One of the key components of the scope of the OECD’s BEPS project has been to examine whether the corporate tax framework is fit for purpose in an increasingly multinational business world. In order to achieve this, significant time has been spent in examining how global businesses operate today. The output of the OECD’s work can be seen across all of the BEPS Action items, but in this commentary we particularly focus on the recommendations arising from Action 7 (redefining permanent establishment) and Actions 8 to 10 (intellectual property and transfer pricing).
The practical implications of the recommendations for these action items are broad, and we have set out just a selection here. Firstly, the way in which a business contracts with both its customers and suppliers needs to be carefully understood – and by this, we mean the day to day reality of how business is conducted “on the ground” rather than the theoretical framework which may be set out by head office, or even the tax department.
For example, when entering new geographic markets, a multinational group may initially operate through a representative office or a local agent. It has long been known that care must be taken to ensure that this activity does not create a local taxable presence (or if it does, that the appropriate legal and fiscal obligations are met). The BEPS project has redrawn the boundaries of what constitutes a taxable presence - meaning that firstly, any previously provided guidelines may no longer be appropriate, and secondly, there will be a greater emphasis on what activity is actually being carried on in country (and whether this is indeed bound by any predetermined framework).
Going forward, it will be important that inter-company agreements and contracts properly reflect the underlying reality of the transactions. This is to ensure that the profits arising from an activity are appropriately allocated to the various parties in the supply chain. Whilst this has always been the case, the revised transfer pricing guidelines set out the approaches in a manner which is more consistent with global operating models. This will require those in the tax and legal department to work very closely with their colleagues in the business to properly understand how stakeholders interact.
Secondly, it will be necessary to take a closer look at substance within the business. So for example, the profits arising from intangibles must align with the activities undertaken in relation to those intangibles, and the OECD’s revised guidance requires careful consideration of the so called “DEMPE” functions (Develop, Enhance, Maintain, Protect, Exploit). Consider also any centralised functions serving your business – e.g. treasury, finance and accounting, procurement – and whether these have the appropriate substance and autonomy to support the profits and intra-group charges.
This close review of the business is very likely to throw up anomalies between activity and profit apportionment, resulting in two options: either the profit allocations and intra-group arrangements are updated, or there is real change to the activity and substance in the business. The second option will, in many cases, be the more attractive option and would have a very real impact on individuals within the business as their roles and responsibilities change, or they are required to relocate to carry on their job in a different location.
Our Tax Value Chain group has in depth experience of considering the interaction of taxes with business operations and decisions. Together with our International Tax team, Transfer Pricing team and wider advisory colleagues, we have advised many multinational groups on the optimal tax structuring to meet the needs of the business. Visit our Tax Value Chain, Transfer Pricing and Value Chain Analysis pages for more information.