Transfer Pricing Times: Volume XII, Issue 2

In this Edition: Commentary on OECD BEPS Discussion Drafts Published.

The Organization of Economic Development and Cooperation (OECD) solicited comments on certain discussion drafts related to its Base Erosion and Profit Shifting (BEPS) project due February 6, 2015. Duff & Phelps submitted commentary on the discussion drafts pertaining to the following action items:

• Action Item 4 (interest deductibility),
• Action Items 8, 9, and 10 (risk, re-characterization, special measures);
• Action Item 10 (profit splits); and
• Action 10 (commodity transactions).

A complete collection of the public commentary, including Duff & Phelps' comments, is available online on the OECD’s website here.

Focus on OECD BEPS Action 4 Discussion Draft

On December 18, 2014, the OECD issued a public discussion draft titled BEPS Action 4: Interest Deductions and Other Financial Payments, and requested comments from the public due February 6, 2015.

The discussion draft primarily relates to interest deductibility in the context of minimizing base erosion and profit shifting. The draft notes that interest (and in particular, related party interest) is perhaps one of the simplest profit-shifting techniques and thus is of importance to the OECD’s BEPS initiative. Specifically, the concern is that deductible payments such as interest under loans (as well as payments under financial instruments such as guarantees and derivatives) can give rise to double non-taxation in both inbound and outbound investment scenarios.
 
In this discussion draft, Working Party No. 11 of the Committee on Fiscal Affairs (CFA) considers a number of approaches to restricting the potential for profit shifting using third-party and intercompany financial transactions and corresponding interest payments but ultimately focuses on some combination of the following:

1. Rules which limit the level of interest expense or debt in an entity by reference to a fixed ratio (group ratio rules).
2. Rules which allocate group net interest, or interest capacity, by some measure of relative economic activity (interest allocation rules).
3. Targeted rules for specific circumstances.

The discussion draft also discusses, but quickly dismisses, an arm’s-length test.
 
Duff & Phelps submitted comments on the discussion draft, which included support for the arm’s-length test. To read our complete response, click here.

Obama Proposes One-Time Tax on Overseas Earnings

President Barack Obama made an open bid proposal for a one-time tax on overseas corporate profits earned by U.S.-based multinational companies to be included in the 2016 budget. Specifically, the proposal outlines a one-time 14 percent tax on what is estimated to be $2 trillion in overseas earnings by U.S.-based multinationals. The potential tax revenue would be earmarked to fund repairs and improvements to a spectrum of transportation infrastructure across the United States.

As written in the current Internal Revenue Code (IRC) law, the rules for subpart F (IRC sections 951-964) provide an opportunity for U.S.-based multinational companies to defer U.S. tax on earnings of their controlled foreign corporations (CFCs). Under President Obama’s current proposal, earnings accumulated in CFCs, and not previously subject to U.S. tax, would be subject to this 14 percent one-time tax now rather than when (if) they are repatriated. The proposal includes a credit for foreign taxes paid. If the proposal passes, it would apply to earnings amassed for taxable years beginning before January 1, 2016.

A full explanation of the 2016 budget proposal can be found on the U.S. Treasury’s website here.

Belgium Excess Profits Regime – Another EU State Aid Challenge

On February 3, 2015, the EU Commission announced that it is conducting an in-depth investigation into Belgium’s excess profits regime on the grounds that “the Commission has doubts if the [Excess Profits] tax provision complies with EU state aid rules.” Reasons given for the investigation include the Commission’s assessment that the regime:

• Benefits only multinationals and not stand-alone companies, and therefore represents “a serious distortion of competition” in the EU;
• Misinterprets the OECD’s arm’s length principle by over-estimating the actual intragroup benefits such as synergies and economies of scale;
• Does nothing to prevent double taxation since deductions in Belgium do not correspond to amounts taxable in another country; and
• Disproportionately benefits companies that have relocated to Belgium or have invested significantly there.

Following on its recent investigations into Apple (Ireland), Amazon and Fiat (Luxembourg), and Starbucks (Netherlands), as well as Luxembourg’s rulings practices generally, this latest investigation demonstrates that there is unlikely to be any let-up in the Commission’s State Aid investigations. In this instance, given the close resemblance of the Belgian excess profits regime to the Netherlands’ informal capital regime, it would not be surprising if the EU Commission also investigates that at some stage.

The EU Commission’s press release can be found here.

Responses to Irish Corporate Tax Law Changes

Companies are responding to recent changes in Irish corporate tax law by taking a long, hard look at the restructuring options likely to be open to them in the future. Although Ireland’s Finance Bill 2014, signed into law on December 23, 2014, effectively puts an end to the ‘Double Irish’ structure by changing company residence rules, grandfathering provisions allow for continued use of structures already in place for a specified period of time.

The length of the grandfathering period, which extends to 2020, combined with the international tax planning environment’s current state of flux means that companies have been afforded the time to assess changes already announced and to monitor ongoing developments associated with the OECD’s BEPS project and the introduction of the Irish “Knowledge Development Box,” as well as internal, operational developments that may inform tax planning decisions prior to 2020.

In other words, companies know that change will be required and have started to strategize about the form that this change could take. One of the key strategies identified for companies currently structured with offshore IP holding structures and onshore Irish operations, is transferring the IP onshore to Ireland within the grandfathering period. Ireland’s 12.5 percent corporate tax rate for trading activities remains unchanged and is proving attractive for its competitiveness and certainty.

Equally, other IP holding locations are under consideration, but considerable uncertainty remains due to a number of ongoing initiatives, including BEPS. Planning-friendly jurisdictions, like companies themselves, appear eager to understand and comply with the eventual requirements of the BEPS project before being able to commit to precisely what form of planning regimes they might offer.

The change to Ireland’s company residence rules (providing that all new companies incorporated in Ireland are tax residents in Ireland from January 1, 2015, and from January 1, 2021 for pre-2015 incorporated companies) is one of ten key elements comprising Ireland’s plan for tax competitiveness, as presented in the Road Map for Ireland’s Tax Competitiveness, released October 2014, by the Department of Finance and available here.

Update on the India Vodafone Tax Case

The Union Cabinet of India elected to accept the October 10, 2014, ruling by the High Court of Bombay rendered in Vodafone India Services Pvt. Ltd. v. India, WP No. 871 of 2014, rather than to appeal to India’s Supreme Court. The case involved allegations by Indian tax authorities that Vodafone India undervalued shares sold to Vodafone India’s UK parent in order to avoid paying tax; in response, tax officials added about $490 million to the company’s taxable income for the financial years 2009-2010 and 2010-2011. However, the High Court of Bombay found that the issuance of shares in a capital financial transaction is not considered taxable income. The Indian government indicated that the decision not to appeal the case was part of a larger effort to make the Indian tax environment more stable and predictable in order to encourage foreign investment.

For more information, click here.

The United States and India Come to an Agreement on Bilateral Advance Pricing Agreements (APAs)

The United States and India have reached an agreement on a framework to resolve pending transfer pricing disputes between American-headquartered multinational corporations and the Indian government.

The framework will mitigate issues of double taxation arising from transfer pricing adjustments initiated by Indian tax authorities. The two sides will work to resolve the roughly 200 double tax cases in mutual agreement procedure (MAP) currently pending before accepting applications for bilateral APAs. The intent is for the two sides to resolve existing open cases so that companies currently involved in the program can begin to file applications for bilateral APAs with the Internal Revenue Service (IRS) prior to the March 31, 2015, deadline. As a start, both the United States and India have already agreed on a range of arm’s length prices for transfer pricing cases that involve information technology enabled services (ITes) and software development services. 

Under the agreed upon framework, the APAs will typically be four to five years in length and will also involve a rollback provision which would allow for transfer pricing issues to be resolved for longer periods when combined with a bilateral APA and competent authority.

Reaching this agreement with the United States is also said to be part of India’s broader efforts of achieving bilateral agreements with their top trading partners. The hope of the bilateral tax agreement is to boost foreign investment and alleviate the tensions stemming from pending double taxation cases.

Michelle Johnson published in Financier Worldwide’s 2015 Transfer Pricing Roundtable

The transfer pricing environment has undergone significant change over the past 12 months. High-profile developments, such as the introduction of the OECD’s BEPS initiative, have heavily impacted the transfer pricing arena, providing infinitively more scope for addressing disclosure, intangibles, risk, and dispute resolutions issues.

In a roundtable discussion presented within Financier Worldwide, Transfer Pricing Managing Director Michelle Johnson provides the U.S. perspective on the significant changes and issues facing transfer pricing in 2015.