The article was published in The Business Times on 29 October 2015.
On Oct 5, the Organisation for Economic Co-operation and Development (OECD) announced new tax proposals under its Base Erosion and Profit Shifting (BEPS) Action Plan, which seeks to make sure that profits are taxed where the economic activity occurs. In some ways, the final OECD reports are a little bit of an anti-climax. Why is that? In the first place, the OECD admits it still has a lot of work to do and secondly, BEPS is really just starting.
The reports are not the end. Rather, it is now up to various countries to implement actual laws to give effect to the OECD recommendations which, considering the political process which underlies BEPS, are not as definitive as many people might think. In my view, there is a long way to go before BEPS can be said to have been implemented successfully.
Some aspects of BEPS are well-developed. Many countries, including Singapore, have implemented or will soon implement enhanced transfer pricing rules requiring taxpayers to implement arms-length pricing and to maintain significant documentation to support that pricing. It also seems certain that larger multinational corporations (MNCs) will need to provide further information to tax authorities, in what is the so-called country-by-country reporting.
The position on many other items isn't so clear and we should take a moment to consider how BEPS will be implemented in various regions. At present, it seems that the Europeans will move the quickest to adopt the BEPS recommendations as they are at the centre of the OECD and the tax morality debate.
The US position is less clear. Given the political climate and the pending election in 2016, one might expect that anything that goes to Congress is likely to take time. It is also relevant to note that it is US MNCs which are the targets of many of these measures and the US response to various countries seeking to take a further tax bite out of these MNCs will be interesting to watch.
In the Asia-Pacific region, Australia and China have been the early movers on BEPS-related issues. Australia is looking to impose additional reporting requirements on MNCs and to impose tax on companies which have big sales, but which pay low tax in Australia. The rest of the Asia-Pacific region has been generally supportive of the BEPS process, but has yet to implement any specific new measures. Singapore has implemented new transfer pricing measures, which have parallels to the BEPS approach.
ADOPTION OF BEPS
As you can see, the adoption of BEPS will not occur in a big bang or at one pace. Rather, it will unfold over time and will often emerge out of negotiation among countries rather than from a central point. Let's take a quick look at some of the issues which could arise as countries consider the adoption of the new tax proposals.
One of the OECD recommendations is to limit interest deductions in tax structures. At present, where debt is used and the interest is deductible, debt is often preferred to equity because of the lower tax rates generally applicable to interest income. The OECD has proposed to limit deductible interest to between 10 and 30 per cent of a company's earnings before interest, taxes, depreciation and amortisation (Ebitda).
Singapore - which does not have rules limiting the level of debt which can be used - and other countries around the region will need to decide whether they adopt these interest limitation rules. The limitations on the use of debt may well increase the tax payable in relation to infrastructure, real estate and other categories of cross-border investment.
The OECD has also proposed rules allowing countries to tax economic activity which is not connected to a taxable business presence in a country. Various media reports have discussed the potential for countries to tax companies on their revenue arising from a country even though the sales are made by an entity outside the country. The adoption of these rules by countries in the region will potentially mean that they can increase their tax base. There is no doubt that these rules have the potential to lead to economic double taxation and more disputes.
A third OECD proposal is designed to stop taxpayers investing via a third country because that country offers them a tax benefit over investing directly. To the extent that investment via these countries is driven primarily by tax outcomes, these benefits may be disallowed. Where there are wider non-tax reasons for the investment, the tax benefits may survive scrutiny. Again, Singapore and other regional countries will need to determine whether and how they should adopt this proposal.
It should also be noted that the OECD will continue to monitor what countries do and countries which do not adopt the various measures or otherwise promote BEPS-like activity can expect to be highlighted by the OECD.
In many ways, the OECD process is all about moral persuasion. It is creating and will monitor a new moral standard to which countries will be benchmarked over time. This is also reflected in the positioning of transparency and transfer pricing as the first key planks of the BEPS process.
Consequently, it may be a matter of good governance for businesses to prepare now rather than to wait for actual measures to be implemented.
In fact, businesses should expect that other countries may take the opportunity to implement the principles outlined in the BEPS proposals in reviewing ongoing transactions. It is therefore prudent for businesses to commence a review of their operations especially for transactions with or within OECD or G-20 countries. Businesses should also engage internal stakeholders including Boards and Audit Committees to highlight any potential risks arising from the principles outlined in the BEPS proposals, and plan appropriately ahead of time to mitigate these risks.
Going forward, shareholders and other stakeholders will perhaps reach a point where they require the companies they invest in to invest only in morally compliant countries. Time will tell whether this is the eventual outcome.
The article is contributed by Mr Simon Clark regional partner, Alternative Investments, at KPMG in Singapore. The views expressed are his own.