoption in 2014?PM 627/13 becomes effective on 1 January, 2015. However, taxpayers may elect to implement Articles 1 and 2 and 4 through 70 (i.e., IFRS convergence) for calendar-year 2014. Once the election to early adopt is made, it is irrevocable.

The election will be made on a form prescribed by the tax administration. The new form may require some degree of information technology systems adaption, which almost certainly could not have been enabled by the second quarter of 2014. The timing of this election may be as early as the filing of one of the monthly 2014 Declaration of Federal Tax Debts and Credits Return due on the third week of the following month. Early adopters should be granted the opportunity to develop their compliance records and systems during the course of the year, and to present them in full compliance with the new rules beginning in 2015. Early adoption in 2014 will facilitate the electronic audit of adjustments by the tax authority, and will reduce the potential litigation over the application of NI 1.397/13 in 2014 for taxpayers with “pre and post-IFRS” profits accounting difference.

Finally, the adoption of the new system implies that taxpayers will be subject to a new regime of administrative penalties that were designed to ensure enforcement and compliance. Several amendments to the enforcement rules have been proposed with the intention to both facilitate compliance and early adoption.

PM 627/13 represents a massive reform of Brazil’s tax system. It also aligns the tax statute with all of the elements of IFRS convergence already incorporated by Brazilian Statutory Accounting under Law 6.404/76 as amended by 11.638/07.

The language or the positions adopted in some of the articles may be problematic though. As a result, those chapters of the PM are the object of more than 200 amendments proposed in Congress,5 which are expected to result in significant enhancements to the 2013 corporate tax reform.

PM 627/13 also introduces 20 articles that deal with foreign-source income earned by Brazilian resident taxpayers (including three articles regarding individuals). These articles are quite controversial and are the subject of massive litigation. Thus, the articles are the object of no less than 83 amendments. It is quite possible that these articles would be significantly redesigned or even suppressed upon conversion of PM 627/13. This is an opportunity for the National Congress to pass amendments that would help large enterprises in Brazil compete globally on more equal footing with companies headquartered in OECD countries, and without the disadvantage that burdens them today.

The PM has been analyzed by a Joint Congressional Committee (Comissão Mista de Medida Provisória or CMMPV) that included more than 30 congressmen and senators. Congressman Eduardo Cunha is the President of the Joint Committee and on 19 February, 2014, he presented a new redraft version of PM 627/13 and the Committee review and revised all articles and proposed amendments to develop a final version of the law to be signed (or vetoed) by the President.

The legislative process in Brazil can be a challenge to understand at the best of times. A provisional measure such as PM 627/13 may be extended for 60 days to allow the legislative process to run its course. This extension may in turn be extended for an additional 60 days. PM 627/13 was extended for a second time on 23 February and so the legislative process run during April.

But one additional dimension of the process is important: in theory, provisional measures only have their effect protected as from their original date of publication if they are converted into law within 60 days of their original date (or 120 days if those original 60 are extended). If it takes longer, the retroactive effect of the measure(s) cannot be taken for granted. This potential delay has given rise to the interpretation by some that any retroactive effect that is detrimental to taxpayers would have to face one additional (formal) argument and obstacle to be deemed legitimate, an argument that could also be used to protect taxpayers from detrimental 2014 effects. This argument, in turn, could be cause for judicial litigation. If this potential delay does not occur, however, then all retroactive benefits (and 2014 benefits) as well as all effects from 2015 onwards will not be impacted.

Whether PM 627/13 remains unaltered, is partly suppressed, vetoed or substantially altered, it is clear that all corporate taxpayers are affected and, as such, all must understand the intricacies of the new law and make decisions — or take actions — before year-end and through the second quarter of 2014. This is a time of sweeping change in Brazil that must be proactively managed so as to both mitigate risks and maximize opportunities.


5. Some of the most relevant amendments have been crafted by CNI, GETAP and significant other associations, and some amendments were designed by taxpayers and have been introduced by numerous Senators and Congressmen, such as Senator Francisco Dornelles, Senators Armando Monteiro and Aloysio Nunes, among others.

R&D worldwide

Replay our 19 February webcast where an experienced panel of EY professionals discussed how leading practices for managing grants and incentives on a global scale can help your organization realize the opportunities available under the law to increase your return on investment.

On the webcast we discussed:

• Current R&D trends and legislative developments for 2014• An overview of the European Union’s new Horizon 2020 program• Current enforcement trends• The leading incentive management practices employed by companies

Webcast: managing global R&D incentives

Access the webcast:

ey.com/r&dwebcast

2013-14 Worldwide R&D incentives reference guide• R&D incentive regimes in 34 countries• Overview of EU’s new Horizon 2020 program effective as of

January 2014• Access or download Guide at:

ey.com/R&Dtaxguide

R&D incentives are an increasingly important element of tax policy and have grown in breadth and scope in recent years. But what’s the best way to identify, obtain and manage grants and incentives on a worldwide basis? How can you build an

incentives framework that allows your organization to utilize the incentives available while minimizing unnecessary costs and risks? And what new measures have been unveiled for 2014?

Global Tax Policy and Controversy Briefing 71Global Tax Policy and Controversy Briefing 71

JapanJapan’s tax policy reform: consumption tax increases on track, targeting corporate growth for future prosperityOn 1 October 2013, the Japanese Government formally approved an increase in the rate of Shouhizei consumption tax (national and local combined) from 5% to 8%, effective 1 April 2014. In order to mitigate expected backlash and avoid a negative impact on the economy, an additional economic support package was also announced.

Koichi SekiyaTax Policy and Controversy Leader – Japan T: +81 3 3506 2447 E: [email protected]

The ¥5 trillion (approximately US$51 billion) package includes a variety of tax measures designed to stimulate private sector investment, as described in the Japan tax newsletter: “Tax reform outline to stimulate private sector investment.”

The new outline details a number of new measures to lower taxes for corporations. These reforms are being introduced separately to the normal annual tax reform outline, which was released in December.

The most notable tax reduction measure in October’s package was the early repeal of the special reconstruction corporate tax which (in 2012) increased the effective corporate tax rate to 38.01%. With the early repeal of the special reconstruction surcharge, and taking into account the 2011 measure to reduce Japan’s (national) headline corporate tax rate by 4.5 percentage points (from 30% to 25.5%), the effective rate will fall to 35.64% in 2014.

In addition, many additional tax incentives for corporations are introduced in the new outline. Also, significant international tax reforms are announced in the 2014 Tax Reform Outline, which was released on 12 December 2013.

BackgroundThe consumption tax increase was first determined by the Diet in August 2012 under the former Democratic Party of Japan (DPJ) Government. It did, however, include a clause which stated that the tax rate increase may not be implemented if economic conditions were not appropriate.

In December 2012, the Liberal Democratic Party (LDP) won a resounding election victory in the Lower House and Shinzō Abe, the LDP leader, was confirmed as Japan’s new Prime Minister.

Since then, Mr. Abe has adopted monetary easing measures, a progressive fiscal policy and an economic growth strategy designed to achieve average growth of 3% (2% in real terms) over the next 10 years. These policies are intended to reverse the deflationary trend the Japanese economy has experienced for many years.

In addition, the Government has desired to reduce the national deficit in order to achieve fiscal health and cope with an aging population and low birth rates. Under this policy, Japanese tax policies should be determined by considering both the stimulation of economy (by way of tax decrease measures) and the achievement of fiscal health (by way of tax increase measures).

For the last two to three years, the main tax decrease agenda was the reduction of the headline corporate tax rate while the main tax increasing measure is the raising of the consumption tax rate.


The LDP’s decisive victory in the upper house election in July 2013 reinforced the political position of Prime Minister Abe and his Government. Leveraging that success, on 1 October 2013, under favorable economic conditions and a high approval rating, the Prime Minister announced that the consumption tax rate would be raised from 5% to 8% on 1 April 2014, as scheduled. At the same time, he also provided a ¥5 trillion (US$51 billion) economic stimulus package.

Historic opposition to consumption tax increasesAlthough previous governments had attempted to raise the consumption tax rate to combat Japan’s growing national debt, such a move has historically been met with strong opposition. The rate rise of 2014 will be the first in 16 years.

Abe stated that he made the decision in order to maintain confidence in Japan and to create a sustainable social security system for future generations. The consumption tax increase, itself the main pillar of comprehensive tax and social insurance reform, has now been confirmed. The second consumption tax rate increase, from 8% to 10%, will be implemented on 1 October 2015.

The decision on this second rate rise should be confirmed at the end of 2014, again depending on prevailing economic conditions. If Japan’s economy continues on its “Abenomics” growth trajectory, the rise should proceed; this is not yet completely certain, however.

There also exists a deeper question of whether 10% will be sufficient in the long term. Compared to other developed countries, Japan’s consumption tax rate of 10% is still considered to be low, particularly in relation to the 2013 OECD average of 18.9%. Due to the increasing costs of social insurance caused by the low birth rate, further such tax increases are probably unavoidable.

Early repeal of the special reconstruction tax on corporationsAs noted, a key tax measure in October’s economic package was the repeal of the special reconstruction tax for corporations. First introduced in April 2012 as a result of the natural disaster in Japan, this 10% surtax on corporate tax was intended to last for three years. The Government had proposed scrapping the tax a year early and made a final decision in the 2014 Tax Reform Outline in December 2013.

It is reported that a one-year-early repeal of the tax will bring Japanese corporations a saving of approximately ¥1 trillion (US$10.2 billion). If the tax is abolished, the effective corporate tax rate (Tokyo area, including local taxes) will be reduced from 38.01% to 35.64% from April 2014.

Japan’s Government debt has ballooned over the past decades and the Ministry of Finance (MOF) has long been searching for new sources of tax revenue. The consumption tax hike has been a long-fostered ambition of the MOF in order to achieve fiscal health, and Abe’s decision was welcomed by the Ministry.

The MOF had not, however, been considering reducing the effective corporate tax rate at this time because the rate had already been reduced once in 2012, from an effective 40.69% to 38.01%. The potential rate decrease in 2014 will move Japan from having the highest corporate tax rate among G20 to the third-highest, behind France and the United States.

Further reductions desiredIt is understood that Abe may be contemplating a further reduction of the statutory corporate tax rate, which could be considered in future tax reform discussions. He is understood to believe that a lower corporate tax rate will enhance the competitiveness of Japanese businesses and will help companies generate surplus funds which can be used for future investment, increased employment and higher wages.

In addition, a lower corporate tax rate will be an incentive for foreign corporations to increase foreign direct investment (FDI) into Japan and for Japanese corporations to stay in Japan. This should, in turn, put Japan on track for higher economic growth.

While the Ministry of Economy, Trade and Industry (METI) and Japanese businesses naturally support further corporate tax reductions, the MOF has traditionally been against tax cuts. The MOF insists that such corporate tax reductions leads to a decrease in tax revenue and the expected consumption tax hike will not make up for such shortfalls. However, Japan’s effective corporate tax rate is still high compared to other comparable economies and therefore it appears that there is potential for further reductions.

On the other hand, there is no guarantee that a corporate tax reduction would vitalize the Japanese economy through increased investment, employment and higher wages. Corporations may simply retain their reserves internally. Moreover, reduced tax would have a negative impact on Japan’s fiscal deficit unless the Japanese economy grows and drives greater tax revenue.


New and revised incentivesOctober’s tax reform package also saw new and revised tax incentives for business, including:

• A tax incentive to promote capital expenditure on productivity-enhancing equipment

• A tax incentive to promote venture capital• A tax incentive to promote corporate reorganizations• An enhancement to the tax incentive promoting capital

expenditure for small and medium enterprises (SMEs) • An enhancement to the R&D tax credit, whereby the expiring

sunset provision for additional R&D tax credits would be extended for three years to fiscal years beginning on or before 31 March 2017

• An extension to the tax incentive for increasing wages, whereby the current sunset provision for the increase in wage incentive would be extended by two years to 31 March 2018 and some requirements would be relaxed

International tax reformsThe 2014 tax reform outline included a number of reforms which were excluded from the October reform package, including specific international tax reforms. These included a shift from entire income principle to attribution income principle under the Authorized OECD Approach (AOA), which will be applied to corporations for taxable years beginning on or after 1 April 2016 as well as an the inclusion in the scope of the transfer pricing regime of an indirect service transaction with a related party through an unrelated party.

Looking forwardThere continues to be heated debate in Japan about reducing taxes paid by businesses (favorable for corporations) while raising consumption taxes paid by the general public (burden for individuals). Nonetheless, there will undoubtedly be intense debate regarding further corporate tax reductions through 2014.

A new Government Tax Advisory Committee has been established and they started their work in June 2013. This committee will deliver official reports related to various tax issues during the course of the next three years and will operate using a number of subcommittees and discussion groups assigned to each specific tax area.

A corporate taxation discussion group was set up in February 2014 and has been tasked with studying a potential reduction of the corporate tax rate, expansion of the tax base, verification of tax policy effects and the relationship between corporate and other tax types.

A main focus of the group will be the potential reduction of the statutory corporate tax rate. In addition, they will also discuss expansion of the corporate tax base to take into account any decrease of corporate tax revenue derived from the corporate tax rate reduction. Topics on the table are likely to include further limitation of net operating loss carry-forward/carry-backs, reduction in the divided received deduction and the abolishment of special tax incentives for specific industries/areas.

It is expected that Abe’s cabinet will announce a “new growth strategy plan” in June 2014, in which the future effective corporate tax rate of Japan may be referred to. Therefore, the discussion group may provide certain level of opinions of such issues around that time.

For Japan, this may be an opportune moment to start sustainable growth while simultaneously reducing its towering fiscal debt. If unsuccessful, the social security system supporting Japan’s aging population could collapse. In this respect, Japan’s upcoming tax reforms are extremely important for the future of the economy.

Increased consumption tax revenues are allocated to social insurance and to reducing Government debt without damaging Japanese economy. A lower corporate tax rate can help businesses grow, resulting in greater tax revenue and further reduction of Government debt. Surplus earnings arising from the lower corporate tax rate can be used for reinvestment or wage increases leading to a healthy economy and further tax revenue. This is the ideal scenario.

These are the difficult challenges awaiting the Abe administration.


Webcast: cloud computing — a global perspectiveDoes your organization understand its global tax risks surrounding cloud-based transactions and how the cloud tax landscape may change in the coming months and years?

Connect with our panel of EY tax professionals and review their 24 January webcast, which included an informative and multinational discussion regarding the cross-border tax considerations for global cloud computing arrangements.

Whether you are a cloud user or cloud service provider, watching this webcast will help you understand the relevant tax issues and opportunities. We discussed the OECD BEPS initiative relevant to the digital economy, as well as legislative updates from various countries, withholding tax issues, the concept of taxable nexus and indirect tax implications of relevant cloud transactions.

Watch the webcast at:

ey.com/taxandthecloud

WebcastGlobal Tax Policy and Controversy Briefing 75

Luxembourg

On 2 December 2013, the newly composed Luxembourg Government published its coalition program, including components of its future fiscal policy. The intention of the new government is oriented toward structural reforms in order to rebalance public finances during the forthcoming parliamentary term. This will be achieved first through a detailed screening of public expenses, second through specific measures supporting economic growth and finally via a number of modifications to the current tax system. The government program announces stability as a key principle of its future tax policy and aims to attract new businesses and corporate headquarters to Luxembourg as well as allowing existing entrepreneurs to continue to develop their economic activities. Other than an increase of VAT, which will remain the lowest in the European Union, no further tax increases are currently foreseen on the governmental agenda.

The position of Luxembourg in an international context will be strengthened with the extension of the current corporate governance and substance rules, the elaboration of a comprehensive transfer pricing legislation in line with international standards as well as the development of a uniform procedure with respect to advance tax clearances. Some of the most relevant taxation laws applicable to companies (for instance the so-called participation exemption, the tax rules applicable to intellectual property and the use of functional currencies) will be amended in order to enable Luxembourg to become a center of excellence for global or regional headquarters of multinational companies. At the same time, SMEs will be encouraged via specific mechanisms to achieve sustainable economic development and growth.

Social fairness will govern the taxation of individuals through a review of the existing progression and tax rates as well as of the current personal allowances. The new Government also announced that there will be no reintroduction of net wealth tax nor amendments to succession tax for individuals. Further details announced are summarized on the following page.

New Luxembourg Government announces main aspects of its fiscal policy.

Marc SchmitzTax Policy Leader — EY Luxembourg T: +352 42 124 7352 E: [email protected]


Reinforcing tax revenuesThe fiscal policy of the Government promises an increase of tax revenues via the support of economic growth combined with a reinforcement of tax collection and modernization of the existing General Tax Law, but also by reforming the criminal law on taxation. Raising taxes, other than an increase of VAT rates considered as unavoidable, is seen as a measure of last resort.

A potential extension of the self-assessment process for direct and indirect taxes to both companies and individuals is under consideration. The respect of existing legislation as regards filing and payment deadlines would as well be reinforced through a more systematic application of the penalties and fines already foreseen in the current legislation. Following the international trend, the Government has also committed itself to further enhance the fight against tax fraud.

VAT increaseAs already largely anticipated, VAT rates shall be increased in order to compensate for the future loss of VAT revenues derived from e-commerce, with a commitment to keep the standard rate (of currently 15%) the lowest within the European Union.

Luxembourg in an international contextThe new Government aims at further developing Luxembourg as prime location for headquarters, fully in line with OECD and EU principles of taxation. A first step will be the extension of existing governance and substance rules, thus reinforcing the material and operational presence of companies and highly skilled workers in Luxembourg.

Furthermore, the Government will work out a comprehensive transfer pricing legislation in line with international standards and develop a uniform frame for advance tax clearances in order to provide more transparency, coherency and legal security. It is also intended to further expand the existing Luxembourg tax treaty network.

The government is not introducing a European Financial Transaction Tax (FTT) as currently proposed, but supports a worldwide FTT which would avoid any relocation of financial activities outside of the European Union. The new Government will continue the path taken by the former Government as regards to the exchange of information: it will continue participating to the work done within the European Union and the OECD, but any extension of the scope of the automatic exchange of information must be made in accordance with the terms and the time scale required to ensure the stability and the competitiveness of the financial sector.

Taxation of companiesLuxembourg should develop itself as center of excellence for headquarters of multinationals: the modernization of the so-called participation exemption regime as well as of the tax rules applicable to income from intellectual property shall help reaching this objective, as well as the formalization of the use of the functional currencies for tax purposes. A further announced action point is the introduction of a tax and legal framework for treasury activities (“cash pooling”).

The goal to achieve sustainable economic development and growth also implies sustaining the business of SMEs. Measures such as the introduction of a mechanism to defer the taxation of profits through the building of a special reserve for investment are hence envisaged.

In order to strengthen the capitalization of companies with shareholders’ equity, the government will introduce the concept of notional interest, allowing companies (under certain conditions and within specific limits) to deduct a deemed interest expense calculated on the amount of their capital.


NordicsTax competition in the Nordics“There are only patterns, patterns on top of patterns, patterns that affect other patterns. Patterns hidden by patterns. Patterns within patterns,” wrote contemporary author Chuck Palahniuk. “If you watch close, history does nothing but repeat itself.”

Patterns are an excellent way to describe the increasingly common phenomenon of one tax policy or legislative measure being replicated across neighboring countries. One country adopts a measure, and its neighbors decide that either imitation is the sincerest form of flattery or, perhaps more likely nowadays, the measure will erode their own tax base and like must be countered with like measures. For the savvy, identifying and decoding these patterns can create opportunity and reduce unwanted surprises.

For some years now, EY has published an annual “outlook” of tax policies around the world. Assessing the myriad changes issued globally around the turn of each year, candles have been burnt at both ends to first identify and then validate ever-changing trends. There were 11 countries that issued accelerated depreciation measures in the first month of 2009 alone. Tax competition to attract large multinationals could have been the headline for the statutory corporate income tax rates of Australia, the Netherlands and the UK over the last decade. Fiscal austerity was the common measures we saw countries adopt as the pendulum swung from stimulus to austerity in 2010 and 2011.

Fashion in 20142014 is certainly no different in this regard, as you can read in our 2014 Outlook summary on page 43.1 Several long nights of data analysis resulted in the identification of a range of key policy trends playing out, more than a few of which could (not surprisingly) be described as “BEPS-inspired.” But perhaps less obvious was the apparent round of legislative measures being put in place among the Nordics group of countries.2 And I’m not referring to the tax deduction awarded to ABBA’s onstage costumes, as my colleague notes on page 44.

Consider the recent evidenceOf the 61 countries we surveyed in our “2014 Outlook,” 10 have so far announced reductions in their statutory corporate income tax rate for the year ahead. Three of the 10 were from the Nordics.

Denmark sees a small decrease, from 25% to 24.5%, part of a wider policy under which the corporate tax rate will gradually be reduced from 25% to 22%, while Norway moves from 28% to 27%. Finnish corporate taxpayers, meanwhile, will enjoy the largest percentage fall among our 61 surveyed nations in 2014, with a reduction from 24.5% to 20%. This follows Finland’s 2012 reduction from 26% to 24.5%. While announcing no new measures in this area for 2014, Sweden lowered its rate from 26.3% to 22% in 2013.

Rob ThomasContributing Editor – Tax Policy and Controversy Quarterly Briefing T: +1 202 327 6053 E: [email protected]


1. Also available at www.ey.com/2014taxpolicyoutlook

2. Excluding Iceland for the purposes of this article.

Of course, there is no such thing as a free lunch and followers of the “patterns” philosophy will know that in the case of countries lowering their statutory CIT rates, there is (almost without exception) a pattern within a pattern — that of the simultaneous move to broaden the tax base. Our Nordics pattern is no stranger to this, and in just a single year, three in our Nordics group have introduced new legislation to limit the deductibility of interest payments in some way.

Norway and Finland have both introduced interest limitation regimes for 2014 which are based on a fixed percentage of earnings before interest, taxes, depreciation and amortization (EBITDA). In contrast to other members adhering to this particular pattern (e.g., Germany and Italy) however, these two countries sensibly apply the EBITDA-based limitation only to interest on related party debt, and not to all interest.

In Sweden, the introduction of tightened interest limitation rules was the most significant tax change for the country in 2013 and the new rules constituted a considerable tightening of the previous measures. In principle, all interest payments to related companies will fall under the main rule disallowing deductions. Accordingly, all companies with internal loans — whether they relate to leveraged companies or, for example, cash pooling arrangements — will have to demonstrate that at least one of the exemptions applies. The limitation of the business reasons exemption to European Economic Area and treaty states means that interest payments to related companies in “tax havens” will not be deductible — again, reflecting wider patterns we see in tax policy, designed to exclude payments made to low tax regimes. Only Denmark has made no move to tighten interest limitations in 2013 and 2014. That’s something to note in itself.

While the interest limitations are not the only Nordics policy trends identified in 2013 and 2014 data (there are also similar themes in the tax treatment of losses and the depreciation of new business assets), it is worth noting just how many countries around the world are continuing down the interest limitation route in advance of any OECD recommendations under BEPS Action Plan Item 4. Thirteen of the 61 countries surveyed for our “2014 Outlook” report are doing so this year. Two of the 13 are from the Nordics group and were joined by Sweden’s 2013 measures.

Competition or coincidence?As pointed out by Professor dr juris Ole Gjems-Onstad of the Norway School of Management,4 the Nordic countries tend to share a higher tax burden as a percentage of GDP than many other developed nations. This is largely due to their highly developed social welfare frameworks and a high level of support for agriculture and their rural regions. Denmark, for example, has the highest tax to GDP ratio among OECD countries at 48% in 2012.5 Finland, Norway and Sweden all ranged between 8 and 10 percentage points above the OECD average tax to GDP figure of 34.1%, according to most recent OECD data.

As Professor Gjems-Onstad points out, this can make the Nordics especially vulnerable to tax competition from other countries with lower tax burdens; as previous patterns elsewhere also indicate, it would also seem to make them especially reactive to policy shifts from near-neighbors with very similar tax regimes, not to mention overall similar levels of attractiveness to business.

Ringing round the housesThe likelihood of these similar policy moves being a coincidence would therefore seem to be low. As Jur. dr Mattias Dahlberg of Stockholm’s School of Economics wrote, “It is no understatement that the Swedish Government has taken the question of tax competition seriously.”6 But does that mean that the neighboring countries look to each other to see who moves first, or that they look more widely? Or perhaps a combination of both?

I asked a number of EY tax policy professionals for their views on this question.

“There is no doubt that the fact that Sweden decided to lower their corporate tax rate first was a strong factor in Denmark making the decision to do the same thing,” says Trine Bonde Jensen, EY’s Tax Policy and Controversy Leader for Denmark. “Indeed, when the Danish bill was proposed, members of government confirmed to the media that the reason for the proposal was that Sweden had decided to lower their corporate tax rate and Denmark needed to stay competitive. In the bill, it is specifically mentioned that Sweden and the UK have lowered their tax rate.”


4. See Tax competition in Europe: Norway. http://www.eatlp.org/uploads/Members/Norway02.pdf

5. See http://www.oecd.org/ctp/tax-policy/revenue-statistics-country-note-for-denmark.htm

6. See http://www.eatlp.org/uploads/Members/Sweden02.pdf

From Helsinki, EY’s Tax Policy Leader Tomi Johannes Viitala echoes that message but adds more, saying, “There is no doubt that for Finland, Sweden has been the benchmark country when it comes to corporate taxation. It’s also clear that Sweden’s decision to lower its CIT rate to 22% triggered Finland’s latest reduction to 20%. However, it was not the only reason. Finland had its tax competitiveness eroded quite significantly in recent years. It’s useful to note that when Finland joined the EU in 1995, its CIT rate (at the time 25%) was more than 10% below the EU average. In more recent years though, Finland’s CIT rate has only been slightly below the EU average. Also, in public debate the Estonian corporate tax system (where no taxes are due as long as profits are not repatriated by the company) is often cited as a tax model that Finland should follow. Although this is unrealistic, the Estonian tax system has increased the pressure to lower the CIT rate in Finland.”

Conversely, Arild Vestengen, EY’s Tax Policy and Controversy Leader for Norway, says his country may also have been looking further afield: “There is no indication that the latest changes (lowering the CIT rate and putting in place tighter interest limitation rules) are consequences of corresponding changes in other Nordics countries. I believe that the main cause was to adjust the Norwegian tax system to competition from all over the world, not just our immediate neighbors. The framing of the taxation rules are inspired by many nations, but again there are no signs of a specific Nordic influence.”

Sweden cements the notion that it’s not just immediate neighbors that factor into tax competition decisions. “One of the main reasons for Sweden’s recent decrease was clearly to be competitive internationally,” says Erik Hultman, our man in Stockholm. “But perhaps more of the focus was on the expansion of the European Union, with more countries with a lower corporate income tax than Sweden coming in.”

Much the same thing goes for the Sweden’s interest deduction changes, says Hultman. “The interest deduction restriction first introduced in 2009 seems to have been inspired by the Dutch interest deduction limitations in both design and approach. Before introducing the additional restrictions imposed in 2013, the measures in Finland and Denmark were studied, but then so was legislation from the Netherlands, France, Germany, Spain and the United Kingdom.”

Key takeawaysThis is not the first time we have seen groupings of seemingly similar countries follow similar policy trajectories. It is not even the first time for the Nordics, and some may remember passing through an earlier round of similar moves at the start of the 1990s.

For those investing or operating in this group of countries, the message is clear — look at the patterns the forerunners of similar moves elsewhere have made and then assess the likelihood of similar moves being made in these countries. What kinds of new measures might they consider as they move to expand the tax base? Are they active on the CFC or thin capitalization fronts? How does their current treatment of tax losses stand against their peers? Is it likely that there will be additional incentives or depreciation allowances designed to attract investment and hence expand the tax base over the longer term? And importantly, how is their tax enforcement approach shifting?

Some of these questions are already being actively discussed in the Nordics. “A committee has been instructed to review the Swedish taxation of companies,” says Hultman. “One objective is to improve the tax neutrality between equity and borrowed capital, and the question of limiting interest deductions is being evaluated once again.” In Finland, the “Working Group for Developing Business Taxation” was set up by the Ministry of Finance and finished its work in June 2013. A memorandum was circulated for consultation, which included proposed changes to, for example, group taxation, loss offsetting and company tax residence. Having a line of sight into these various policy for a has always been important. That’s probably more so than ever today, with capital becoming more mobile and more and more countries putting in reform commissions to help assess the flow of OECD and other recommendations.

Bonde Jensen signs off her email by encapsulating everything with typical Nordic efficiency: “I do think that if the other Scandinavian countries came up with other significant tax policy moves, there is a strong likelihood that Denmark would follow.” Patterns within patterns, once again.


Webcast

Webcast: Exploring the Possible: making Tax a value creator in finance transformationMore and more companies are taking a closer look at their corporate tax function — a fundamentally different look that explores the possible by reevaluating how their tax departments operate and integrate within the company.

What actions they take can vary in scope. Will it be a full-scale change in the operating model or an opportunity to facilitate tax’s role in an enterprise-wide finance transformation? Or will it be to a focused change that targets specific improvement or process integration goals? Whatever form it takes, successful change requires a thorough understanding from all the stakeholders as well as buy-in throughout the relevant areas of the enterprise.

Exploring the Possible is a quarterly series that looks at tax in today’s organizations and its strategic role in helping reach the broader business objectives.

Exploring begins 2014 with a four-part series that focuses on finance transformation as the catalyst for achieving enhanced performance across the tax function and empowering you to enable change.

In the first edition of 2014, held on 20 February 2014, leading EY professionals looked at tax in the overall construct of finance transformation — why, when and how tax should be involved, what risks are likely to arise with insufficient involvement, and what benefits can be gained with proper engagement. They discussed what it takes to make a compelling business case for involving tax in finance transformation, identify critical success factors, analyze some common perceptions that CFOs have and talked about how to move the needle toward better understanding and more integrated involvement.

Replay the webcast and join the conversation:

ey.com/taxandfinancetransformation


PanamaPanama’s short-lived worldwide income tax regime: a strange week in tax history On 30 December 2013, a new law was approved and published in Panama. The enacted law amended Section 694 of the Panamanian Tax Code, adopting a taxation system based on worldwide income and abandoning Panama’s traditional territorial taxation model.

Just a few days later on 2 January 2014, an extraordinary Cabinet Council was called to authorize the Ministry of Finance to propose to the National Assembly a bill to repeal the changes. The National Assembly approved this bill during its third debate on 10 January 2014 and the first Law of 2014 was enacted to restore the territorial principle with retroactive effect to 30 December 2013.

In this article, we review the course of events during this unorthodox period for Panama’s tax regime.

Luis OcandoTax Policy and Controversy Leader – Panama T: +507 208 0144 E: [email protected]

The territoriality principle of the Panamanian income tax system has been in place for a century and has been an integral part of the country’s tax history and an important element of its economic development and success. Panama’s economic strategy relies on its platform of international, legal and maritime services and the financial sector, among others. These sectors have been developed by taking advantage of the territoriality principle as well as other geographical and economic characteristics of Panama.

Despite all this, a short-lived law withdrew this historical pillar in late December and replaced it with a worldwide income principle. The National Assembly approved the law on 28 December 2013, and the President of the Republic, Ricardo Martinelli, signed it two days later. The law immediately prompted strong concerns among tax practitioners and the business community.

This law, which represents a significant alteration of the Panamanian tax system, was enacted without any prior notice, consultation or public debate despite the multiple repercussions it would have caused. Putting the pros and cons of a worldwide regime aside, the consensus among practitioners and the Panamanian business community was that the approach used by the promoters of this initiative transgressed any standard of legal certainty.


The story began on 27 December 2013 when Bill No. 689 was used to introduce the worldwide principle into the income tax system. The original text of that bill did not include any modification to the Fiscal Code or the territoriality tax system, An amendment to Article 694 of the Fiscal Code, changing the paradigm of the current tax system by introducing the worldwide tax system, was included in the second debate of the National Assembly. The third debate was made just one day later, and Law 120 was approved on 28 December 2013.

The bill originally related to the modification of the free-trade zone for merchandise sold to tourists and a logistic multimodal system in the Port of Baru district of Panama’s Chiriquí Province, created by Law 19 of 2001. Many legislators were on their New Year’s holidays when it was approved and Bill No. 689 ended up being discussed in an extraordinary session of the National Assembly.

On 30 December, Law 120 of 2013 was published in the Panamanian Official Gazette, entering into force on that date. Articles 2 and 3 thereof included changes to the Fiscal Code.

Law 120 did provide for some exemptions to the application of the new worldwide income tax system; these related to special regimes, such as free-trade zones, the Panama-Pacific Special Economic Area, the Multinational Companies Headquarters regime (SEM), banks and institutions regulated by the Panamanian Banking Superintendence, and those companies with contracts with the Panamanian Government that have the force of law in the hierarchy of norms.

From a technical perspective, the wording of Law 120 was not clear and would have required amendments to clarify the application of the new worldwide tax system in Panama. For example, as it was published, the scope of the worldwide tax system was not limited to Panamanian residents and it did not contemplate a system to eliminate double taxation.

This modification of the Panamanian tax system caused not only surprise but also a strong opposition from the financial community, the Panamanian Chamber of Commerce, providers of corporate services, the Maritime Law Association of Panama, Panamanian lawyers, the tax community in general and even within the Government itself. Thus, on 31 December 2013, just 24 hours after Law 120 was enacted, the Government issued an Official Announcement informing the public that Articles 2 and 3 of Law 120 would be repealed.

For that purpose, on 2 January 2014 and following a procedure set out in the Constitution, an extraordinary Cabinet Council was called to authorize the Ministry of Finance to propose a bill to the National Assembly to repeal the changes made in the Fiscal Code by Law 120. As a result of this extraordinary Council, Bill No. 694 was submitted to the National Assembly on 6 January 2014.

After the meeting of the extraordinary Cabinet held on 2 January 2014, the Office of Communications of the Government issued an official communication announcing the following: “… with this step, the Government reaffirms its historic commitment to the principle of territoriality as the source for purposes of computing the income tax for both individuals and legal persons operating within the Republic of Panama.”

Furthermore, according to the explanation on the bill, the Government is aware that the implementation of the worldwide income principle requires more discussions and debates and that such modification changes the country’s tax system.

On 10 January 2014, the National Assembly approved Bill No. 694 during its third debate and the first Law of 2014 was enacted to restore the territorial principle with retroactive effect to 30 December 2013 (i.e., the date when Law 120 entered into force). The deputies unanimously endorsed the bill. According to media reports, Law 120 was promoted by the General Director of the National Revenue Authority, who just after its entry into force announced via his Twitter account that the reform was a mistake: “Yo propuse los artículos 2 y 3 de la Ley 120 y me equivoque. No estamos preparados para renta mundial,” he wrote — “I proposed Articles 2 and 3 of Act 120, and I’m wrong. We are not prepared to tax worldwide income.” The reaction of the Government and especially of the President of Panama and the Economic and Finance Minister seems to indicate that the shift to a worldwide income tax system is not expected to be part of the Government’s upcoming tax policy changes.

Broadly speaking and from a policy-making perspective, if the Government wants to implement this major change in the near future, a public debate and a detailed cost-benefit assessment should be conducted at the very minimum. Any change from the territorial system to a worldwide income tax system must include a special regime for international businesses, such as the ones existing in Barbados and Madeira.


United StatesFive things businesses should know about Chairman Camp’s tax reform plan House Ways and Means Committee Chairman Dave Camp’s (D-MI) release of a comprehensive tax reform plan marks a significant development in the ongoing tax reform debate. While few expect tax reform to be enacted in the near term, businesses should take note of the Camp proposal, not only because it lays out the choices made by the House’s chief tax policy leader across a broad range of issues, but also because of the plan’s level of detail and the accompanying analysis of its revenue effects. The depth and breadth of Chairman Camp’s proposal demonstrate his willingness to address the difficult trade-offs needed to achieve significant reductions in both corporate and individual tax rates.

Michael DellCenter for Tax Policy T: +1 202 327 8788 E: [email protected]

Robert CarrollQuantitative Economics and Statistics (QUEST) T: +1 202 327 6032 E: [email protected]

The proposal, with statutory language, extensive technical explanations, revenue estimates, distributional tables and a macroeconomic analysis by the Joint Committee on Taxation (JCT), represents a significant contribution to the tax reform debate, and has already drawn reactions from industries that would feel its effects.

The proposal would lower the maximum corporate and individual tax rates to 25% and 35%, respectively, paid for by greatly broadening the tax base (see Table 1 for key features). Generally, businesses that pay high effective tax rates would gain through the lower tax rates, while industries that currently benefit from some of the tax provisions the plan curtails or eliminates would see their taxes rise. Below are five key aspects businesses should understand to help inform their assessment of the proposal.

1. The proposal would lower income tax rates for both corporations and individualsAt the heart of Chairman Camp’s tax reform proposal are lower corporate and individual income tax rates. On the corporate

side, the plan would reduce the maximum income tax rate from 35% to 25%, phased in over 5 years. On the individual side, the current rate structure would collapse to two income tax rates – 10% and 25% — plus a 10-percentage point surtax, effectively creating a third rate bracket. The third bracket would apply to a broader tax base. The 10% rate would apply to the first $37,400 of taxable income for single filers ($74,000 for joint filers), and the 25% rate would apply to taxable income above $37,400 ($74,800).

The 10-percentage point surtax would apply to single taxpayers with modified adjusted gross income (MAGI) over $400,000 ($450,000 for joint filers). MAGI does not allow most itemized deductions, and would include other items currently excluded from taxable income, such as tax-exempt bond interest and employer-provided health insurance premiums. MAGI would be reduced by certain charitable contributions and qualified domestic manufacturing income. Because the 10-percentage point surtax effectively disallows most itemized deductions, it, in effect, would limit the tax benefit of the affected deductions to 25%.


Table 1. Key elements of Chairman Camp’s tax reform proposal

*Figure represents net revenue amount.

Category Provision Revenue estimateCorporate tax rate 25% (phased-in over five years). Eliminates current

15% rate on corporate income under $50,000.-$680 billion

Business tax revenue-raising provisions (non-international)

Significant reductions to or elimination of many business tax provisions.

$1,332 billion

Corporate and individual alternative minimum tax (AMT)

Repealed. -$1,442 billion

International taxation Allows a 95% dividend exemption on active foreign earnings. Reforms subpart F with current inclusion and a reduced rate applied to certain foreign “intangible” income. Imposes one-time transition tax on untaxed foreign earnings of foreign subsidiaries.

$68 billion*

Individual tax rates 10%, 25%. 10-percentage point surtax for filers with modified adjusted gross income above $400,000 (single), $450,000 (married). Surtax is similar to a 35% tax rate bracket, but applied to a broader base. Benefit of 10% rate bracket begins to phase out for taxpayers with incomes above $250,000 (single), $300,000 (married).

-$544 billion

Capital gains and dividends 40% exclusion for dividends and capital gains. $45 billion

Financial institution excise tax Imposes quarterly 3.5 basis-point excise tax on financial institutions with more than $500 billion in consolidated assets.

$86 billion

Under the proposal, capital gains and dividends would be taxed at ordinary income rates, with 40% exclusions for both. This exclusion would apply to all the rates, including the new surtax. The 3.8% tax on investment income enacted under the 2010 health insurance reform would also continue to apply, resulting in a 24.8% top effective rate on dividends and capital gains. The proposal would also repeal both the corporate and individual alternative minimum taxes.

2. Tax base broadening would reach beyond traditional tax ‘expenditures’Like many other recent tax reform proposals, Chairman Camp’s plan is revenue-neutral, meaning it would not add to the deficit. And like others, it would pay for the rate reductions by curtailing or eliminating targeted tax preferences by broadening the tax base. Most previous tax reform proposals have focused on a host of tax provisions that are considered spending through the tax code, known as tax expenditures. Chairman Camp’s plan, however, goes well beyond typical tax expenditures in its attempt to broaden the tax base enough to pay for lower income tax rates without adding to the deficit.

Nearly 44% of the revenue derived from business-related base broadening in the proposal comes from modifying provisions that are not normally viewed as tax expenditures. These include many long-standing and familiar tax provisions, such as the deduction for research and experimentation (R&E) expenditures and the deduction for advertising expenses. Under the proposal, R&E expenditures would be amortized over 5 years, phased in over several years. According to the JCT, this change would raise $193 billion over 10 years. The proposal would also curtail companies’ ability to currently deduct advertising expenses; 50% would be currently deductible and the remainder would need to be amortized over 10 years, phased in over 4 years. That provision is estimated to raise $169 billion over 10 years. These provisions, along with replacement of accelerated depreciation with the alternative depreciation system (ADS) that more closely approximates economic depreciation, plus indexing of the depreciation system, scored by JCT as raising $270 billion over 10 years, are among the largest revenue-raising business-related provisions in the proposal.

Other examples of such business-related base broadening include the proposed repeal of the non-recognition of gain or loss on exchanges of like-kind property, and repeal of last-in-first-out (LIFO) and lower-of-cost-or-market accounting methods.


On the individual tax side, Chairman Camp’s proposal includes significant base broadening that could have major tax consequences for taxpayers. In fact, much of the proposal’s revenue redistribution occurs through changes to individual taxation. The proposal would set the standard deduction at $22,000 for joint returns and repeal personal exemptions and the so-called “Pease” limitation on itemized deductions. It would phase out certain benefits for higher-income taxpayers, including the benefits of the 10% rate bracket.

The proposal would repeal the individual deduction for state and local taxes, and would lower the cap on deductible home mortgage interest to $500,000, down from the current $1 million. Only charitable contributions above 2% of a taxpayer’s adjusted gross income would be deductible.

The proposal would also make significant changes in the tax laws governing retirement savings. It would prohibit tax-deductible contributions to IRAs and eliminate the income limits on contributions to Roth IRAs. For employers with more than 100 employees, it would push employers and participants in 401(k) plans toward Roth accounts and cap pre-tax elective deferrals. The proposal would also modify the minimum required distribution rules.

In the area of compensation, the proposal would place limits on nonqualified deferred compensation and would make changes to the rules governing the deductibility of certain executive compensation. In addition to expanding the group of executives subject to the $1 million deduction limitation, the proposal would repeal the exceptions to the limitation for commissions and performance-based compensation.

Overall, the revenue-raising individual tax provisions in Chairman Camp’s proposal

are estimated to raise $3 trillion over 10 years, while the proposal’s revenue-raising business tax provisions are estimated to raise $2 trillion over the same period. To place this into perspective, this base broadening equals about 18% of total income tax revenue projected over the next 10 years.

3. The proposal would shift the United States toward a territorial tax systemUS-based global companies are currently taxed on their worldwide income, but can defer US tax on earnings of foreign subsidiaries until repatriated, so long as the income of those subsidiaries does not fall within the US anti-deferral rules (also known as the “subpart F rules”). When the deferred income is repatriated back to the United States, it is taxed at the full statutory corporate tax rate (the highest rate is 35%), subject to the foreign tax credit. Under Chairman Camp’s proposal, these past foreign earnings held abroad would face an immediate transition tax at an effective rate of either 8.75% (if held in cash, cash equivalents or certain other short-term assets) or 3.5% (for accumulated earnings invested in property, plant or equipment). The tax could be paid over 8 years.

Chairman Camp’s plan draws heavily on his 2011 international tax reform draft, which proposed moving the US toward a more territorial system of international taxation. In a provision that is somewhat similar to what he proposed in 2011, the plan would exempt from US tax 95% of the active, non-mobile, foreign-source portion of dividends received by a US corporation from a foreign corporation in which it owns at least a 10% stake.

Chairman Camp’s tax reform plan also includes anti-base-erosion provisions that would create a new category of income subject to taxation under subpart F. In essence, the provision would impose

immediate US tax, at a 15% effective rate, on income of a foreign subsidiary from sales in foreign markets, to the extent that the income exceeded 10% of the subsidiary’s investment in tangible business assets. This type of income, if earned directly by a domestic corporation, would also be taxed at the reduced 15% effective rate. The plan would also make permanent the “look-through” rule that allows US-based companies to move active, non-mobile foreign earnings from one foreign subsidiary to another without incurring US tax.

“Thin capitalization” rules (similar to the 2011 international tax reform draft) would apply to US corporations that own foreign subsidiaries and would limit deductions for interest expense based on how leveraged the US parent is relative to the worldwide group. Several other provisions would modify subpart F, reform the foreign tax credit rules and extend and modify the active financing exception for 5 years (subject to the potential application of the new anti-base-erosion provision).

The JCT estimates that, on balance, the international tax provisions in the proposal would raise a net $68 billion in revenue over 10 years. This is despite a $212 billion loss over 10 years from the establishment of a participation exemption system for dividends received from certain corporations. The one-time tax on existing unrepatriated earnings is estimated to raise $170 billion over 10 years.

While the 95% dividend exemption might benefit some companies, there are significant tradeoffs that could raise the taxes of some US companies with operations abroad, depending on their circumstances. US-based global companies will need to carefully examine each of the provisions in the context of their own situation to determine the net tax effect of the proposals taken together.


4. The proposal could affect businesses’ choice-of-entity decisionsOwners of business entities organized as pass-throughs are taxed at the individual level. In contrast, corporate income is taxed twice, once at the corporate level and again as dividends when corporate earnings are distributed or as capital gains when investors sell their stock. Under Chairman Camp’s proposal, the lower 25% corporate tax rate, combined with the proposal’s 40% exclusions for dividends and capital gains, would result in a significant reduction in the top integrated tax rate (combined taxes paid at the corporate and individual levels) on corporate earnings. Currently 51.3%, this integrated tax rate would fall to 43.6%1 under Chairman Camp’s proposal for corporate earnings paid out and subject to the top dividend tax rate.

At the same time, many pass-through businesses would have income subject to the 25% individual tax rate, plus the 10-percentage point surtax. An exception exists for pass-throughs with qualifying manufacturing income, which would not be subject to the surtax and thus would be taxed at the maximum 25% individual rate.

The proposal also contains several other provisions that would affect pass-through entities. It would subject certain partnership interests held in connection with the performance of services to a rule characterizing a portion of any capital gains as ordinary income. This would change a tax policy that currently allows such investment profits, or “carried interest,” to be taxed as capital gains instead of ordinary income. The proposal would also make several other changes to partnership and S-corporation rules.

Naturally, businesses consider many factors when deciding whether to choose a corporate or pass-through structure, and taxation is only one of them. But the modifications Chairman Camp proposes to the corporate income tax rate and to how capital gains and dividends are taxed would change the calculus involved in such choice-of-entity decisions. Taken together, these provisions might affect the way businesses choose to configure their business operations.

5. Chairman’s Camp proposal represents a significant contribution to the tax reform debateChairman Camp has put forth a bold proposal that calls for changes to many long-existing provisions of the tax code. Politically, however, the proposal faces many challenges. While House Speaker John Boehner (R-OH) has said the proposal marks the beginning of a “public conversation” on tax reform, Senate leaders have indicated tax reform is a non-starter in that chamber this year.

While the proposal may not have a clear immediate legislative path forward, it is likely to be a foundation for future tax reform discussions. Already it has sparked conversations at all levels, among policymakers, politicians and businesses. In making tough choices to achieve significant reductions in corporate and individual income tax rates, Chairman Camp has put a host of proposals on the table for debate. It is also possible that some of these proposals, which are sources of significant revenue, could resurface in other contexts.

ConclusionChairman Camp released his plan as a discussion draft rather than introducing it as formal legislation. House leaders have said it will serve as the starting point for a public discussion but have mentioned no plans about bringing it to a vote in the House or even the Ways and Means Committee. There is an expectation that the Committee could hold hearings related to the plan at some point. Already there have been member briefings on the plan, and those are expected to continue. At the same time, the Committee is seeking input and feedback on technical and tax policy issues the plan raises.

Both the House and Senate would have to vote and approve any tax reform legislation for it to become law. Senate leaders have been pessimistic about the prospects for advancing a tax reform bill in that chamber this year. While Senate Finance Committee Chairman Ron Wyden (D-OR) and Ranking Finance Committee Republican Sen. Orrin Hatch (R-UT) released a joint statement commending Camp on releasing the plan, Wyden said 14 February that enacting a comprehensive tax reform package this year would be a “big lift” and that he would first focus on extending the host of tax provisions that expired at the end of 2013.

Whatever the future outcome, businesses should familiarize themselves with the tax reform plan and understand how its provisions might affect their operations, industry and market. Weighing the tax benefits of lower rates against the detriments of the various base-broadening provisions will be important. Communicating with others who are similarly situated and engaging with policymakers will improve the quality of any potential future legislation.


1. EY calculations. Calculations include the corporate income tax, investor-level taxes on capital gains and dividends and the 3.8% tax on investment-related income enacted under the Affordable Care Act.

Table 1. Global CIT rates — largest 50 “economies” or “jurisdictions” by GDP, sorted by tax rateNote: Where applicable, rates include an average subnational (state/provincial) tax rate in addition to the national/federal rate.

Corporate income tax (CIT) rates

1. IMF World Economic Outlook Database — September 2012.

Jurisdiction

GDP 2014 ($US billions)1

2014 CIT rate (national statutory rate only)

2014 CIT rate (national and subnational, average)

Worldwide vs. territorial taxation

Notes

United States 15,653 35.00% 39.00% Worldwide

France 2,580 38.00% Territorial The initially proposed 1% tax on EBITDA (earnings before interest, taxes, depreciation and amortization) is replaced by an increase of the temporary additional contribution to CIT from 5% to 10.7%, that applies to companies (or tax consolidated groups) with an annual turnover exceeding €250 million. The increase would apply to fiscal years (FYs) ending between 31 December 2013 and 30 December 2015. The maximum CIT rate would thus amount to circa 38% instead of the current 36.1%.

Japan 5,984 35.64% Territorial The government has repealed the 10% special corporate reconstruction surtax a year early. The effective corporate tax rate (Tokyo area, including local taxes) will be reduced from 38.01% to 35.64% for taxable years beginning on or after 1 April 2014.

Argentina 475 35.00% Worldwide

Pakistan 231 35.00% Worldwide

Brazil 2,425 34.00% Worldwide

Venezuela 338 34.00% Worldwide

India 1,947 33.99% Worldwide Rate illustrated is applied to domestic companies, including surcharge and education CESS. Foreign companies pay tax of 43.26% including surcharge and education CESS.

Belgium 477 33.99% Territorial

Germany 3,367 33.00% Territorial

Italy 1,980 31.40% Territorial

Australia 1,542 30.00% Territorial

Spain 1,340 30.00% Territorial

Mexico 1,163 30.00% Worldwide An additional 10% CIT will be imposed on certain profits and dividends from 2014 onwards. Because the tax on dividends would be on the distributing company, there would be no tax treaty protection.

Nigeria 273 30.00% Worldwide

Philippines 241 30.00% Worldwide

South Africa 391 28.00% Territorial

Dominican Republic

28.00%

Guatemala 28.00%

Norway 500 27.00% Territorial Corporate tax rate is reduced from 28% to 27% with effect from 1 January 2014.

Egypt 255 26.50% Worldwide

Israel 247 26.50% Territorial Increase in the standard CIT rate from 25% to 26.5% effective 1 January 2014.

Canada 1,770 15.00% 26.23% Territorial


Greece 255 26.00% Territorial Income from business activity acquired by entrepreneurs, private businesses and partnerships (OE) or limited partnerships (EE) with single-entry accounting books is subject to taxation at 26% for income up to €50,000 and at 33% for the portion of income exceeding €50,000. New private businesses and entrepreneurs (business start-up as from 1 January 2013) with income up to €10,000 are taxed at 13% for the first three years of operation. Corporate tax rate for corporations (AE), limited liability companies (EPE) and permanent establishments is increased to 26% (previously 20%).

China 8,250 25.00% Worldwide

Indonesia 895 25.00% Worldwide

Netherlands 770 25.00% Territorial Rate for the first €200,000 taxable basis is 20%.

Islamic Republic of Iran

484 25.00% Worldwide

Austria 391 25.00% Territorial

Colombia 365 25.00% Worldwide Reduction of the CIT rate from 33% to 25% except for foreign taxpayers without a branch office or permanent establishment in Colombia. Those taxpayers will continue to be subjected to a 33% tax rate on income and capital gains of Colombian source.

Malaysia 307 25.00% Territorial

Algeria 207 25.00% Worldwide

Denmark 309 24.50% Territorial

Korea 1,151 24.20% Worldwide 24.2% top tax rate includes a 10% surcharge applicable to taxable income in excess of KRW20 billion (US$18 million). While headline tax rates are the same in 2013, large companies with taxable income exceeding KRW100 billion will see the minimum tax rate raised from the current 15.4% to 17.6%.

Thailand 377 23.00% Territorial Thailand recently enacted a two-phased corporate tax rate reduction. Phase one reduction is from 30% to 23% and is effective for accounting periods beginning on or after 1 January 2012. Phase two reduces it down to 20% for accounting periods beginning on or after 1 January 2013 and 1 January 2014.

Portugal 211 23.00% Territorial

Sweden 520 22.00% Territorial

Vietnam 22.00%

Slovak Republic 22.00%

Switzerland 623 7.80% 21.17% Territorial

United Kingdom

2,434 21.00% Territorial Mainstream rate of corporation tax will reduce to 21% in 2014 and be further reduced to 20% with effect from April 2015, the first time that the UK’s main rate and small profits rate have coincided since 1973.

Russia 1,954 20.00% Territorial

Turkey 783 20.00% Territorial

Saudi Arabia 657 20.00% Worldwide

Chile 268 20.00% Worldwide

Finland 247 20.00% Territorial Finland cut the rate by 4.5 percentage points as of 2014

Poland 470 19.00% Worldwide

Czech Republic 194 19.00% Territorial

Taiwan 466 17.00% Worldwide

Singapore 268 17.00% Territorial

Hong Kong SAR

258 16.50% Territorial

Romania 171 16.00% Worldwide

Ireland 205 12.50% Worldwide

United Arab Emirates

362 0.00% N/A



2014 CIT rateNote: Where applicable, rates include an average subnational (state/provincial) tax rate in addition to the national/federal rate.

Figure 1. 2012 Headline CIT rates — largest 50 “economies” or “jurisdictions” by 2011 GDP

Figure 2. “Economies” or “jurisdictions” taxing worldwide income

Figure 3. “Economies” or “jurisdictions” taxing territorially

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Mal

aysi

aA

lger

ia

Chin

a

Aus

tria

Belg

ium



The trend toward a reduction of statutory CIT rates started with the tax reforms in the United Kingdom and the United States in the mid-1980s, which broadened the tax base (for example, by making depreciation allowances for tax purposes less generous) and cut statutory rates. CIT rates have continued to be cut in recent years, accompanied by various base broadening measures, including limitations in interest (and other business expenses) deductibility, more limited utilization of losses and continuing to restrict depreciation allowances).

Figure 1 below shows that the statutory CIT rates in OECD member countries dropped on average by more than seven percentage points between 2000 and 2012, from 32.6% to 25.5%. This trend seems to be widespread, as rates have been reduced in more than 90 countries. Within the OECD area, the rate has stayed constant in Norway and the United States, as well as in non-OECD countries such as Brazil. A number of countries around the world (Colombia, Dominican Republic, Thailand, United Kingdom, for example) continue to reduce rates in 2013 and beyond.

Figure 1. Statutory CIT rates in OECD nations, 2000 and 2012

2012 2000

0

10

20

30

40

50

60

JPN

USA FR

ABE

LPR

TDE

UA

US

MEX ES

PLU

XN

ZLN

OR

ITA

SWE

CAN

AU

TDN

KIS

RN

LD FIN

KOR

GBR

CHE

EST

CHL

GRC

ISL

SVN

TUR

CZE

HU

NPO

LSV

KIR

E

OECD average in 2000 (32.6%) and 2012 (25.5%)

InsightsStatutory CIT rates in OECD nations, 2000 and 2012


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Global Tax Policy and Controversy Briefing · 2014-07-08 · Global Director, Tax Controversy Services T: +1 202 327 5696 E: [email protected] at the end of January. The OECD then