Madalina cotrut international tax structures in the BEPS era an analysis of anti abuse measures

Abbreviations and AcronymsBEPS Base erosion and profit shifting BEPS Action Plan OECD and G20 Action Plan on Base Erosion and Profit ShiftingCFC Controlled foreign company ECJ Court of J

International Tax Structures in the BEPS Era:

An Analysis of Anti-Abuse Measures

Editorial Team

Madalina Cotrut (Managing Editor)

Aleksandra Bal Rijkele Betten Ridha Hamzaoui Belema Obuoforibo Ola Ostaszewska

Volume 2IBFD Tax Research Series

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This book does two things First, in picking up the key themes of the BEPS project, it provides asolid critique of the main proposals set out by the OECD Each chapter draws its authority fromin-depth research carried out by its author, not only into the OECD proposals, but also intoexisting domestic and international tax measures This approach provides the reader with a clearview on how the BEPS proposals would, or could, work in practice Second, this book isinvaluable for the excellent analysis that it provides on the main anti-avoidance rules currently inforce, whether set out in domestic law, or under tax treaties How these would interact with theBEPS proposals, and where the challenges remain – those are the key themes of this timelypublication.

This book is written entirely by a team of researchers at IBFD Drawing upon their own specialistexpertise, each author has brought to this book a contribution of ideas, research, and richexperience Such research activities enrich us in our daily work It is our expectation that ourreaders are similarly enriched

Belema R Obuoforibo CTA ATT (Fellow)

Director, IBFD Knowledge Centre

Tax planning structures used by some MNEs (where it is considered that low or no tax is paid incomparison with small-sized enterprises and individuals), have become the bane of policymakersnowadays, at OECD level as well as at EU level This is due to the fact that recent statisticsrevealed that the public budgets were deprived of billions of euros

The OECD and G20 members initiated the BEPS Action Plan based on the idea that “BEPS is aglobal problem which requires global solutions” 1 The objectives of the BEPS Action Plan are torelease reports which “will give countries the tools they need to ensure that profits are taxedwhere economic activities generating the profits are performed and where value is created, while

at the same time give business greater certainty by reducing disputes over the application ofinternational tax rules, and standardising requirements” 2

At EU level, the European Commission is working on a Tax Transparency Package where the keyelement is “to introduce the automatic exchange of information between EU Member States ontheir tax rulings” 3 The next step is to launch an Action Plan on Corporate Taxation to “focus onmeasures to make corporate taxation fairer and more efficient within the Single Market, including

a re-launch of the Common Consolidated Corporate Tax Base (CCCTB) and ideas for integratingthe work of OECD and G20 members to combat BEPS at EU level” 4

Within the context of these developments, this book examines the anti-abuse measures thatalready exist in different countries and scrutinizes how effective these measures are in counteringabusive tax structures This book can be considered complementary to the reports issued, or to beissued, by the OECD as it provides practical information on what happens in various countries thatencounter abusive tax structures and evaluates the effectiveness of anti-abuse measures It alsodiscusses the measures proposed by the OECD until 1 May 2015, with some exceptions

Part One provides the reader with a global overview of the most common strategies against taxavoidance by trying to find clear answers to what tax avoidance is and what the conditions are thatfacilitate and encourage tax avoidance (see chapter 1) The authors agree that, although taxpayersare free to organize their affairs as they consider fit within the law, they should nevertheless paytheir “fair share of tax” Unfortunately, the principle of “fair share of tax” is not defined andpolicymakers and taxpayers frequently meet challenges, not least due to uncertainty

Part Two focuses on key concepts in international tax structuring, such as the use of PEs (see

chapter 2) and the exploitation of transfer pricing rules (see chapter 3) in the current tax arena.Much attention is paid to the problems arising from the narrow scope of the definition of thepermanent establishment However, the authors emphasize that no concrete proposals have yetbeen put forward as regards the profit allocation to such a PE and recommend that it would bebetter to consider some form of quantitative profit threshold for deeming the presence of a PE.Furthermore, the arm’s length principle is vital in the quest for more transparency, as intra-grouptransactions will be increasingly scrutinized by the tax authorities However, at this stage, there is

no clear guidance on how taxpayers and tax authorities will benefit from the new reporting rules.The third part of the book focuses on tax structuring used for financing activities The authors

analyse the state of practice and recent developments in various countries related to intra-groupdebt financing (see chapter 4), as well as transactions involving hybrid instruments (see chapter 5)and hybrid entity mismatches (see chapter 6).

The final four chapters analyse the most common tax structures related to selected businessmodels, specifically related to supply chain management (see chapter 7), IP migration andexploitation (see chapter 8), the digital economy (see chapter 9), and holding companies (see

chapter 10)

This book highlights the intricacies of the anti-abuse measures that the countries apply incountering abusive tax structures, which are expected to be relevant for EU and OECD work.Similarly, the book highlights the challenges implicit in the recommended measures in the draftreports issued by the OECD until 1 May 2015, with some exceptions

We hope this book will stimulate further discussion and be of use to practitioners, students andpolicymakers

Abbreviations and Acronyms

BEPS Base erosion and profit shifting

BEPS Action Plan OECD and G20 Action Plan on Base Erosion and Profit ShiftingCFC Controlled foreign company

ECJ Court of Justice of the European Union

GAAR General anti-avoidance rule /general anti-abuse rule

G20 Argentina, Australia, Brazil, Canada, China, France, Germany,

India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, SouthAfrica, South Korea, Turkey, the United Kingdom and the UnitedStates and the EU

MNE Multinational enterprise

OECD Organisation for Economic Co-operation and Development

OECD Model OECD Model Tax Convention on Income and on Capital

SAAR Specific anti-avoidance rule/specific anti-abuse rule

TFEU Treaty on the Functioning of the European Union (formerly EC

Treaty)

UN Model United Nations Model Convention on Income and Capital

Lydia G Ogazón Juárez and Ridha Hamzaoui1.1 Introduction

1.2 Tax avoidance: General

1.2.1 Scope of the term

1.2.1.1 Tax avoidance versus tax evasion

1.2.1.2 Tax avoidance versus tax planning

1.2.1.3 The role of policymakers in defining clear boundaries

1.2.2 Conditions facilitating tax avoidance

1.3 Tax planning schemes: Domestic law and treaty provisions

1.3.1 Domestic law rules

1.3.1.1 Regimes allowing for exemption of foreign-source income

1.3.1.1.1 Patent box regimes

1.3.1.1.2 Participation exemption regimes

1.3.1.1.3 Holding company regimes

1.3.1.1.4 Territorial tax systems

1.3.1.2 Regimes allowing the use of mismatches between tax rules in

different countries1.3.1.2.1 US check-the-box regime

1.3.1.2.2 Use of hybrid financial instruments and entities

1.3.1.3 Provisions relating to residence

1.3.1.3.1 Dual resident companies and stateless companies

1.3.1.3.2 Tie-breaker rule for companies

1.3.2 Tax treaty rules

1.3.2.1 Tax sparing clauses

1.3.2.2 Modification of treaty classification of income

1.3.2.3 Circumvention of thresholds found in treaty provisions

1.4 Countering aggressive tax planning

1.4.1 Domestic legislation: General anti-avoidance rules

1.4.1.1 General anti-avoidance rules generally

1.4.1.2 The concept of “arrangement” or “scheme”

1.4.1.3 The concept of “tax benefit” or “tax advantage”

1.4.1.4 Compatibility of domestic GAARs with tax treaties

1.4.2 Domestic legislation: Specific anti-abuse rules

1.4.2.1 Specific anti-abuse rules in particular

1.4.2.2 Controlled foreign company rules

1.4.2.2.1 CFC rules: Main features

1.4.2.2.2 Strengthening CFC rules: BEPS Action 3

1.4.3 Tax treaties: Anti-abuse provisions

1.4.4 Another approach: Exchange of information and cooperation

between tax authorities1.4.4.1 Convention on Mutual Administrative Assistance in Tax Matters1.4.4.2 Standard for Automatic Exchange of Financial Account

Information1.4.4.3 OECD Aggressive Tax Planning Directory

1.4.4.4 United States: Foreign Account Tax Compliance Act

Annexes

Part TwoNew Roles of the Concepts in International Tax StructuringChapter 2: Permanent Establishments in International Tax Structuring

Rijkele Betten and Monia Naoum2.1 Introduction

2.2 Use of permanent establishments for tax structuring purposes2.2.1 Avoidance of permanent establishment status

2.2.1.1 Commissionaire arrangements

2.2.1.2 Splitting up of contracts

2.2.1.3 Undertaking activities of a preparatory or auxiliary nature

2.2.2 Limited attribution of profits to permanent establishments

2.2.3 Intentional creation of a permanent establishment

2.2.3.1 Exemption regimes

2.2.3.2 Financing structures

2.3 Approach of countries to tackling abuse structures

2.4 BEPS Action Plan

2.4.1 Artificial avoidance of permanent establishment status through

commissionaire agreements and similar strategies

2.4.2 Artificial avoidance of permanent establishment status through the

specific activity exemptions2.4.3 Splitting up of contracts

2.4.4 Profit attribution to permanent establishments and interaction with

Actions on transfer pricing2.5 Limitation and restrictions regarding solutions

2.6 Conclusions and expectations

Chapter 3: Transfer Pricing from the Perspective of Substance and

Transparency: Is the OECD on the Right Track?

Anuschka J Bakker3.1 Introduction

3.2 Selected transactions with transfer pricing relevance

3.3 Transfer Pricing and the BEPS Action Plan

3.3.1 Country-by country reporting

René Offermanns and Boyke Baldewsing4.1 Introduction: Funding with debt or equity?

4.2 Tax structures for group financing and the applicable anti-base

erosion measures4.2.1 Tax structures using a low-taxed group financing company

4.2.1.1 Thin capitalization rules as an anti-base erosion measure

4.2.1.2 General anti-abuse rules

4.2.1.3 Restrictions in the case of notional interest deduction regimes4.2.1.4 CFC rules

4.2.1.5 Restrictions applicable to payments to tax haven entities

4.2.2 Tax structures using a finance company with a financing branch4.2.2.1 Anti-triangular rule in tax treaties to counter the use of low taxed

finance branches4.2.2.2 Substance at the level of the financing branch

4.2.3 Tax structures using back-to-back loans

4.2.3.1 Substance and residence requirement for holding companies to

obtain tax treaty protection4.2.3.2 Beneficial ownership requirement

4.2.3.3 Limitation on benefits provision

4.2.3.4 Anti-abuse rules in tax treaties

4.3 Recent developments of the BEPS Action Plan

4.3.1 Context of Action 4

4.3.2 Summary of the three main recommendations under Action 4

Chapter 5: Hybrid Instruments in the Post-BEPS Era

Shee Boon Law and Marjolein Kinds5.1 Introduction

5.2 OECD recommendations on hybrid instrument mismatches

5.2.1 Direct hybrid mismatches

5.2.2 Hybrid transfers

5.2.3 Indirect hybrid mismatches

5.2.4 Hybrid mismatches and other actions in the BEPS Action Plan5.3 Managing coordination rules under domestic law

5.3.1 Relationship between the OECD recommendations and other

domestic law5.3.1.1 Netherlands

5.3.2.6 Tax treaty considerations

Chapter 6: Past, Present and Future of Tax Structuring Using Hybrid Entity

MismatchesOana Popa6.1 Introduction: Hybrid entity mismatches in the spotlight

6.2 Tax structures using hybrids and reverse hybrids: Manipulating

mismatches6.2.1 (Ab)using the domestic rules for entity classification

6.2.2 Basic models of tax structuring using hybrid entity mismatches6.2.3 Practical aspects

6.3 Rules addressing hybrid entity mismatches before BEPS

6.3.1 Experiences of various countries before BEPS

6.3.2 Countries’ options before BEPS

6.3.2.1 GAARs: An answer to artificial features of hybrid entity

mismatches6.3.2.2 SAARs: Same purpose from two perspectives – Source and

residence state defence against hybrid entity mismatches6.3.2.2.1 CFC rules

6.3.2.2.2 Rules limiting interest deduction

6.3.2.3 Other rules

6.3.2.3.1 Withholding taxes

6.3.2.3.2 Anti-tax haven rules

6.3.2.3.3 Reconsideration of group consolidation regimes

6.3.3 Lessons for the future

6.4 Rules addressing hybrid entity mismatches in the BEPS era6.4.1 OECD recommendations

6.4.1.1 Arrangements that produce DD outcomes

6.4.1.2 Arrangements that produce D/NI outcomes

6.4.1.3 Arrangements using reverse hybrids

6.4.2 Responses of countries to BEPS: Current state of affairs

6.4.3 Hybrid entity mismatches in the BEPS era: Closely scrutinized

worldwide6.5 Concluding remarks

Part FourSelected Business ModelsChapter 7: Business Restructurings: The Toolkit for Tackling Abusive

International Tax StructuresMadalina Cotrut and Laura Ambagtsheer-Pakarinen7.1 Overview of potential reasons for business restructuring

7.2 Typical business restructuring models

7.2.1 Restructuring manufacturing activities

7.2.2 Restructuring distribution activities

7.2.3 Centralization of services

7.2.4 IP and centralization

7.3 Business restructuring structures and anti-abuse measures: The

fight for substance7.3.1 Testing business restructurings by applying GAARs

7.3.2 Testing substance by analysing available documentation

7.3.3 Transfer pricing analysis

7.3.4 Analysis of the substance of the principal

7.3.5 Testing the PE exposure

7.3.6 Testing whether compensation upon conversion should be paid7.3.7 Restricting the tax deductibility of expenses arising from a

conversion

Chapter 8: Intellectual Property Structuring in the Context of the OECD

BEPS Action PlanRuxandra Vlasceanu8.1 Setting the scene

8.2 Structuring IP

8.3 Impact of the BEPS Action Plan

8.3.1 General comments

8.3.2 Actions tackling the prevention of double non-taxation

8.3.3 Action 5 on harmful tax practices

8.3.3.1 Existing regimes

8.3.3.2 Specific comments on Action 5

8.4 Recent developments and a blueprint for the future

8.4.1 Domestic provisions targeting aggressive tax planning

8.4.2 The redesign of IP regimes

8.5 Concluding remarks

Chapter 9: Taxation of the Digital Economy

Aleksandra Bal and Carlos Gutiérrez9.1 Introduction: The digital economy as a new way of doing business9.2 Concept of the digital economy

9.3 Tax challenges of the digital economy

9.3.1 Residence taxation

9.3.2 Source taxation: Physical versus digital presence

9.3.3 Source taxation: Taxation of business profits of a PE

9.4.2 New taxes on specific transactions

9.4.3 New taxes on profits

Chapter 10: International Tax Structuring for Holding Activities

Andreas Perdelwitz10.1 Introduction

10.2 General characteristics of holding companies

10.3.3 Key criteria for holding company locations

10.4 Limits on tax structuring with holding companies

10.4.1 General anti-abuse rules

10.4.2 Transfer pricing

10.4.3 Residence

10.4.4 Beneficial ownership requirement

10.4.5 Interim conclusion

10.5 Potential impact of the BEPS Action Plan

10.5.1 Action 6: Prevent treaty abuse

10.5.2 Limitation on benefits rules in tax treaties

10.5.2.1 Publicly-traded companies test

10.5.2.2 Ownership/base erosion test

10.5.2.3 Active business test

10.5.2.4 Derivative benefits test

10.5.3 Principal-purpose test under tax treaties

List of Authors

Part One

Recent Developments in International Tax Structuring

Chapter 1 Common Strategies against Tax Avoidance: A Global Overview

Lydia G Ogazón Juárez and Ridha Hamzaoui *1.1 Introduction

As a starting point for a chapter on tax avoidance strategies, it is pertinent to address severalquestions First, precisely what is meant by the term “tax avoidance”? Second, what are theconditions that facilitate and encourage tax avoidance? A clear answer to the first question woulddefine the scope of this chapter A clear answer to the second would make apparent the necessityfor properly drafted rules, as well as provide useful analysis of the likely success (or otherwise) ofparticular anti-avoidance rules

This chapter is structured as follows:

Section 2 addresses the precise scope of the term “tax avoidance”, recognizing the cleardistinction between “avoidance” and “evasion”, as well as the unclear distinction between theformer and “tax planning” The authors make the argument for certainty, and highlight the role ofpolicymakers in clarifying the scope of these terms The main conditions that facilitate andencourage tax avoidance are also examined

Section 3 offers a brief overview of the main tax planning considerations taken into account bytaxpayers This is necessary as a precursor to the discussion that follows in section 4

Section 4 is the heart of the chapter: now that there is some clarity on the scope of tax planningand tax avoidance (section 2), and the schemes that taxpayers frequently employ in pursuit ofthose objectives, have become clear (section 3), the question arises as to what governments aroundthe world have been doing to address this, and how successful (or otherwise) have their effortsbeen

Section 5 presents the authors’ conclusions

The chapter is set against the backdrop of the OECD’s efforts against BEPS 1 The BEPS projectsprang into life in February 2013, with a report outlining the key issues and setting out proposalsfor an Action Plan In July 2014, the OECD issued the Action Plan, which contained 15 specificactions to address BEPS (see Table 1) in a comprehensive and coordinated manner The objective

of those actions was:

to complement existing standards that are designed to prevent double taxation withinstruments that prevent double non-taxation in areas previously not covered by internationalstandards and that address cases of no or low taxation associated with practices thatartificially segregate taxable income from the activities that generate it 2

Each action describes the issues to be addressed, the expected outcome and the deadline The

Action Plan is expected to be completed within a two-year period, taking into account that someactions have already been advanced while others might require longer-term work.

The Action Plans will be analysed in detail elsewhere in this publication 3

The European Union has also made concerted efforts in the fight against tax fraud and tax evasion

In December 2012, the European Union presented an Action Plan 4 in this regard The Action Plansets out a comprehensive set of 34 measures “to help member states to protect their tax bases andrecover billions of euros legitimately due” 5 Most of those actions are also included in the BEPSAction Plan 6 The 34 actions of the EU Action Plan are summarized in Table 2

1.2 Tax avoidance: General

1.2.1 Scope of the term

1.2.1.1 Tax avoidance versus tax evasion

Tax avoidance is a term:

generally used to describe the arrangement of a taxpayer’s affairs that is intended to reducehis tax liability Although the arrangement could be legal (i.e in line with “the letter of thelaw”), it is usually in contradiction with the intent of the law it purports to follow (i.e against

“the spirit of the law”) 7

Therefore, tax avoidance is, in principle, lawful because the tax advantage is being sought withinthe boundaries of the rules This behaviour has pushed the legislatures in several countries toenact measures dedicated to counter tax avoidance schemes, whether they are meant to catch alltypes of tax schemes or are designed to restrict only a specific type of avoidance

Tax avoidance is contrasted with tax evasion where a taxpayer takes steps to avoid paying a taxliability that has already arisen 8 Tax evasion carries an element of dishonesty In this sense, theterm “tax evasion” is “generally used to mean illegal arrangements where the liability to tax ishidden or ignored” 9

In addition, tax evasion may be characterized as intentional illegal behaviour consisting of notdeclaring, or under-declaring, income or assets which are subject to tax, which is often sanctioned

by financial or criminal penalties 10

1.2.1.2 Tax avoidance versus tax planning

The distinction between tax avoidance and tax planning seems more difficult to determine Both,tax avoidance and tax planning involve tax reduction arrangements that may comply with thespecific wording of the law 11 Tax planning is seen as compliant behaviour, while tax avoidance

is more of a grey area 12

Nevertheless, “tax planning may reach a point beyond which it cannot be tolerated within a legal

system intended to conform to principles of justice” 13 This gives rise to what has been labelled

as “aggressive” tax planning which goes beyond an acceptable level and may fall in the area of taxavoidance, as it consists in taking advantage of the technicalities of a tax system, or ofmismatches between two or more tax systems with the aim of reducing the overall tax liability.Aggressive tax planning can take various forms and its effects could include several taxadvantages, such as double deductions and very often double non-taxation 14 Aggressive taxplanning refers, therefore, to arrangements that “push the limits” of acceptable tax planning 15

and would fall into the realm of tax avoidance Similarly, tax avoidance exists where a taxpayerseeks to obtain a tax advantage by means of sham or artificial transactions, considering that thelaw could not have intended to grant a tax advantage in such way

In many instances, the distinction between tax avoidance and tax planning is also determined bythe judicial system 16 This would occur when a taxpayer takes advantage of a tax provisionexploiting a legislative loophole; in that case the behaviour of the taxpayer could be challenged bythe tax authority based on the fact that a loophole is an unintentional imperfection in the law Inseveral jurisdictions, the courts have considered the use of a loophole as permissible, such that thetaxpayer’s transaction would then qualify as tax planning This could, in turn, trigger thelegislature to amend the existing legislation, thereby closing the loophole

1.2.1.3 The role of policymakers in defining clear boundaries

Multinationals are being strongly encouraged to justify their tax positions, especially regardingthe level of taxes they pay, as an aspect of their corporate social responsibility 17 Multinationalsoften justify and defend their actions by referring to the fact that they have acted according to thelaw However, this explanation is not always considered acceptable Consequently, the questionconcerns whether it is appropriate to exploit loopholes in the tax law or whether there is some sort

of moral duty to refrain from doing so Paying a “fair” amount of tax in the countries in whichmultinationals carry out transactions is increasingly seen as responsible behaviour, consideringthat such tax revenues are meant to finance public services and social benefits Avoiding paying afair share has been deemed to be morally indefensible, as it represents the avoidance of a socialobligation 18 It also deters governments from playing their role as redistributors of wealth

On the other hand, one might ask whether it is justified to focus so much on the behaviour ofmultinationals Should they be blamed for using, to their own benefit, loopholes and existingmismatches between non-aligned domestic tax systems? It is clear that multinationals and, ingeneral, taxpayers must bear social responsibility However, should not this also apply topolicymakers? 19 While governments complain that their tax bases have been eroded in recentyears through the use of tax planning structures, should not policymakers bear the responsibilityfor enacting regimes and provisions that open the door to such erosion? There is also the veryvalid point that morality considerations undermine legal certainty Taxpayers should havecertainty under the law as to the precise extent of their tax liability The moral dimension adds alayer of uncertainty Policymakers have an unassailable duty to ensure that the law is clear andallows for no ambiguity

From a technical perspective, legislatures should not have trouble in designing and implementinglegislative measures against base erosion Some of these measures have been implemented in thepast by several countries – in many cases, with much success A good example is limitation on

benefits provisions to limit treaty shopping which are used by the United States in most of itstreaties That said, policymakers also face another dilemma, namely the need to improve theattractiveness of their countries from a tax perspective The interaction of these competingconsiderations (the need to raise tax revenues versus the need to have an attractive tax system)often leads to incoherent tax policy and uncertainty for taxpayers.

1.2.2 Conditions facilitating tax avoidance

Tax avoidance thrives where several conditions are present Chief amongst these is the existence

of a “favourable” domestic tax system “Favourable”, in the sense, means that the system containslaws that lend themselves to be manipulated by taxpayers This advantageous position could even

be intensified by the interaction of those systems with the tax systems of other jurisdictions

Judicial precedent has sometimes affirmed the right of taxpayers to engage in tax planning 20

However, this should be viewed against the development of comprehensive judicial avoidance doctrines 21

anti-Tax rules have failed to follow the astonishing evolution of cross-border trade Globalization hastransformed the way in which business has been carried out in recent decades which, undoubtedly,reflected on how tax planning has been implemented In addition, free trade barriers have beengradually removed, and the digital economy, technology and telecommunications have alldeveloped rapidly In this regard, it is a fact that current international tax rules have not been able

to keep pace with all these changes, due to an obvious absence of international tax harmonizationefforts For example the physical presence requirement – which is still a prerequisite under taxtreaties for a non-resident person to be taxable in another country – is no longer necessary in order

to conduct business in a foreign jurisdiction 22 Accordingly, a large quantum of profits is beingextracted from several jurisdictions without first paying any taxes, due to the lack of physicalpresence there This is increasingly pushing governments, academics and civil society to questionthe fairness of existing rules, including those pertaining to the allocation of taxation rights undertax treaties

Although it is true that tax planning has generally been considered as a legitimate practice aroundthe world, the manner in which tax bases have been eroded based on complex and sophisticatedstructures in recent years has forced governments and international organizations to revisit theirposition This move was accelerated by economic recessions, budgetary cuts and the substantialgrowth of the tax collection gap which forced governments to change their policy and demand that(large) taxpayers settle their fair share of taxes Aggressive tax planning has also raised issues as

to the fairness of the overall tax system Civil society organizations and non-governmentalorganizations have also added their voices to the general debate

Various initiatives have been undertaken by tax administrations and international organizations tocurtail what has been labelled as rampant corporate tax aggressiveness In addition to severalinitiatives by individual countries, three major actors have recently played this role, namely theOECD, the European Union and the United States Each of these actors has developed a specialplan to address the issue

1.3 Tax planning schemes: Domestic law and treaty provisions

The discussion below provides an overview of the main tax planning considerations taken intoaccount by taxpayers, and the types of domestic law and treaty rules used in furtherance of suchplanning The aim of this overview is to identify the main targets of attack for any effective anti-avoidance strategy The overview is necessarily brief, as these schemes are addressed in greaterdetail elsewhere in this publication.

1.3.1 Domestic law rules

Several countries use their tax systems to compete with each other in order to attract foreigndirect investment In fact, in a competitive world, tax sovereignty is illusory Governmentsconsider they have the freedom to determine their effective tax rates for companies incorporated

or effectively managed in their jurisdictions However, in reality they are forced to establish theireffective tax rates by taking into consideration what their competitors are implementing in terms

of preferential tax regimes 23

Many countries provide “attractive” tax regimes which allow taxpayers to minimize their taxliability, provided that certain conditions are met These regimes – often in conjunction with taxtreaties entered into by a specific jurisdiction – could contribute to base erosion and profitshifting

1.3.1.1 Regimes allowing for exemption of foreign-source income

1.3.1.1.1 Patent box regimes

A patent box regime (also known as an innovation box or intellectual property regime) is apreferential tax regime granted by several countries in order to attract research and developmentactivities to their jurisdiction, as well as to encourage their local companies to invest in innovativetechnologies Generally, a patent box regime provides for the application of an effective tax rate(exempting a substantial part of the tax base) which is lower than a country’s standard corporatetax rate, to income derived from licensing intellectual property (e.g patents, models, copyrights,designs)

Moreover, royalties and profits derived from selling products or providing services using theintellectual property can also be eligible for such a regime In most jurisdictions where thisregime is available, research activities are not required to be conducted in the country whichgrants the tax incentive Table 3 summarizes some patent box regimes which are currently inforce

On 18 October 2013, the European Commission announced 24 that it considered the UK patentbox regime (which took effect as from 1 April 2013) as violating the EU Code of Conduct ofbusiness taxation, on the grounds that it constitutes harmful tax competition 25 Accordingly, thisregime and other patent box regimes in force in other EU Member States are subject to closerexamination 26

1.3.1.1.2 Participation exemption regimes

A participation exemption regime is a mandatory measure to avoid economic double taxation atthe level of a parent company, based on the fact that dividends were already subject to corporatetax at the level of the distributing subsidiary 27 The conditions required for application of aparticipation exemption regime (such as a minimum percentage holding requirement and/or aminimum holding period requirement) vary from country to country, but, in general, incomederived from domestic and/or foreign participations would be wholly or partially tax exempt.

Countries like Austria, Belgium, Cyprus, Denmark, France, Ireland, Italy, Luxembourg, Malta, theNetherlands, Spain, Switzerland, the United Kingdom and the United States include a participationexemption regime in their domestic legislation, making these countries an attractive jurisdiction

to locate holding companies Usually, under participation exemption regimes, the tax burden onforeign-source dividends is considerably reduced In fact, participation exemption regimes, incombination with tax treaties, have allowed tax planners to achieve almost a double non-taxation

of dividends by reducing the withholding tax on dividends at the subsidiary level and exemptingthose distributions when received by the parent company

1.3.1.1.3 Holding company regimes

Holding company regimes provide significant tax benefits to multinationals (e.g reduction orelimination of withholding taxes on dividends, interest and royalties; reduction or elimination ofincome tax and tax on capital gains; access to a wide treaty network) Currently, countries such asAustria, Belgium, Cyprus, Hungary and Ireland offer attractive benefits to holding companies set

up in their jurisdictions For tax planning purposes, holding companies are established in countriesacting as a conduit of the group in order to have access to tax advantages which otherwise wouldnot be available to the group Table 4 summarizes some of the holding companies regimescurrently in force

For more details on the use of holding companies for tax structuring purposes, see chapter 10

1.3.1.1.4 Territorial tax systems

Under a territorial tax system, foreign-source income is exempt from residence country taxation.Only that income which arises from sources within the country is subject to tax

A territorial tax system can be particularly attractive, as the exemption of foreign-source incomereduces the effective income tax rate and encourages the location of activities for tax purposesrather than for business purposes In addition, countries with a territorial tax system can be used toestablish conduit companies or holding vehicles in order to engage in treaty shopping – a situationwhich may have harmful effects on other countries 28

Currently, countries such as Hong Kong, Panama and Singapore have a territorial tax system inforce

1.3.1.2 Regimes allowing the use of mismatches between tax rules in different countries

1.3.1.2.1 US check-the-box regime

The US check-the-box regime allows certain business entities to make an election as to whetherthe entity will be fiscally transparent or opaque for US tax purposes A business entity may beclassified as a corporation or a partnership, or may be disregarded as an entity If the entity isclassified as a corporation, it will be fiscally opaque and subject to tax However, if the entity istreated as a partnership or a disregarded entity, it will be fiscally transparent for US tax purposes.

29

Many types of tax planning opportunities are afforded by the US check-the-box regime Forexample the US anti-tax haven legislation which deals with CFCs may be applicable even insituations where a CFC is, in fact, subject to a high tax rate in the residence country The amount

of foreign tax liability may be reduced without modifying the US CFC position This is possible ifthe CFC sets up a new entity in a low-tax jurisdiction in circumstances where that new entity isnot regarded as a corporation for US tax purposes Subsequently, this new entity makes a loan tothe CFC, thereby creating an interest deduction and reducing the profits of the CFC which aresubject to a high tax rate Consequently, as the United States does not recognize the new entity as

a corporation, the interest payment and the receipt are treated as merely internal cash flows,leaving the US CFC tax liability unchanged 30

1.3.1.2.2 Use of hybrid financial instruments and entities

Hybrid financial instruments and entities used in international transactions allow tax planners totake advantage of characterization mismatches (e.g different definitions or tax treatment) indifferent jurisdictions, in circumstances that give rise to international tax avoidance 31

A hybrid financial instrument is defined as an:

instrument with economic characteristics that are inconsistent, in whole or in part, with theclassification implied by their legal form Hybrid financial instruments normally containelements from equity, debt and/or derivatives, the advantages of which they seek to combine

in the same instrument 32

A hybrid entity could be defined as “an entity that is characterized as transparent for tax purposes(e.g a partnership) in one jurisdiction and non-transparent (e.g a corporation) in anotherjurisdiction” 33 Depending on the circumstances, a payment by a hybrid entity can give riseeither to a double deduction (deduction in two countries) or to a deduction in one country with notaxable income in another country One of the most prominent tax regimes which allows for theuse of hybrid entities for tax planning purposes is the check-the-box regime in the United States.This regime allows US companies to create foreign entities that were treated one way in theUnited States and another way in the foreign country In fact, it was possible to elect that theforeign entity is considered either as fiscally transparent or opaque for US tax purposes Abusiness entity may be classified as a corporation, a partnership or a disregarded entity If theentity is classified as a corporation, it will be fiscally opaque However, if the entity is treated as apartnership or a disregarded entity, it will be fiscally transparent for US tax purposes

For further details on tax structuring using entity mismatches, see chapter 6

1.3.1.3 Provisions relating to residence

1.3.1.3.1 Dual resident companies and stateless companies

Unless domestic legislation or the applicable tax treaty includes a tie-breaker rule, there arecircumstances in which a company might be considered to be resident in two different countries.This could be the case where a company is incorporated in a country which determines residencebased on legal registration, while at the same time it is controlled and managed from a countrywhich uses an economic test to determine such residence A dual resident company could be usedfor tax planning purposes where, for example, a multinational group has profitable groupmembers in both countries, the same losses could be offset twice through a consolidation regime

34 In addition, a dual resident company can take advantage of the tax treaty network of bothcountries of residence, electing to apply that which offers the most advantageous tax treatment

The reverse situation of a dual resident company concerns an entity that is incorporated in acountry relying on the place where the company is managed and controlled in order to determinetax residence, while the same company is managed and controlled in a country that determines taxresidence based on the place of incorporation This results in a “stateless company” The entity istherefore not resident for tax purposes in any of those jurisdictions, and, accordingly, would not besubject to tax in either country

1.3.1.3.2 Tie-breaker rule for companies

In order to avail itself of relevant tax treaty benefits, a taxpayer must be a resident of one or both

of the relevant treaty states Where a company qualifies as a resident under the domesticlegislation of both states, if there is a tie-breaker rule in the applicable tax treaty, it will determinewhich of the two states should be treated as the taxpayer’s state of residence In general, theOECD 35 and UN 36 Models consider as the decisive criterion the place where the company hasits place of effective management This criterion has been used for tax planning purposes in manyways Therefore, as part of the proposals made in the BEPS Action Plan, the tie breaker rule whichgives preference to the country where the place of effective management is located should bereplaced with a provision that, in the case of double resident companies, the matter should beresolved based on the mutual agreement procedure

1.3.2 Tax treaty rules

1.3.2.1 Tax sparing clauses

Tax sparing clauses are, in general, incorporated in tax treaties negotiated by developed countrieswith developing countries, but can also be found in tax treaties between developed countries.Currently, although tax sparing clauses are not negotiated as often as they were in the past, thereare countries that still include them in their tax treaties mainly because they have been shown to

be “very vulnerable to taxpayer abuse” 37, offering plenty of opportunities for tax planning andtax avoidance that erode the tax bases of the residence and source countries, several (developing)countries still include them in their tax treaties in order to secure the efficiency of their taxincentives legislation In this respect, it has been argued that tax sparing clauses are considered anineffective tool to promote economic development 38

A tax-sparing provision may be inappropriately exploited by residents under a particular taxtreaty Additionally, the residence country may also be used as a conduit by third-countryresidents The cost of such use to the residence country – which is required to grant a tax sparingcredit for foreign taxes (which should have been paid but were not, due to specific legislation such

as tax incentive rules) – may be significant This is the case particularly where the country is used

as a conduit to obtain access to such provision Moreover, the source country may find that itsrevenue base is eroded in unintended ways as a natural result of the tax incentive rules

The OECD Report on Tax Sparing mentions the following as the most common tax avoidanceschemes involving tax sparing provisions: transfer pricing abuse, conduit situations, routing andpotential government abuse 39

1.3.2.2 Modification of treaty classification of income

In general, taxing rights are allocated between countries depending on the nature of the incomeunder the rules established in articles 6 to 21 of tax treaties Such classification is based on acombination of tax treaty and domestic law definitions However, in some cases, taxpayers maytry to manipulate such classification in order to obtain treaty benefits that would not otherwise beavailable 40

1.3.2.3 Circumvention of thresholds found in treaty provisions

Some tax treaty provisions include thresholds to determine the country which has the right to tax

In certain cases, taxpayers may manipulate these thresholds to obtain tax treaty benefits thatwould otherwise not be available to them (e.g the time limit for certain PEs, the participationrequired on dividend payments in order to apply a lower withholding tax rate, the thresholds forthe source taxation of capital gains on shares)

1.4 Countering aggressive tax planning

In recent years, governments have witnessed the spread of aggressive tax planning structures andhave had to react swiftly to address the risk that this poses to their tax bases It is clear thattaxpayers may be tempted to abuse the tax laws of a state by exploiting the mismatches betweenthe laws of several countries However, such attempts may be countered by provisions or legaldoctrines that are part of the domestic law of the state concerned 41 These provisions range fromspecific, general anti-avoidance rules to new penalty regimes for taxpayers and scheme promoters,

as well as mandatory disclosure rules and additional reporting obligations

In this regard, it has been mentioned that the main weapon that a government has against taxavoidance is to introduce amending legislation to prevent avoidance schemes being used in thefuture, specifically taking into account that it can be dangerous for a government to rely on courts

to interpret provisions so as to prevent tax schemes 42

The discussion below considers the main strategies available to tax administrations in their efforts

to defeat tax avoidance schemes of the sort covered in this publication

1.4.1 Domestic legislation: General anti-avoidance rules

1.4.1.1 General anti-avoidance rules generally

A general anti-avoidance rule (GAAR) is defined as “An anti-avoidance measure, generally statutebased, providing criteria of general application, i.e not aimed at specific taxpayers ortransactions, to combat situations of perceived tax avoidance” 43 GAARs have been described as

“the only way to plug gaps discovered by ingenious tax consultants”, 44 as they should be broadenough to catch tax avoidance schemes not yet contemplated by the drafter of the GAAR 45 Theyare considered necessary to ensure that the tax base is not minimized due to “the failure of thelegislature to keep pace with newly emerging tax avoidance schemes”, 46 as well as “to preventabusive arrangements that are not adequately dealt with through specific rules or juridicaldoctrines” 47 In this sense, GAARs are a sort of catch-all provision for tax avoidance schemes

In general, GAARs are considered more acceptable than many specifically targeted anti-avoidanceprovisions However, the major drawbacks of a GAAR are that it creates increased uncertainty fortaxpayers and there is a greater risk that genuine business transactions would fall within its ambit.For instance in the 2009 case of Glenbarrow Holdings v Commissioner, 48 the New ZealandSupreme Court highlighted that there is an inevitable lack of certainty whenever relying on aGAAR, due to the broad nature of such a provision The Supreme Court stated that when theParliament enacts a measure such as a GAAR, the benefit of the taxing statute’s ability toanticipate tax avoidance is traded off against certainty 49 In addition, it not possible to cover allissues that might arise from a specific set of rules, and therefore there should be a limit to thelevel of detail to be set out in legislation In fact, too much detail would increase the opportunitiesfor tax avoidance 50

GAARs the world over have some elements in common However, the scope of transactionsfalling within a GAAR varies from country to country Currently, the domestic laws of countriessuch as Australia, China, Brazil, Finland, Germany, Indonesia, Peru, South Africa, Switzerland,the United Kingdom and the United States incorporate a GAAR provision India has approved theintroduction of a GAAR into its domestic legislation which will enter into force as from 2016

Some of the oldest GAAR provisions in the world are those in New Zealand 51 and Australia Thefocus of the discussion below is on these laws, in addition to the newly introduced UK GAARprovisions However, the UK provision is a “general anti-abuse rule”, and not a “general anti-avoidance rule” By focusing on abuse, rather than avoidance, the UK provisions have muchnarrower application than “traditional” GAARs

1.4.1.2 The concept of “arrangement” or “scheme”

The concept of an arrangement or scheme under many GAAR provisions includes a wide range ofagreements, undertakings, understandings and promises, whether expressed or implied andwhether or not enforceable Under the Australian GAAR, a scheme would also include a plan,proposal, action, course of action or course of conduct 52 Under the UK legislation, anarrangement is defined in connection with the purpose of obtaining a tax advantage 53 This is anobjective test which is to be implemented by taking into consideration all the relevant

circumstances and questioning whether, in light of those circumstances, a reasonable conclusionwould be that obtaining a tax advantage was the main purpose 54

Where a scheme is part of an overall arrangement, in assessing whether a tax benefit was realizedand whether that was the main purpose of the scheme, it is more effective for the taxpayer toconsider the overall arrangement, rather than the particular scheme in isolation There is a viewthat the narrower the scope of enquiry, the more probable it is to conclude that the tax motivation

is prevailing 55

1.4.1.3 The concept of “tax benefit” or “tax advantage”

Under most GAAR provisions, a scheme or an arrangement must give rise to a tax advantage Taxbenefits would generally cover not only amounts which have not been integrated into the taxablebase, but also expenses which would not have been deductible were the arrangement not to havebeen put in place In addition, the concept of tax advantage encompasses capital losses incurred bythe taxpayer or foreign taxes which may either be offset against other capital gains or allow for adouble taxation relief when they would not have been were the scheme not to have been put inplace Generally, a benefit will not be regarded as tax advantage if it comes on the basis of achoice, an election or an option by the taxpayer 56

Some tax authorities take the approach that, in order to determine the existence of a tax advantage,

a test must be applied in order to compare what actually happened based on the scheme and whatmight have happened without the scheme The purpose is to make sure that a tax advantage wasactually realized 57

1.4.1.4 Compatibility of domestic GAARs with tax treaties

The issue of whether domestic GAARs are compatible with tax treaties was clarified by the OECDCommentary in 2003 The OECD Commentary on Article 1 was revised in 2003 in order to stateexpressly that GAAR, substance-over-form and economic substance measures are part of domestictax rules and are not addressed in tax treaties 58 Therefore, these rules are not affected by taxtreaties and there should be no conflict between them 59

The 2003 update to the OECD Commentary added that one of the purposes of tax treaties is tocombat tax avoidance, and that states do not have to grant the benefits of a tax treaty wherearrangements have been entered into that constitute an abuse of the provisions of that treaty 60

With regard to the BEPS Action Plan, the OECD did not touch upon domestic GAARs per se,however, under Action 6 dealing with preventing the granting of treaty benefits in inappropriatecircumstances, one of the deliverable is to strengthen the assertion that tax treaty provisions donot prevent the application of a domestic GAAR 61 It is also proposed to introduce a sort ofGAAR under the OECD Model in the context of Action 6 which is based on a principal purposetest 62

1.4.2 Domestic legislation: Specific anti-abuse rules

1.4.2.1 Specific anti-abuse rules in particular

Specific anti-abuse rules (SAARs) are relied upon under the domestic law of many countries as atool to counteract specific tax avoidance schemes SAARs include:

– CFC legislation;

– thin capitalization rules;

– anti-tax haven rules;

– anti-hybrid rules; and

– earnings stripping or interest barrier rules

The BEPS Action Plan has addressed several SAARs in some detail Regarding tax planning usinghybrid instruments and hybrid entities, see also chapters 5 and 6 of this publication, which analysethe Actions relevant to both issues

The BEPS Action Plan also contains recommendations for strengthening CFC rules An analysis

of these recommendations is presented below

1.4.2.2 Controlled foreign company rules

1.4.2.2.1 CFC rules: Main features

CFC rules were “introduced for the purpose of countering the use of base companies in low-taxjurisdictions that derive income not directly related to the exercise of commercial or industrialactivities (i.e ‘passive income’)” 63 CFC rules vary from country to country, but “are generallydefined by reference to criteria regarding (1) control, (2) effective level of taxation, (3) activity,and (4) type of income of the CFC” 64 Where the effective level of taxation “is relevant to theapplication of the rules, various tests may be applied, such as a comparison with the equivalent taxwhich would have been paid on the income under the tax laws of the shareholders” 65 With thisobjective, some countries draw up lists of countries which are considered outside the scope of theCFC rules in all cases (a so-called “white list”), or only in certain cases (“gray list”), or which arealways considered to fall within the scope of CFC rules (“black list”) 66 In general, “income ofthe controlled company is typically either deemed to be realized directly by the shareholder ordeemed to be distributed to them by way for dividend” 67

A critical issue when attempting to implement CFC rules in practice concerns whether these rulesare restricted by the effect of tax treaties In fact, it has been argued that CFC rules are notapplicable under tax treaty provisions drafted along the lines of article 7(1) of the OECD Model

68 This provision, in the treaty between the country of the parent and the country of thesubsidiary, allows the taxation of the non-resident subsidiary on its business profits in the country

of residence of the parent entity only when the subsidiary has a PE there In the absence of such a

PE, it has been stated that the taxation of the subsidiary’s profits in the parent’s country ofresidence, based on its domestic CFC rules, is not permissible Similar reasoning has beenasserted also based on tax treaty provisions similar to article 10(5) of the OECD Model 69

The OECD view is that CFC rules are generally compatible with the tax treaty provisions 70 As is

to be expected for most cross-border tax issues, court decisions vary, depending on the country 71

1.4.2.2.2 Strengthening CFC rules: BEPS Action 3

OECD Action 3 of the BEPS Action Plan deals with strengthening CFC rules A discussion draftreport was issued on 3 April 2015 and is the first document of the output to be produced under thiselement of the BEPS Action Plan The draft proposes as a first main recommendation to broadlydefine entities that are within the scope of the CFC rules Accordingly, in addition to includingcorporate entities, CFC rules should cover within their ambit partnerships, trusts and PEs eitherwhen those entities belongs to CFCs or when treated in the parent company country as taxableentities which are separate from their direct owner

The first recommendation in the discussion draft regarding the widening of the scope of CFClegislation could have major implications for the taxation of global businesses Undoubtedly, thiswould increase the risk of double and multiple taxations A global company could very likely facethe situation of being subject to multiple layers of CFC rules at the level of main parent company,

as well as at the level of other intermediate companies In such instances, the issues that remain to

be solved are how to provide relief from double taxation and whether this should be providedunder some special tax treaty provisions or under the domestic tax law of the country applying itsCFC legislation

The discussion draft 72 addresses these issues and focuses on three situations where doubletaxation may arise, namely:

– situations where the attributed CFC income is subject to foreign corporate taxes;

– situations where CFC rules in more than one jurisdiction apply to the same CFC income; and– situations where a CFC distributes dividends out of income that has already been attributed

to its resident shareholders under the CFC rules, or a resident shareholder disposes of theshares in the CFC

With regard to the first two situations, the discussion draft recommends that countries shouldallow a credit for foreign taxes paid, including CFC tax at the level of intermediate companies.This solution proposed by the OECD is not fully satisfactory for double taxation relief purposes,

as it does not take into consideration the possible sources of double taxation This is due to thefact that several countries apply their CFC rules by recalculating the CFC taxable incomeaccording to their own tax law In fact, gross CFC income is integrated into the taxable base of theparent company, and then the net taxable CFC income is determined and taxed under the domestictax rule applicable at the level of the parent entity Double taxation may occur from taxing thesame income in both the CFC country and the parent company’s country, but also due tomismatches regarding the rules on determination of net taxable income with respect todepreciation, provisions and other deductibility rules

Moreover, it is a fact that US multinationals rely heavily on the various exceptions andexemptions included in the US CFC rules (also known as subpart F rules), and therefore asuccessful implementation of Action 3 would require firm support from the United States in order

to amend its own CFC rules (which remains to be seen in practice)

One last concern that should be assessed and addressed by the OECD is the impact of CFC rules

on developing countries, especially those with tax incentives regimes (e.g free zone regimes,export-oriented incentives) The strengthening of CFC rules might jeopardize the effectiveness of

all these regimes by neutralizing the exemptions granted by source countries An appropriatesolution needs to be developed for these regimes where genuine economic activities are carried on

in developing countries

1.4.3 Tax treaties: Anti-abuse provisions

A view persists that the current tax treaty network has increased the risk of abuse by facilitatingthe use of artificial legal structures aimed at securing the benefits of both the advantages availableunder domestic laws and the relief granted under tax treaties 73 Consequently, governments havereacted in an effort to protect their tax bases from such abuses by (i) denying treaty benefits topersons who, under different circumstances, would not be entitled to them or (ii) granting access

to such benefits only if certain conditions are met

Some countries have considered that the simple introduction of a general anti-abuse rule in theirtax treaties is enough to protect their tax bases, while others have considered it necessary inaddition the inclusion of specific anti-abuse rules The most common anti-abuse provisions to befound in tax treaties include:

– “beneficial ownership” requirements;

– limitation on benefits clauses; and

– general anti-abuse provisions

Regarding the last item, some comments are appropriate General anti-abuse provisionsincorporated in tax treaties give the tax authorities the discretion to deny treaty benefits wheretransactions are entered into merely for tax purposes A general anti-avoidance provision will besuccessful depending on the attitudes of the courts or other appellate bodies in upholding the right

of the tax authorities to collect what they deem to be the correct amount of tax 74

Some countries have the practice of including a general anti-abuse rule in their bilateral taxtreaties 75 Paragraphs 34 to 36 of the Commentary on Article 1 of the UN Model provide someexamples of such rules The introduction of a GAAR in tax treaties must take into account thelevel of expertise required by tax officials, as well as the administrative burden that theapplication of such provisions will represent for the tax authorities Unfortunately, this does notalways happen in practice

The difficulty for these rules in a tax treaty context concerns (i) how to determine that a taxbenefit was realized by the taxpayer and (ii) whether the tax burden should be assessed from theperspective of the source country or also include the residence country, as the taxpayer may besubject to residence taxation on its income

1.4.4 Another approach: Exchange of information and cooperation between tax authorities

GAARs have always faced much criticism which stems from the following factors First, a heavyburden of proof is borne by tax authorities in order to be able to implement such measures.Second, taxpayers are exposed to an increased uncertainty and might see their genuine businesstransactions recharacterized on the grounds of a tax-driven motivation The same uncertaintyelement also applies to tax authorities that might face a very narrow interpretation by the courts

and, consequently, lose significant tax revenue even in obvious cases of tax avoidance These riskshave pushed tax authorities to look for more effective ways to reduce the tax collection gap andlocate tangible information on taxpayer behaviour Therefore, exchange of information hasemerged in the last decade as the ultimate instrument to combat tax evasion and discourage anytax avoidance conduct Obviously, international organizations and tax authorities are determined

to consolidate and strengthen this tool in favour of the tax collector Some steps taken infurtherance of exchange of information and cooperation are considered below

1.4.4.1 Convention on Mutual Administrative Assistance in Tax Matters

The Convention on Mutual Administrative Assistance in Tax Matters 76 is a key multilateral taxinstrument that was designed by the OECD and the Council of Europe to promote internationalcooperation for the better operation of domestic tax law while respecting the fundamental rights

of taxpayers The Convention provides for all possible forms of administrative cooperation in theassessment and collection of taxes, particularly with a view to combating tax avoidance andevasion Currently, the Convention has been signed by over 70 countries, including all G20members, all BRIICS countries, almost all OECD member countries, major financial centres and agrowing number of developing countries

This instrument represents an achievement for the tax authorities of signatory countries, as itprovides elements to combat tax avoidance and tax evasion on an international level.Nevertheless, exchange of information undoubtedly will generate additional administrative burdenand costs for tax administrations

1.4.4.2 Standard for Automatic Exchange of Financial Account Information

In October 2014, 51 jurisdictions signed a competent authority agreement to implement the newstandard for automatic exchange of financial account information 77 Under the new standard, thesignatory jurisdictions may obtain financial information from their financial institutions and willautomatically exchange such information with other jurisdictions on an annual basis

The standard does not restrict the other types or categories of automatic exchange of information

It merely sets out a minimum standard so that jurisdictions may choose to exchange informationbeyond that minimum standard The agreement specifies the type of information to be exchanged,

as well as the time and manner for such exchanges Some signatories agreed to carry out the firstexchange by the end of September 2017, while others before September 2018 78

On the one hand, the agreement creates transparency so that the use of offshore financial accountsand assets to avoid tax liabilities will no longer be an option On the other hand, banks and otherfinancial institutions are facing significant challenges in establishing appropriate complianceprogrammes to provide the financial account information

1.4.4.3 OECD Aggressive Tax Planning Directory

The OECD Aggressive Tax Planning Steering Group developed a directory 79 to helpgovernments keep pace with aggressive tax planning and enable member countries to better and

more easily understand new schemes, facilitate their detection, adapt risk management strategiesand identify successful legislative and administrative countermeasures The Directory includesinformation on scheme types, the legal provisions which are exploited, how these schemes weredetected and the measures that governments are undertaking to counteract them The schemesprotect taxpayer privacy by not disclosing taxpayer identities Access to the Directory is limited togovernment officials who are from OECD member countries and actively contribute to theDirectory.

The Directory has been a useful tool for tax authorities of OECD member countries, allowingthem to counteract tax planning schemes in a timely manner

1.4.4.4 United States: Foreign Account Tax Compliance Act

The Foreign Account Tax Compliance Act 80 (FATCA) was enacted in 2010 by the US Congress

to target non-compliance by US taxpayers using foreign accounts FATCA requires foreignfinancial institutions (FFIs) to report to the Internal Revenue Service (IRS) information aboutfinancial accounts held by US taxpayers, or by foreign entities in which US taxpayers hold asubstantial ownership interest 81 FATCA requires information on accounts in existence on orafter 30 June 2014

The exchange of this information in general is not permitted under bank secrecy, data protection

or confidentiality provisions established by domestic laws of various countries Therefore, inorder to allow the application of this Act at the domestic level, many governments have alreadyentered into, or have already agreed to enter into bilateral intergovernmental agreements (IGAs)with the US government

For this purposes, there are two types of IGA:

– Model 1: This is a reciprocal agreement under which the US government will also provideinformation about residents of the counterparty jurisdiction It requires that an FFI report allFATCA-related information to their competent authorities, which will then report suchinformation to the IRS FFIs covered by a Model 1 IGA are not required to sign anagreement with the IRS, but are required to register through the IRS FATCA registrationportal; and

– Model 2: This is not a reciprocal agreement It is designed to address potential conflicts withdomestic legislation in certain countries (e.g Switzerland, Japan) that would representdifficulties for FFIs in their efforts to comply with FATCA Under this agreement, FFIs arerequired to report FATCA-related information directly to the IRS Also, FFIs must registerthrough the IRS FATCA registration portal and, in certain cases, sign an agreement with theIRS

Currently, 41 countries have signed an IGA based on Model 1 and six countries have signed anIGA based on Model 2 In addition, 47 jurisdictions which opted for a Model 1 IGA and sevenjurisdictions which opted for using Model 2 IGA have reached agreements in substance and haveconsented to being included in the list of jurisdictions with agreements in substance (as published

on the website of the US Department of Treasury) 82

Under FATCA, the US imposes a 30% withholding tax on US-source income paid by US-basedentities to FFIs, unless the FFI enters into an agreement with the IRS and discloses theinformation on US account holders.

Due to the heavy burden in terms of resources needed to implement all FATCA requirements,there are still other countries which are reluctant to sign this type of agreements with the USgovernment 83 It is therefore expected that their financial institutions face difficulties incompeting with other financial institutions located in countries with an IGA in force

1.5 Conclusion

While it is generally accepted that a taxpayer is free, within the limits of the law, to order its taxaffairs in a manner that is most convenient for the taxpayer, several caveats are increasingly beingsounded An expectation is growing that multinationals must pay their “fair share” of tax, aconcept that has very little to do with the requirements of the strict letter of the law It might berelevant to question what would be a “fair share” in terms of tax liability However, a definition of

“fair share” which satisfies all interested parties would be difficult to find, and if such a definitioncould be found, it would be a subjective one Even though it is not being suggested that companiesmust pay more taxes, what is required from them is that their tax contributions be reasonablycomparable to other taxpayers As the consultancy firm SustainAbility suggests, taxes could beseen “not as a cost to be avoided, but as a legitimate payment from wealth created to the countriesand communities that contributed to the wealth creation in the first place” 84 In this sense, taxbecomes a moral duty towards the jurisdiction where a company is operating and benefitting fromassets such as sound infrastructure, access to market opportunities and a skilled labour force

As existing norms are not in line with the above objectives, policymakers reached the conclusionthat international taxation rules must be amended to reflect these principles It also becomes veryclear that there has been a need for increased international tax harmonization to assess the overallimpact of the interaction between domestic tax systems

In the meantime – and due to the absence of consensus on whether and how to implement thesepolicies – several countries have already started introducing unilateral measures in their domestictax laws to counteract “aggressive” tax planning structures Nevertheless, the administrativecapacity of tax authorities as well as taxpayer rights are two important points which must be takeninto consideration before introducing such amendments It seems that these points have not beentaken into account, mainly in the case of developing countries

The current international tax environment is ultimately forcing legislatures to narrow down thescope of legitimate tax planning The Duke of Westminster principle is increasingly questionedand will most likely not stand after the implementation of the BEPS Action Plan The limits ofacceptable tax planning will change, 85 and this will affect businesses around the globe

Finally, it is crucial that governments evaluate whether all these actions are in line with theirdomestic tax policy and with their social and economic contexts The simple adoption of certainmeasures without properly assessing the consequences may have a disastrous effect on thecompetitive position of the country and the juridical safety of the tax system 86 In this context,one of the biggest fears expressed by the business community and tax practitioners is that, if the

OECD were not to succeed in the adoption of coordinated actions, arbitrary measures adoptedunilaterally by various countries could potentially give rise to double taxation, deter cross-borderinvestment and worsen the business environment International tax avoidance is a multilateralproblem that cannot be solved by unilateral measures 87 In order to be dealt with effectively and

in the absence of an international tax body in charge of coordinating the various measures taken tofight base erosion, enhancing international tax coordination should be given the highest priorityand supported by political leaders

Annexes

Table 1 OECD BEPS Action Plan

Area covered Action Description of the actions

Digital Economy

Action 1 Address the tax challenges of the digital economy

Identify the main difficulties that the digital economy poses for the application of existing international tax rules and develop detailed options to address these difficulties, taking a holistic approach and considering both direct and indirect taxation.

Aggressive Tax

Planning

Action 2 Neutralise the effects

of hybrid mismatch arrangements

Develop model treaty provisions and recommendations regarding the design of domestic rules to neutralise the effect (e.g double non- taxation, double deduction, long-term deferral) of hybrid instruments and entities.

Action 4.

Limit base erosion via interest deductions and other financial payments

Develop recommendations regarding best practices in the design of rules to prevent base erosion through the use of interest expense.

Action 6 Prevent treaty abuse

Develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances.

Action 7 Prevent the artificial avoidance of PE status

Develop changes to the definition of PE to prevent the artificial avoidance of PE status in reaction to BEPS, including through the use

of commissionaire arrangements and the specific activity exemptions

Preferential Tax

Regimes

Action 3 Strengthen CFC rules

Develop recommendations regarding the design of controlled foreign company rules.

Action 5.

Counter harmful tax practices more effectively, taking into account transparency and substance

Revamp the work on harmful tax practices with a priority of improving transparency, including compulsory spontaneous exchange on ruling related to preferential regimes, and on requiring substantial activity for any preferential regime.

Action 8 Assure that transfer pricing outcomes are

in line with value creation - Intangibles

Develop rules to prevent BEPS by moving intangibles among group members.

Action 9 Assure that transfer pricing outcomes are

in line with value

Develop rules to prevent BEPS by transferring risks among, or allocating excessive capital to, group members.

Transfer Pricing

creation -Risks and capital

Action 10 Assure that transfer pricing outcomes are

in line with value creation -Other high risk transactions

Develop rules to prevent BEPS by engaging in transactions which would not, or would only very rarely occur between third parties.

Action 13.

Re-examine transfer pricing

documentation

Develop rules regarding transfer pricing documentation to enhance transparency for tax administration, taking into consideration the compliance costs for business.

Gathering

information

Action 11 Establish methodologies to collect and analyse data on BEPS and the actions to address it

Develop recommendations regarding indicators of the scale and economic impact of BEPS and ensure that tools are available to monitor and evaluate the effectiveness and economic impact of the actions taken to address BEPS on a ongoing basis

Action 12.

Require taxpayers to disclose their

aggressive tax planning arrangements

Develop recommendations regarding the design of mandatory disclosure rules for aggressive or abusive transactions, arrangements

or structures, taking into consideration the administrative costs for tax administrations and businesses and drawing on experiences of the increasing number of countries that have such rules.

Dispute Resolutions

Action 14.

Make dispute resolution mechanisms more effective

Develop solutions to address obstacles that prevent countries from solving treaty-related disputes under MAP, including the absence of arbitration provisions in most treaties and the fact that access to MAP and arbitration may be denied in certain cases.

Implementation of

Measures

Action 15.

Develop a multilateral instrument

Analyse the tax and public international law issues related to the development of a multilateral instrument to enable jurisdictions that wish to do so to implement measures developed in the course of the work on BEPS and amend bilateral tax treaties.

Table 2

EU Action Plan

ACTION PLAN Better use of existing

instruments and

commission

initiatives to be

progressed

1 New framework for administrative cooperation

2 Closing saving taxation loopholes

3 Draft anti-fraud and tax cooperation agreement

4 Quick Reaction Mechanism against VAT fraud

5 Optional application of the VAT reverse charge mechanism

6 EU VAT forum New Commission

Initiatives

7 Recommendation regarding measures intended to encourage third countries to apply minimum standard of good governance in tax matters

8 Recommendation on aggressive tax planning

9 Creation of a Platform for Tax Good Governance

10 Improvements in the area of harmful business taxation and related areas

11 “Tax identification number on EUROPA” portal

12 Standard forms for exchange of information in the field of taxation

13 A Euro denaturant for completely and partly denatured alcohol

Future Initiatives and

actions to be

developed in 2013

Tackle mismatches and strengthen anti abuse provisions

14 A revision of the parent subsidiary directive 2011/96/EU

15 A review of anti abuse provision in EU legislation

Promote EU standards, instruments and tools

16 Promote the standard of automatic exchange of information in international fora and the EU IT tools

Enhance tax compliance

17 A European taxpayer’s code

Enhance tax governance

18 Reinforced cooperation with other law enforcement bodies

Enhance administrative cooperation

19 Promote the use of simultaneous controls and the presence of foreign officials for audits

Action regarding third countries

20 Obtain an authorisation from Council to start negotiations with third countries for bilateral agreements on administrative cooperation in the field of VAT

Future Initiatives and

21 Develop computerised format for automatic exchange of information

22 Use of an EU Tax Identification Number (TIN)

23 Rationalise IT instruments

Tackle trends and schemes of tax fraud and tax evasion

24 Guidelines for tracing money flows

25 Enhance risk management techniques and in particular compliance risk management

26 Extend EUROFISC to direct taxation

Enhance tax compliance

27 Create a one stop shop approach in all Member States

28 Develop motivational incentives including voluntary disclosure programmes

29 Develop a tax web portal

30 Propose an alignment of administrative and criminal sanctions

31 Develop an EU Standard Audit File for Tax (SAF-T) Actions to be

undertaken in the

longer term (beyond

2014)

32 A methodology for joint audits by dedicated teams of trained auditors

33 Develop mutual direct access to national databases

34 Elaborate a single legal instrument for administrative cooperation for all taxes

Table 3 Patent box regimes

Belgium 20% of qualifying gross patent income is taxable at the standard corporate income tax rate

France A 15% corporate income tax rate applies on income derived from the license, sublicense, sale or

transfer of qualified intellectual property Hungary 50% of the royalties received for the use of intellectual property may be deducted

Luxembourg 80% of the net income derived from the use of qualified intellectual property is tax exempt

Netherlands A 5% tax applies on income which arises from technological R&D activities

Spain 40% of the income derived from intangible property is subject to corporate income taxes

Country Taxable

dividends

Corporate income tax rate

Capital gains

on shares

Withholding tax on dividends paid

by the HC

Withholding tax on interests paid

by the HC

Withholding tax on royalties paid

by HC Austria Exempt 25% Exempt under

certain conditions

25%

Lower under tax treaties 0% when paid

to a parent company located in the EU

0% - 35 Lower under tax treaties 0% under EU P-S Directive

Belgium 95% of

dividends received are exempt form income tax if certain conditions are met

33.99% Exempt from

income tax

25%

Lower under tax treaties 0% when paid

to a parent company located in the EU

25%/15%

Lower under tax treaties 0% under EU P-S Directive

25%

Lower under tax treaties 0% when paid

to a parent company located in the EU

Cyprus 100% of

dividends received from

a foreign participation are exempt from income tax Certain exceptions apply

10% Exempt from

income tax

No withholding tax on

dividends paid

to non residents

No withholding tax on interest paid to non residents

No withholding tax on royalties paid by a Cyprus company Rights used in Cyprus 10%

Finland Exempt 20% Generally

exempt

20%

Lower under tax treaties 0% under EU P-S Directive

0%

Hungary Dividends

received from domestic or foreign sources are exempt from income tax, except in the case of a CFC

10%/19% Exempt from

income tax for qualifying participations

No withholding taxes on dividends paid

if recipient is corporate entity

No withholding taxes on interest paid if recipient is corporate entity

No withholding

on payments

to a corporate entity

Hong Kong Dividends

received from

a company subject to profits tax in Hong Kong are not

16.5% Exempt from

profits tax

No withholding tax on

dividends paid

to residents and non residents

No withholding tax on

dividends paid

to residents and non residents

4.95%

royalties paid

to non related party and 16.5.% to related party Lower under

included in the taxable

income

tax treaties

Ireland No

participation exemption.

Foreign tax credit in excess may

be credited against tax payable on other dividends received within the same period

12.5% on business income and 25% on passive income

Exempt from capital gains tax

20%

Lower under tax treaties 0% under EU P-S Directive

20%

Exemption on payments to a company resident in the EU

20% only patent royalties Lower under tax treaties Exemptions apply under the EC Interest and Royalty Directive

Luxembourg Dividends

received are exempt from income tax if certain conditions are met

29.22% Exempt from

income tax

15%

Lower under tax treaties 0% under EU P-S Directive

No withholding tax on

payments to non-residents;

in certain cases 15% or 35%

10% on payments to non-residents

No withholding tax, exceptions apply

* Lydia Ogazón, Senior Research Associate, IBFD; Ridha Hamzaoui, Principal Research

Associate, IBFD

1 BEPS has been defined as tax planning strategies that exploit gaps and mismatches in tax rules

to make profits “disappear” for tax purposes or to shift profits to locations where there is little or

no real activity but the taxes are low, resulting in little or no overall corporate tax being paid

2 OECD, Action Plan on Base Erosion and Profit Shifting (OECD 2013), International

Organizations’ Documentation IBFD, at 13

3 In this book, chapter 2 highlights the main aspects of Action 7; chapter 3 addresses Actions 4, 9,

10 and 13; chapter 4 addresses Action 4; chapter 5 focuses on Action 2; chapter 6 addresses

Action 2, as well; chapter 7 addresses Actions 7, 8, 9, 10 and 13; chapter 8 highlights various

aspects of Actions 2, 3, 5, 6 and 8; chapter 9 deals with the main proposals under Action1; and

chapter 10 focuses on Action 6

4 EU Action Plan: Communication from the Commission to the European Parliament and theCouncil, An Action Plan to Strengthen the Fight against Tax Fraud and Tax Evasion, COM(2012)

722 final (6 Dec 2012), EU Law IBFD

5 European Commission, Activities of the European Union (EU) in the Tax Field in 2013 (28 Feb.2014), available at

http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/info_docs/tax_reports/report_activities_2013_en.pdf

6 However, unlike, the BEPS Action Plan, the EU Action Plan includes as part of its actions ataxpayers’ code (Action 17) which will set out best practices for “enhancing cooperation, trust andconfidence between tax administrations and taxpayers, for ensuring greater transparency on the

rights and obligations of taxpayers and encouraging a service-oriented approach” The set of 34actions identifies specific measures to be developed in the coming years Regarding aggressive taxplanning in a direct taxation context, two specific recommendations were made The first

indicates that Member States must include a provision within their tax treaties to assure that

income will remain untaxed in a contracting state only if it is subject to tax in the other

contracting state The second proposes the adoption of a common general anti-abuse rule in thedomestic legislation of all the Member States As the recommendations are not binding, theiradoption in domestic legislation of Member States is optional Some States have already startedamending their domestic rules accordingly

7 OECD, Glossary of Tax Terms, available at:

http://www.oecd.org/ctpa/glossaryoftaxterms.htm#E

8 A Miller & L Oats, Principles of International Taxation (Tottel 2009), at 11

9 OECD, Glossary of Tax Terms, supra n 7

10 EU Action Plan, supra n 4

11 CA: Canada Revenue Agency, Tax Avoidance, available at

http://www.cra-arc.gc.ca/gncy/lrt/vvw-eng.html

12 Institute of Business Ethics, Tax Avoidance as an Ethical Issue for Business (Apr 2013), at 1,available at: http://www.ibe.org.uk/index.asp?upid=51&msid=8

13 K Vogel, Klaus Vogel on Double Taxation Conventions (Kluwer 1997), at 117, para 78

14 EU: Commission Recommendation on Aggressive Tax Planning of 6 December 2012, C(2012)

8806 final

15 CA: Tax Avoidance, supra n 11

16 P Merks, Tax Evasion, Tax Avoidance and Tax Planning, 34 Intertax 5 (2006), at 281

17 M Nouwen, The Gathering Momentum of International and Supranational Action againstAggressive Tax Planning and Harmful Tax Competition: The State of Play of Recent Work of theOECD and European Union, 53 Eur Taxn 10 (2013), Journals IBFD

18 Institute of Business Ethics, supra n 12, at 2

addition to the fact that the accounting records, place of audit, bank account and register of

transfers were moved from the United Kingdom to a foreign country (Egypt, in this case) Moreimportantly, several court decisions confirmed the right of the taxpayer to arrange its affairs in away to minimize its tax liability From the landmark Duke of Westminster case, issued in 1936 bythe House of Lord, to the Azadi Bachao Andolan issued in 2003 by the Indian Supreme Court,judges asserted that a transaction or arrangement which is perfectly permissible under a law andthat has the effect of reducing the tax burden of a taxpayer must not be looked upon with

disfavour UK: House of Lords (HL), Commissioners of Inland Revenue v His Grace the Duke ofWestminster [1935] All ER 259; IN: SC, 7 Oct 2003, Union of India v Azadi Bachao Andolan,2003-(263)-ITR-0706-SC, Tax Treaty Case Law IBFD

21 US courts developed a certain number of judicial anti-avoidance doctrines to disallow taxbenefits from transactions that are entered into for tax avoidance purposes These include the

substance-over-form doctrine, the step-transaction doctrine and the sham transaction doctrine

These doctrines may be applied in addition to the economic substance doctrine.

22 Physical presence is a requirement to trigger the existence of a PE of a non-resident company

in a specific country under the basic rule of article 5(1) of the OECD and UN Models The same isrequired under the service PE provision included in article 5(3)(b) of the UN Model

23 Miller & Oats, supra n 8, at 393

24 See PwC, OECD BEPS Recommendations Require Careful Examination of Potential EU LawIssues (30 June 2014), available at http://download.pwc.com/ie/pubs/2014-pwc-ireland-eu-beps-july-16-07-2014.pdf; Freshfields Bruckhaus Deringer, UK Patent Box: EU Decision Deferred(Dec 2013), available at

http://www.freshfields.com/uploadedFiles/SiteWide/Knowledge/UK%20patent%20box%20-%20EU%20decision%20deferred.pdf

25 The Code of Conduct for business taxation encourages EU Member States to refrain fromintroducing measures which constitute harmful tax competition The Code sets out five criteria todetermine when a regime can be considered potentially harmful Based on these criteria, the

European Commission determined that the UK patent box breaches two of the five criteria Apatent box regime requires significant involvement in the development of the innovation to whichqualifying rights relate In this regard, the Commission concluded that this condition may besatisfied without requiring any real economic activity or business substance in the United

Kingdom Therefore, the criterion related to the granting of tax advantages in the absence of anyreal economic activity in the country concerned, is met In addition, the UK patent box regime isalso incompatible with the criterion that the use of rules which depart from internationally

accepted principles developed by the OECD, should be discouraged

26 According to an unofficial source, after the conclusion of the Council of Economic and

Financial Affairs meeting held on 9 December 2014, an EU diplomat indicated that every EUMember State with a patent box tax regime will have to change its legislation to narrow the scope

of its patent box regime The changes are to be implemented as from 2015 and must be finalized

30 Miller & Oats, supra n 8, at 241

31 K Holmes, International Tax Policy and Double Tax Treaties (IBFD 2014), at 374

32 IBFD, International Tax Glossary (Barry Larking ed., 5th edition, 2005) at 212

33 IBFD, International Tax Glossary, supra n 32, at 211

34 Miller & Oats, supra n 8, at 245

35.OECD Model Tax Convention on Income and on Capital (22 July 2010), Models IBFD

36.United Nations Model Double Taxation Convention between Developed and Developing

Countries (2011), Models IBFD

37.OECD Model Tax Convention on Income and on Capital: Commentary on Article 23B para 76(2010), Models IBFD

38 OECD, Tax Sparing: A Reconsideration (1998), at 12

39 OECD, Tax Sparing: A Reconsideration, supra n 38, at 28