BASE EROSION AND

PROFIT SHIFTING
Joe Calianno / Malcolm Joy / Hans
Noordermeer / Jay Tang / John Wonfor

24 NOVEMBER 2015
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AGENDA

4 INTRODUCTION 32 PERMANENT ESTABLISHMENT

INTEREST DEDUCTIBILITY AND HYBRID

6 FINANCING ARRANGEMENTS 40 HARMFUL TAX COMPETITION

16 TRANSFER PRICING AND COUNTRY BY

COUNTRY REPORTING 42 GENERAL OBSERVATIONS

26 TREATY BENEFITS 43 Q&A

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INTRODUCTION
GOALS OF THE BEPS PROJECT

• Perception that Multinational groups were not paying their “fair share” by taking
advantage of a international tax system that was no longer “fit for purpose”
• Fifteen action points designed to fix the problem all under three core principles:
• Establish international coherence of corporate international taxation
• Restore full effects and benefits of international standards through realignment of taxation and
relevant substance
• Ensure transparency while promoting increased certainty and predictability
• Extensive consultation involving 62 countries directly, covering over 90% of the global
economy, as well as a number of regional bodies
• Final recommendations issued October 5, 2015

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INTEREST DEDUCTIBILITY AND HYBRID FINANCING
ARRANGEMENTS
BEPS ACTION 2
NEUTRALISING THE EFFECTS OF HYBRID MISMATCHES

THE ISSUE
• Hybrid Instruments, Hybrid Payments, Imported Mismatches, Reverse Hybrids lead to non
taxation
SOLUTION IN DOMESTIC LAW
• Primary Linking Rule: Payer jurisdiction denies deduction
• Secondary or Defensive Rule: Receptive jurisdiction includes income
SOLUTION IN TREATIES
• Dual resident and hybrid entities shall not be entitled to treaty benefits
• Treaties shall allow solutions in domestic law without treaty overriding this (!)

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BEPS ACTION 2
CAUGHT STRUCTURES – D/NI HYBRID ENTITY

Parent A Secondary response - inclusion

Loan

HoldCo B Primary response - disallow

Sub B

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BEPS ACTION 2
CAUGHT STRUCTURES – DD HYBRID ENTITY

Parent A Primary response – disallow here

Bank loan HoldCo B Secondary response – disallow here

Sub B

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BEPS ACTION 2
CAUGHT STRUCTURES - IMPORTED MISMATCHES

Parent A
PECs/CPECs
Finco B

Loan
Opco C Primary response - disallow

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BEPS ACTION 2
IMPORTANT PLANNING POINTS

• The rules apply automatically without any exception

• The rules do not apply to:
• Timing differences (12 months safe harbour)
• Tax rate arbitrage situations
• Low Tax
• No tax / tax haven
• Payments only deemed to be made for tax purposes
• Notional interest deductions
• Interest free loans (tp corrections)

• The rules are not intended for situations where there is no “payment”, although
countries may consider to extend rules to “all deductible items regardless whether it is a
payment”
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BEPS ACTION 4
LIMIT BASE EROSION VIA INTEREST DEDUCTIONS AND OTHER FINANCIAL PAYMENTS

THE ISSUE
• International groups deduct more interest expenses than they pay to third parties
• Net interest EBITDA of 10% in many cases vs 30% as considered in many local regulations
THE SOLUTION
• Report analyses several best practices and recommends an approach
• Recommended approach
• Fixed net interest EBITDA ratio
• Corridor of possible ratios: 10-30%
• Application on third party and IC interest (uplift of 10% to third party exp.)
• Option to apply a group ratio rule, equity escape rule, de minimis threshold, carry forward rules
• Additional work to be completed end of 2016
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BEPS ACTION 4
SOME OBSERVATIONS

• The proposed rule is a mechanical approach

• Changes to interest deduction rules are potentially costly
transitional and
grandfathering rules are appropriate
• The proposed rule is a best practice rule, so countries may choose not to implement
• Nevertheless, countries may still (continue to) use targeted rules (the Netherlands for
example)
• A number of EU/G20 countries already have a similar rule
• Differences in implementation will lead to double taxation
• Third party debt is a concern as a lot of groups have debt in excess of corridor

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BEPS ACTIONS 2 & 4
ACTIONS TO TAKE

• Review your financing structure

• Are you within the corridor?
• Can you get out of the financing arrangement
• Can you influence the EBIT(DA)
• Do you have hybrid mismatches?
• Can you convert into a structure that still works?

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TRANSFER PRICING AND COUNTRY BY COUNTRY REPORTING
BEPS ACTIONS 8, 9 AND 10
ALIGNING TRANSFER PRICING OUTCOMES WITH VALUE CREATION
Single report covering all three actions (issued in final form on 5 October 2015) with
deliverables including:
• A rewrite of Section D, Chapter I of the OECD Guidelines – reaffirmation of the arm’s length
principle, but focus on identification of the actual transaction and allocation of risk
• Additions to Chapter II of the OECD Guidelines – dealing with commodity transactions
• Guidance on Transactional Profit Split methods (further work to be undertaken in 2016)
• A rewrite of Chapter VI of the OECD Guidelines on Intangibles
• A rewrite of Chapter VII of the OECD Guidelines covering low value-adding intra-group services
• A rewrite of Chapter VIII of the OECD Guidelines covering Cost Contribution Arrangements

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BEPS ACTIONS 8, 9 AND 10
ALIGNING TRANSFER PRICING OUTCOMES WITH VALUE CREATION

• Arm’s length principle is here to stay – anything else (eg formulary apportionment) is too
hard and would not solve the problem
• Accurate delineation of the actual transaction is fundamental
• Need to analyse both the contractual arrangements and the conduct of the parties
• On intangibles – legal ownership alone does not necessarily generate a right to all (or
even any) of the return generated by the exploitation of the intangible
• Need to look at development, enhancement, maintenance, protection and exploitation of
the intangible
• Provision of funding alone (eg cash box companies) will justify no more than a risk-free
financial return

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 Source: http://www.slideshare.net/OECDtax/beps-webcast-8-launch-of-the-2015-final-reports

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BEPS ACTIONS 8, 9 AND 10
ALIGNING TRANSFER PRICING OUTCOMES WITH VALUE CREATION

• Hard to value intangibles

• Concern about information asymmetry
• Ability of tax authorities to consider ex post outcomes as presumptive evidence of ex ante pricing
arrangements
• Corporate synergies
• Benefits allocated to group members that have contributed to these synergistic benefits
• Recognition that location savings may exist
• Elective simplified approach for low value-adding intra-group services
• Effective date for changes?
• Revisions to Transfer Pricing Guidelines regarded as shared interpretations of how article 9, para 1
of the OECD and UN model convention should be applied. They will therefore have immediate
effect through the existing treaties
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BEPS ACTION 13
TRANSFER PRICING DOCUMENTATION AND COUNTRY-BY-COUNTRY REPORTING
THE ELEMENTS OF THE THREE-TIERED APPROACH
Masterfile
• a Master File - standardised information
relevant for all MNE group members

• a Local File - containing information to material

transactions of the local taxpayer Local
country
• a Country-by-Country Report - information files
relating to the global allocation of the MNE’s
income and taxes paid together with certain
indicators of the location of economic activity Country by Country Report
within the MNE group)

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BEPS ACTION 13
CHINA CONTEMPORANEOUS DOCUMENTATION REQUIREMENT
• Master file shall disclose group organizational structure, overview of group business
operation, group intangibles, group financing arrangement, and group financial and tax
position.
• Local file mainly follows the requirements set out in Circular 2, with additional
disclosure requirements for value chain analysis, foreign investment, and related-party
share transfer.
• Special issue documentation shall be prepared under each of the following conditions
• The taxpayer conducts the related-party service transaction;
• The taxpayer implements the cost sharing arrangement;
• The taxpayer violates the thin capitalization rules.

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BEPS ACTION 13
CHINA CONTEMPORANEOUS DOCUMENTATION REQUIREMENT - THRESHOLD
• Taxpayers that meet one of the following conditions shall prepare the master file and
local file:
• Annual related-party purchase and sales transaction amount exceeds RMB 200 million;
• Other related-party transaction amount exceeds RMB 40 million;
• Loss-making entities with limited functions.
• Special issue documentation
• There is no threshold for transaction amount on related-party service payment and cost sharing
arrangement.
• For thin-capitalization documentation, the threshold for debt-to-equity ratio is 2:1 for most
taxpayers and 5:1 for financial institutions.

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BEPS ACTION 13
CHINA COUNTRY-BY-COUNTRY REPORT FORM

• Taxpayers that meet one of the following conditions shall prepare the country-by-
country report form in the “Annual Reporting Forms for Related-Party Transactions”:
• The taxpayer is the ultimate holding entity in the group and its group consolidated revenues in
the previous fiscal year exceeds RMB 5 billion;
• The ultimate holding entity of the taxpayer is outside P.R.C, but the taxpayer is assigned by the
group as the reporting entity for the country-by-country report form.

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BEPS ACTIONS 8, 9, 10 AND 13
ACTIONS TO TAKE

• Review your transfer pricing documentation

• Prioritise your updates

• Consider arrangements that are targeted by BEPS

• Entities lacking substance
• Allocation of risk
• IP ownership structures

• Economic Substance Review

• Identifies areas where insufficient economic substance could create tax risks

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TREATY BENEFITS
BEPS ACTION 6
PREVENT TREATY ABUSE
THE ISSUE
• Treaty Shopping is part of our daily practice
THE SOLUTION (MINIMUM STANDARD)
• Clear statement in treaties that common intention is to eliminate double taxation
without creating opportunities for tax evasion or avoidance (eg treaty shopping) and no
double non-taxation
• Include a specific anti-abuse rule (LOB clause as known in the US’ DTTs)
• Mechanical test, flow chart, quite objective
• Include a general anti-abuse rule (principal purpose test ‘PPT’)
• …one of the main purposes…, quite subjective
• Allow domestic GAAR rules to override the treaty

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BEPS ACTION 6
PRACTICAL IMPACT FOR HOLDING COMPANIES

WHY WOULD YOU WANT TO USE A HOLDING COMPANY?

Company A
• HQ function in the ‘home’ country
• Joint venture vehicle in a ‘neutral’ territory
HoldCo B • Access to finance / local financial market
• First foothold in other continent (time zone /
management proximity)
Company C • Use of preferential investment protection
agreements
• Flexible local company law rules
• And of course sometimes purely for tax planning

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BEPS ACTION 6
PRACTICAL IMPACT FOR HOLDING COMPANIES
• The recommendations seem to deny that HoldCo’s can serve purposes other than tax
• Even if economic reasons are the primary choice, tax is always a consideration
• Neutrality, you do not want a HoldCo to increase the tax burden
• … one of the main reasons …
• So a lot of HoldCo’s will fail ?
• Publicly traded would be fine
• Large economy ‘add-on’ HoldCo’s could be fine
• HoldCo’s with business purpose that are not aimed at getting more treaty benefits than its
members (discretionary relief) could be fine as well
• Widely held SPV HoldCo’s could fail
• The ‘neutral territory’ HoldCo JV’s could fail
• Closely held SPV HoldCo to access local finance market could fail

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BEPS ACTION 6
ACTIONS TO TAKE?
• Increase substance and activities to pass LOB and remove tax as a main purpose
• Verify to what extent the holding company needs access to treaty – for instance capital
gain may not be an issue
• Consider alternative ways to avoid invoking tax treaties – for instance revisit transfer
pricing strategy to avoid making profits that could become subject to higher withholding
taxes
• Reorganize and remove holding companies that can no longer meet the tests

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PERMANENT ESTABLISHMENT
BEPS ACTION 7
AVOIDANCE OF PEs - COMMISSIONNAIRES

PREVENTING THE ARTIFICAL AVOIDANCE OF PE STATUS BY COMMISSIONNAIRE STRUCTURES

AND SIMILAR STRATEGIES
• The OECD report contains some alternative wordings of Art. 5 par. 5 OECD Model Tax
Convention to prevent commissionnaire structures.
• A permanent establishment is currently assumed if the agent/commissionnaire is empowered to
conclude contracts on behalf of the company or otherwise bind the company.

• The changes now suggested will likely strengthen the requirement of independence by extending
the definition of the dependent agent PE (concludes contracts or plays the principal role leading
to the conclusion of contracts that are routinely concluded without material modification by
the enterprise).

Current structures need to be reviewed!

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BEPS ACTION 7
AVOIDANCE OF PEs - COMMISSIONNAIRES

PREVENTING THE ARTIFICAL AVOIDANCE OF PE STATUS BY COMMISSIONNAIRE STRUCTURES

AND SIMILAR STRATEGIES
• Independent Agent Exemption in Art. 5 par. 6 OECD Model Tax Convention:
• Independent agent should not act (almost) exclusively on behalf of one or more enterprises to
which it is closely related

Only acting in the ordinary course of that independent agent business is relevant for this test!

• Closely related: directly or indirectly more than 50% of the beneficial interest

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BEPS ACTION 7
AVOIDANCE OF PEs – ACTIVITY EXEMPTIONS

ARTIFICAL AVOIDANCE OF PE STATUS THROUGH THE SPECIFIC ACTIVITY EXEMPTIONS

Solution of OECD:
• Restrict all activities to preparatory and auxiliary activities, hence adjust Article 5 (4)
in the following manner:
„Notwithstanding the preceding provisions of this Article, the term „permanent
establishment“ shall be deemed not to include:
a) ....
provided that such activity or, in the case of subparagraph f), the overall activity of the
fixed place of business, is of a preparatory or auxiliary character.“
• Accordingly it is intended to change the wording of the commentary

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BEPS ACTION 7
AVOIDANCE OF PEs – FRAGMENTATION
ANTI-FRAGMENTATION RULE
• A new Article 5 (4.1) shall be added, which prevents the application of paragraph 4 to a
fixed place of business that is used or maintained by an enterprise where the same
enterprise or a closely related enterprise carries on business activities at the same
place or at another place in the same Contracting State and
• (a) that place or other place constitutes a PE for the enterprise or the closely related enterprise
or

• (b) the overall activity resulting from the combination of the activities carried on by the two
enterprises at the same place, or by the same enterprise or closely related enterprises at the
two places, is not of a preparatory or auxiliary character, provided that the business activities
carried on by the two enterprises at the same place, or by the same enterprise or closely related
enterprises at the two places, constitute complementary functions that are part of a cohesive
business operation.

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BEPS ACTION POINT 7
AVOIDANCE OF PEs – SPLITTING OF CONTRACTS

SPLITTING-UP OF CONTRACTS
Problem:
• Permanent establishments are usually (provided the respective DTA does not contain
other regulations) created by running a building site or construction or installation
project for more than a threshold period with the effect that the foreign enterprise is
subject to the taxation of the State in which the construction is located.
• This provision has often been prevented by splitting-up the business (up to eleven
months of business for each entity) between two entities belonging to one group.

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BEPS ACTION 7
AVOIDANCE OF PEs – SPLITTING OF CONTRACTS

SPLITTING-UP OF CONTRACTS
Solution:
• OECD suggests an amendment of the Commentary. Besides an example that clarifies the
application of the Principle Purpose Test (AP 6!) in a PE context, the Commentary shall
include an option for an automatic aggregation clause.

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BEPS ACTION 7
CHINA SAT’S OPNION
• China’s domestic treaty interpretation rules (Guoshuifa [2010] No. 75) has already
addressed several issues mentioned in Action 7:
• Requires the preparatory and auxiliary test to apply to all activities included in Article 5 of the
standard double tax treats;
• Dependant agent provision may also apply to the situation where contracts are not concluded in
the name of the foreign enterprise.
• Will consider to incorporate the recommendations in Action 7 report in future
negotiation of double tax treaties.
• Will continue to improve PE administrative rules and practice.

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HARMFUL TAX COMPETITION
BEPS ACTION 5
COUNTER HARMFUL TAX PRACTICES MORE EFFECTIVELY, TAKING INTO ACCOUNT
TRANSPARENCY AND SUBSTANCE
THE ISSUE
• Preferential regimes continue to be a pressure point
THE SOLUTION
A BOX AROUND THE BOX
• Substantial activity requirement
• Nexus approach
R&D needs to be done in the resp. country (preferred approach)

qualifying costs (no IC contract R&D, no acquisition costs; 30% uplift possible) vs. overall
costs
Tracking necessary!
• Patents, software, other similar IP but not marketing IP!
• Improving transparency through compulsory spontaneous exchange on rulings related to
preferential regimes (on Oct. 6, 2015 ECOFIN announced implementation in the EU)

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GENERAL OBSERVATIONS
Q&A
THANK YOU
CONTACT DETAILS

JOE CALIANNO JAY TANG

jcalianno@bdo.com | +1 202 644 5415 jay.t@bdo.com.cn | +86 21 6313 9352 ext. 816

MALCOLM JOY JOHN WONFOR

malcolm.joy@bdo.co.uk | +44 (0)207 893 3718 jwonfor@bdo.ca | +1 416 369 3105

HANS NOORDERMEER
hans.noordermeer@bdo.nl | +31 (0)102 424 660

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