The OECD’s final package of measures to tackle base erosion and profit shifting (BEPS), represents the most ambitious effort in history to harmonise tax laws across national boundaries. Kirsty Rockall explains why companies need to shift into high gear now to evaluate and comply with the final recommendations.
In the wake of the global financial crisis and the crackdown on unacceptable international tax avoidance, governments and tax authorities want to see multinationals approach tax planning more responsibly. This means greater requirements for transparency, an emphasis on substance and aligning profits with value creation.
Sensitivity to ‘immoral’, yet legal, tax avoidance by multinationals is what drove the world's 20 richest countries and their finance ministers – on October 8 2015 in Lima, Peru – to endorse a package of measures under the Organisation for Economic Cooperation and Development's BEPS initiative.
The new measures set out 15 recommended actions to equip governments and tax authorities with the information needed to address perceived tax avoidance and ensure that profits are taxed in line with where a multinational's key economic activities are undertaken and value created.
The 15 actions cover the tax spectrum and this is a complex area to navigate. Notably it should not be left to the finance department to steer you through the BEPS waters. All parts of a business should shape the way a business responds to BEPS.
Why? Because BEPS is initiating changes to tax rules in multiple countries that will have a huge business impact. These need to be understood at Board level as their bearing is felt on future legal structures, financing arrangements and operating models. Questions and challenges from stakeholders are also to be expected, with investors, the media and general public all expecting answers.
The BEPS recommendations are not mandatory and there is uncertainty in the short-to-medium term about how countries may start implementing them. Some countries, like the UK and Australia, have moved quickly to implement the new guidance. Others may take a more piecemeal approach. No two reformed regimes will look alike, as countries remain keen to use tax policy as a source of competitive advantage. The latest European Commission proposals suggest that these recommendations are likely to be implemented across EU countries.
Under BEPS a theme has appeared and that is the realignment of taxing rights with economic substance coupled with demand for transparency. Critical to this realignment is the identification and assessment of value creation. Multinationals need a coherent and holistic picture of their business, which articulates how and where value is created, as well as help to identify and explain profit and tax outcomes. For instance the existence of intangible property (IP) can attract the attention of tax authorities as they are wary of its fragmentation from tangible assets so as to generate a favourable tax effect. They want to ensure that the entities creating and driving the IP, presumed valuable, are appropriately rewarded.
Articulating a multinational’s value chain can help to ease tax authorities’ concerns. Scrutiny of a multinational’s transfer pricing risk profile and value chain should therefore top a Boards’ BEPS to do list. Such an analysis can also have additional benefits such as identifying business opportunities and driving commercial change.
Following a risk assessment, the choices are stark. Adopt a defensive position and protect your current structure and policies - or change. But what do you change to, when and what is the business impact of this change? Tax Directors and Chief Tax Officers need to determine a transfer pricing post-BEPS strategy and ensure that the messages delivered to stakeholders are clear and consistent.
Transfer pricing documentation forms a key component of managing these risks and mirroring those messages. As such the new Master File documentation requirement is an important risk management tool; it explains the operating model of the group, positions markets and functions in the wider value chain and puts the transfer pricing strategy in context. Too little information and tax authorities will be suspicious they are not seeing the full picture; too much, and you risk creating material that is irrelevant to most countries and exposes you to opportunistic tax assessments. Worse still, a poorly crafted Master File can be perfect media material –all it takes is an unscrupulous tax inspector or a disgruntled employee to leak the document. So the File must be prepared with public exposure in mind, and be supportive of current pricing without limiting a multinational’s flexibility.
Whether you believe in New Year’s resolutions or not, 2016 comes with a responsibility to shift into high gear and approach tax planning more responsibly. So our advice is straightforward. You should review your structures to ensure they reflect commercial reality, linking profit recognition to value creation and be prepared to change them if they don’t.
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