Issue 4/2019 4th Quarter 2019
On 8 November, the OECD Secretariat released a public consultation document on technical and design issues regarding Global Anti-Base Erosion (GloBE) Proposal, which would provide for global minimum taxation, under Pillar Two of Programme of Work for Addressing the Tax Challenges of the Digitalisation of the Economy.
GloBE calls for the development of a coordinated set of rules to address ongoing risks from structures that allow multinational entities (MNEs) to shift profits to jurisdictions where they are subject to no or very low taxation. Specifically, as explained in the consultation document, the four component parts of the GloBE proposal are:
- An income inclusion rule that would tax the income of a foreign branch or a controlled entity if that income was subject to tax at an effective rate that is below a minimum rate;
- An undertaxed payments rule that would operate by way of a denial of a deduction or imposition of source-based taxation (including withholding tax) for a payment to a related party if that payment was not subject to tax at or above a minimum rate;
- A switch-over rule to be introduced into tax treaties that would permit a residence jurisdiction to switch from an exemption to a credit method when the profits attributable to a permanent establishment (PE) or derived from immovable property (that is not part of a PE) are subject to an effective rate below the minimum rate; and
- A subject-to-tax rule that would complement the undertaxed payment rule by subjecting a payment to withholding or other taxes at source and adjusting eligibility for treaty benefits on certain items of income when the payment is not subject to tax at a minimum rate.
These rules would be implemented by way of changes to domestic law and double tax treaties and would incorporate a coordination or ordering rule to avoid the risk of economic double taxation that might otherwise arise when more than one jurisdiction seeks to apply these rules to the same structure or arrangements.
The document does not discuss the minimum tax rate that might be agreed to, or specifically how the income inclusion rule would be coordinated with the other rules under consideration.
Tax base determination
The consultation document seeks comments on whether using financial accounts, subject to agreed adjustments, could provide an appropriate base for measuring income and could simplify and reduce the compliance costs of the proposal. The document seeks views on the use of the accounting standard of the ultimate parent entity instead of the local generally accepted accounting principles (GAAP) of each entity, and on the acceptability of different standards. Consideration would also need to be given to cases in which consolidated financial statements are not prepared for any other purpose.
Recognizing that accounting profits may differ significantly from taxable profits, the document considers adjustments to accounting profits that could be required. The document seeks views on the types of material “permanent differences” between financial accounting income and taxable income that may need to be removed from the tax base. The document notes that “temporary differences” – such as differences between the timing of accounting depreciation and tax relief on capital expenditure, or the carry-forward of losses – have distortive effects on effective tax rates that typically reverse in future years. Three basic approaches are described that could address the effects of temporary differences:
- Carry-forward of excess taxes and tax attributes;
- The use of deferred tax accounting; and
- Multi-year averaging.
High-tax and low-tax income blending
The extent to which an MNE can combine high-tax and low-tax income from different sources taking into account the relevant taxes on such income in determining the effective (blended) tax rate on such income can be done on a narrow or broad basis and three approaches are described:
- A worldwide blending approach: Requiring a business to aggregate its total foreign income and total foreign tax. When the tax on the total foreign income is below the minimum rate, additional tax would be due.
- A jurisdictional blending approach: Requiring businesses to aggregate amounts on a jurisdiction-by-jurisdiction basis, paying additional tax in respect of the income in those jurisdictions effectively taxed below the minimum rate.
- An entity blending approach: Requiring the calculation of income, taxes, and effective tax rates of each individual group entity (and foreign branch).
The consultation document also describes the possibility of “local group blending,” a variation of the entity blending approach that would allow for the results of entities within a local tax consolidation or local group relief regime to be aggregated.
Carve-outs and thresholds
Carve-outs to be considered include exceptions for regimes compliant with the standards of BEPS Action 5 on harmful tax practices and other substance-based approaches, a return on tangible assets, and for controlled corporations with related-party transactions below a certain threshold. Carve-outs may be based on a qualitative overall evaluation of the facts and circumstances or based on more quantitative objective criteria – for example, based on formulas.
Other related matters under consideration include using thresholds to restrict application of the rules based on the size of the group, de minimis thresholds, or specific industries. Views are sought on which options should be adopted or avoided.
On 27 November, the Australian Taxation Office released the final version of a schedule to a practical compliance guide (PCG) that sets out the ATO’s view on various risks presented by cross-border related-party financing arrangements.
Schedule 2 of PCG 2017/4 deals with the ATO’s views on specific risks in related-party derivative arrangements that are used to hedge or manage economic exposure. As is common with the PCG format, color-coded risk ratings are provided for taxpayers to assess the risk level of their particular arrangements.
A draft version of schedule 2 was released on 1 August 2018, and the final version remains similar to the approach articulated in the draft. The finalized PCG maintains 14 risk indicators against which taxpayers must self-assess, using Yes/No answers, for each of their related-party derivatives. However, some key changes from the draft include:
- The term “derivative” in schedule 2 is based on the definition used in Australian Accounting Standard AASB 139, with the added requirement that the derivative must be related to a financing arrangement with a related party to be within scope of the schedule. However, the definition of arrangements addressed by the schedule has been broadened in the final version to encompass total return swaps (TRS) even when these TRS are with unrelated parties. Accordingly, these arrangements are expected to be scored under the risk rating schema. The basis of this change in the definition is not explained in the schedule but it is significant that a PCG dealing with related-party financing now also addresses itself to certain unrelated-party arrangements.
- The definition of a “low tax jurisdiction” has been amended to include those jurisdictions with a corporate tax rate of below 15 percent (previously 18 percent).
The newly published schedule 2 to PCG 2017/4 is effective from 1 January 2019.
On 29 September 2019, the Russian Parliament adopted a new law (FZ-325) that amends and supplements the Russian Tax Code. One of the key changes is the introduction of a new section on the mutual agreement procedure (MAP).
Historically, the MAP has been part of Russia’s income tax treaties but not of local legislation. In light of this, very few MAP cases have been initiated and closed over the years. Following its commitment to implement the BEPS Action 14 minimum standard, Russia introduced regulations to make MAP more effective.
The new section of the Russian Tax Code (effective 1 January 2020) clarifies the following:
- The MAP process should be determined by the guidance of the Russian Ministry of Finance (issued in January 2019) and relevant income tax treaty.
- Adjustments resulting from a MAP should be made in line with the general rules stipulated by the Russian Tax Code, that is, rules regarding refund or offset against future payments of the taxpayer.
- The general limitation on the tax refund/credit period (three years from the date of payment) should not apply to situations whereby a tax refund/credit is granted as a result of a MAP.
Given the observed increase in the number of tax audits challenging the deductibility of expenses related to intercompany services and royalties, Russian subsidiaries of multinational enterprise (MNE) groups have expressed interest in the MAP, and this procedure could be a good alternative to litigation.
In addition to MAP, there are other tools to achieve greater tax certainty. For example, some Russian taxpayers (deemed “the largest” taxpayers) are eligible to enter into bilateral advance pricing agreements (BAPAs). Relevant BAPA guidance was released in March 2018.
In view of the above, Russian subsidiaries of MNE groups currently have more options to avoid and resolve tax and transfer pricing disputes, and the implemented mechanisms are in line with the BEPS environment.
Another important change the law introduced is the requirement to perform a DEMPE (development, enhancement, maintenance, protection, and exploitation) analysis for intellectual property (IP) transactions, though no further specific guidance has been provided.
On 13 November, Costa Rica’s tax authorities issued a resolution that provides guidelines on the information taxpayers must provide in the master file (corporate information) and the local file (specific taxpayer information).
Resolution DGT-R-49-2019 became effective as of its publication, repealing the provisions of Resolution DGT-R-16-2017, published in March 2017. Taxpayers must prepare their documentation for the 2019 period taking into account the new provisions.
Article 2 of the new resolution establishes the following documentation guidelines.
The resolution introduces three new master file requirements under Article 2:
- Section (d), which requests the provision of internet links that would allow a representative analysis of the industry and the company prepared by rating agencies or similar entities;
- Section (n), which requires the submission of a chart that shows the multinational entity’s (MNE’s) total number of employees in each country in which it does business; and
- Section (o), which requires a copy of the MNE group’s most recent consolidated financial statement.
Article 2 also made the following changes and additions to the documentation requirements in the local file:
- Section (a) requests that the taxpayer characterize its transactions according to the type of activity performed, for example, manufacturing, distribution, or the provision of services;
- Sections (b) and (d) requests that taxpayers submit the total amount of expenses for each category of the transactions and that those expenses be compared to expenses during prior periods (without detailing the amounts for such prior periods);
- Section (e) requests the identification and documentation of other controlled transactions that may directly or indirectly affect the price of transactions characterized as required under section (a); and
- Section (m) requests audited financial statements for the prior three years (previously, only one year of financial statements was requested).
The documentation must be provided to the tax authorities upon request, under the provisions and within the time period indicated in Article 109 of the Code of Taxation Rules and Procedures.