On 18 December 2014, the OECD released two further discussion drafts related to transfer pricing matters under its Base Erosion and Profit Shifting (“BEPS”) Plan. The first draft addresses the need to make double tax dispute resolution more effective. The second draft addresses the deductibility of interest and other financial payments. Since both issues fundamentally originate from intercompany transactions, we summarise key observations on these latest BEPS drafts from a transfer pricing perspective.
Tax treaties serve the purpose to eliminate double tax on income and capital. Action Item 14 is part of the BEPS Plan because there is sentiment that in fact, double tax elimination through Mutual Agreement Procedures (“MAP”) is not being adequately achieved. Guidance presented in the BEPS draft report cites four principles to improve MAP effectiveness, and describes common obstacles observed in the tax authorities’ efforts to eliminate double tax. The four principles are:
The report provides several options aimed to address obstacles observed in providing tax relief, broadly grouped as follows:
1. Update OECD Model Tax Convention (“MTC”) - Double tax treaties in the developed world are generally based on the OECD MTC. The OECD suggests certain changes to the MTC aimed at making MAP effective, such as a mandatory clause in Article 25 on MAP. Changes to the MTC could cascade into bi-lateral treaties, thereby putting into law provisions requiring double tax resolution between two countries. A multi-lateral instrument to make such changes widely in effect has been contemplated by the OECD in BEPS Action Item 15.
2. Mandatory arbitration – Arbitration is viewed as a way to expedite double tax cases when tax authorities are unable to reach a settlement. Mandatory arbitration is contained in several but not many bilateral tax treaties. The OECD suggests that treaties should incorporate a form of arbitration, mandatory or otherwise, although some governments are resistant to any form of arbitration in their treaties.
3. Commit to adopt best practices – In 2007, the OECD produced a Manual on Effective Mutual Agreement Procedures (“MEMAP”), intending to describe best practices for individual tax authorities to resolve double tax cases. The draft report suggests that if tax authorities were to properly adopt MEMAP principles, they will overcome many of today’s current obstacles in MAP, such as consistent minimum documentation to be eligible for MAP.
The pricing of intercompany transactions for tax is largely guided by the arm’s length principle. The broad exception is interest and other financial payments, where domestic tax law predominantly overrides transfer pricing rules based on the arm’s length principle. This consultation draft on interest is important because governments view intercompany debt and interest is a very common technique used by multinationals to erode their tax bases.
In the BEPS webcast on 15 December 2014, the OECD hinted at guidance it was developing on interest payments. The draft released by the OECD outlines two options to limit excessive interest deductions.
The draft suggests a combined approach, allowing some flexibility to business under one of two approaches shown below.
|Approach 1||Approach 2|
|Main rule||Group-wide test||Fixed ratio rest|
|Carve-out rule||Companies which meet a low fixed ratio test or opt to apply the fixed ratio as a limit on interest deductions||Companies which exceed the set fixed ratio test but can demonstrate they are within the equivalent ratio of their group-wide debt|
Transfer pricing touches on many of the BEPS Plan’s Action Items. These two particular drafts significantly interact with other Action Items and their related discussion drafts. For instance, effective double tax relief from MAP is highly contingent on the OECD passing a multi-lateral instrument on tax treaties. As well, new rules arising from the interest deductibility report will depend on similar outcomes from the report on hybrid mismatch arrangements. Businesses with operations in Ireland and abroad will need to understand how future rules are drafted and adopted into law in Ireland as well as in foreign countries.
Our transfer pricing team will help you frame and understand the key value drivers of your business in a manner that supports a robust approach to transfer pricing. We will evaluate where profits from your international business will be taxed and on what basis. With a broad range of experience from Ireland, the US, Canada, Asia, South America and Europe, our team is well placed to advise you in how to meet these new requirements so you can remain focused on managing your business.