Multinationals everywhere should check their situation urgently, as they will soon come under the tax microscope.
Multinational corporations are in the firing line at the moment.
In Israel, several large companies were persuaded to pay several billions of shekels of tax late in 2013, at reduced rates, on “trapped profits” after claiming tax breaks on undistributed profits. As a result, personal income-tax rates did not go up 1 percent to 2% at the beginning of 2014.
At the international level, the OECD is busy formulating a program for dealing with BEPS (base erosion profit shifting). This refers to expense payments by companies in high-tax countries to related companies in offshore jurisdictions. The amounts of tax revenues lost are enormous. On January 23, 2014, the OECD held a webcast and gave a progress report. The OECD then published a wolf in sheep’s clothing (see below). Israel has been a member of the OECD since 2010.
According to the OECD webcast, thanks to BEPS, multinational enterprises are often able to artificially separate the allocation of their taxable profits from the jurisdictions in which these profits arise. This can result in income going untaxed anywhere, thus affecting competition, distorting investment decisions and reducing overall trust in the tax system. And most of such BEPS planning is legal; if governments are unhappy with the results, the rules should be changed. But no single country acting alone can effectively address the issue; there is G20 support to address the issue collectively.
By the end of 2015, the OECD expects to address a wide array of tax-planning techniques and suggest countermeasures for governments to adopt. The first thorny issue is the digital economy; for example, does an Internet operation (such as a search-engine email company) have a taxable presence in any country when its servers and clouds are somewhere else? Other issues include hybrid companies, transfer pricing, tax-treaty abuse, loan-interest deductibility, controlled foreign corporations, intangible assets, a multinational information-exchange agreement, mandatory disclosure rules, dispute resolution, etc.
Transfer pricing documentation
On January 30, the OECD published a slick but innocuous- looking discussion draft on transfer-pricing documentation and CbC (country-by-country) reporting. Transfer pricing relates to the pricing of transactions between related companies. Much international trade is done this way. In 1995 the OECD published transfer pricing study “guidelines,” which it now proposes to develop. The stated aims are: (1) provide tax administrations with information for risk-assessment purposes; (2) ensure taxpayers consider transfer-pricing requirements; (3) facilitate tax audits.
The proposed new documentation would consist of a master file and a local country file. The master file would contain a wealth of information about the group as a whole around the world.
In particular, the master file would include a country-by-country template (spreadsheet) spelling out revealing facts and figures for each and every country the company operates in, including: place of effective management; business activity codes; revenues; earnings before income tax; income tax paid to the country concerned and to other countries; withholding tax paid, capital and accumulated earnings; number of employees; total employee expense; tangible assets other than cash and cash equivalents; royalties paid to constituent entities; royalties received from constituent entities; interest paid to constituent entities; interest received from constituent entities; service fees paid to constituent entities; service fees received from constituent entities.
The contents of the master file would also include information on the organizational structure, the intangible assets, intercompany financial activities, financial and tax positions.
The deadline for filing all this would be one year after the ultimate parent entity’s year-end, annually, in English. Noncompliance would result in penalties to be determined. Tax authorities would be expected to observe confidentiality (this might seem questionable in some countries).
It is possible that some countries will allow reduced reporting by small- and medium-sized enterprises.
Multinationals everywhere should check their situation urgently, as they will soon come under the tax microscope. The OECD documentation guidance doesn’t address turf wars that are sure to develop between tax authorities.
When an onshore country sees offshore income on the template, that country is liable to issue a tax assessment for that amount on some pretext. If all the other onshore countries do the same, an unprepared multinational may soon find its offshore income taxed many times over.
There is also the issue of the enhanced bureaucracy multinationals will face in assembling the data. Two approaches are discussed: top down and bottom up. Both will take time and manpower.
Another issue will be where to make adjustments to exclude inter-company profits – otherwise total profits for these purposes will exceed 100% of the real profit made by the group as a whole.
A further general issue the OECD is reportedly stalled on is if a company operates in cyberspace, does that count as operating in any country at all? Apparently not. The general rule is that a taxable “permanent establishment” is a fixed place of business. As airline passengers know, a cloud is not really a fixed place.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.