On 5 October 2015, the OECD published their final report of recommendations under the ‘Base Erosion and Profit Shifting (‘BEPS’) Action Plan. In summary, the BEPS project is the OECD’s initiative to counter tax avoidance arising from cross-border transactions and the ability of multinational companies to shift profits between different jurisdictions. Over the last couple of years, the BEPS plan has consulted on 15 key action areas of the international tax systems and the report published earlier this week represents their final recommendations on these action points.
While the clear focus of this initiative are multinational companies, domestic only companies will need to be aware of the potential changes that could be made to UK legislation as a result of this initiative as this may well have impact on them, of particular note are the recommendations regarding interest deductions and changes to the definition of Permanent Establishments (‘PE’).
The actions and the recommendations that were contained within this report relate to: 1 – Digital Economy, 2 –Hybrid mismatch arrangements, 3 – CFC Rules, 4- Interest deduction, 5 – Harmful tax practices, 6 – Treaty abuse, 7 – Artificial avoidance of PE Status, 8/9/10 – Transfer pricing, 11- Data collection, 12- Disclosure of Aggressive Tax planning, 13- Transfer pricing documentation, 14- Dispute Resolution and 15- Multilateral Instrument. Looking further at the interest and PE sections:
Action 7 – Artificial avoidance of PE Status
Of particular concern to OECD under this action point has been the use of commissionaire structures, the “preparatory and auxiliary” activities exemption and the use of split contracts of less than 12 months (e.g. on a building site) to avoid creating a taxable PE. As a result the report recommends significantly increasing the scope of the definition of a PE including “where an agent habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise”. If implemented as recommended, the result is likely to lead to far more taxable PEs being created both here and abroad.
Action 4 – Interest Deductions
The OECD has identified three basic scenarios that are of concern in relation to interest deductions, including third party debt:
- Groups placing higher levels of third party debt in high tax countries;
- Groups using intragroup loans to generate interest deductions in excess of the group’s actual third party interest expense.
- Groups using third party or intragroup financing to fund the generation of tax exempt income.
In order to combat these concerns, the OECD recommends a fixed ratio rule is adopted by jurisdictions that will limit an entity ability to claim a deduction for net interest (i.e. interest expense in excess of interest income) to 10%-30% of EBITDA. This report also recommends that countries could supplement this basic principle by allowing:
- A Group ratio rule, which would allow an entity with a net interest expense above a country’s fixed ratio to deduct interest up to the level of the net interest/EBITDA ratio of the worldwide group;
- A de minimis threshold
- Exclusion for public interest projects
- Carry Forward of interest expense and/or unused interest capacity for use in future years.
For industries that are typically highly geared such as real estate, the implementation of an EBITDA approach is likely to significantly increase the post-tax cost of the finance and there will no doubt be much lobbying by such industries in advance of any implementation by the UK Government. For all of those borrowers who are taking on long term finance, they will need to continue to have an eye on these proposals and their implementation as this will no doubt impact their overall business plan.
In the UK, we already have the worldwide debt cap rules for large corporates as well as the recent introduction of an interest limiter for BTL Landlords being applied from April 2016, it will therefore be interesting to see how the UK Government choses to take this further and adopt the OECD recommendations.
For the majority of the identified action areas, there are now clear recommendations from OECD, the emphasis will therefore now shift to how the various jurisdictions look at implementing these recommendations. Even for companies which are solely UK based, they will need to keep an eye on these implementations as this could still impact their businesses going forward.
For further information please contact the TaxDesk on 0845 4900 509 and ask for Caroline Fleet.