In this article, we’ll explain the 15 action points of BEPS. We first summarize the points, and then go into more detail. We’ll also summarize what actions have been taken so far (if any).
If you’re completely new to BEPS, we suggest you first read our article What is BEPS. It provides a clear picture of what BEPS is and why it is being addressed.
The 15 Action Points BEPS
You can click on each point to go read more on a specific point, or simply scroll down and read them all.
- Address the tax challenges of the digital economy
- Neutralize the effects of hybrid mismatch arrangements
- Strengthen CFC rules
- Limit base erosion via interest deductions and other financial payments
- Counter harmful tax practices more effectively, taking into account transparency and substance
- Prevent treaty abuse
- Prevent the artificial avoidance of Permanent Establishment (PE) status
- Aligning transfer pricing outcomes with value creation: intangibles
- Aligning transfer pricing outcomes with value creation: risks and capital
- Aligning transfer pricing outcomes with value creation: other high-risk transactions
- Measuring and monitoring BEPS
- Require taxpayers to disclose their aggressive tax planning arrangements
- Re-examine transfer pricing documentation
- Make dispute resolution mechanisms more effective
- Develop a multilateral instrument
BEPS Action Point 1: Address the tax challenges of the digital economy
The goal of Action 1 is to identify the challenges the digital economy poses to international taxation. It also aims to develop options to address these. This applies ot direct taxes like corporate taxation, but also indirect taxes like Value Added Taxes and Custom Duties.
An example of such a challenge is a company that has significant digital presence in the economy of another country than from which the company is run. Like selling digital products, or advertising to the local market. Current tax rules are not very clear on how to tax the profits of such a company.
Not surprisingly, the final report on Action 1 concluded that the digital economy cannot be seen as separate from the rest of the economy. However, it also concluded that the digital economy has no unique BEPS issues. For that reason, some of the challenges identified for the digital economy have been addressed in other Action points (Action points 3, 7 and 8-10, to be precise).
BEPS Action Point 2: Neutralise the effects of hybrid mismatch arrangements
Hybrid mismatch arrangements focus on the differences in the tax treatment of an entity or a financial instrument under the laws of two or more countries.
An example of a hybrid mismatch arrangement is a hybrid entity. Such an entity is regarded as “tax transparent” in one country and “non-tax transparent” in another country. The use of such entity in a corporate structure can offer opportunities to avoid taxation on certain income.
The goal of Action 2 is to neutralize the effects of hybrid mismatches. The final report on Action 2 proposes to include a new provision in the OECD Model Tax Convention. This will ensure that the benefits of tax treaties are granted in appropriate cases with regard to the income concerned. It will also ensure that these benefits are not granted when neither country taxes this income.
It is anticipated that the revisions of the OECD Model Tax Convention will be completed and released somewhere this year (2017).
Implementation of these rules is considered important. The OECD, together with the G20, will monitor whether countries actually implement them in their tax treaties.
BEPS Action Point 3: Strengthen CFC rules
Controlled Foreign Company rules (CFC rules) lead to the taxation of income of controlled foreign subsidiaries in the hands of resident shareholders, if certain conditions are met. For example, CFC rules can test whether a subsidiary is based in a low-tax jurisdiction and if it earns passive income.
Application of CFC rules can have the effect that low-taxed income of controlled foreign subsidiaries is taxed in the residence country of the parent company. An addition effect is that controlled foreign subsidiaries do not have an incentive to shift profits into a third, low-tax jurisdiction.
The final report on Action 3 provides recommendations on CFC rules, but also gives member status flexibility to implement these. Therefore, the impact of these recommendations is still uncertain. The recommendations could result in the implementation of CFC rules in countries that don’t have them now. In other cases, it could result in the amendment of existing CFC rules.
BEPS Action Point 4: Limit base erosion via interest deductions and other financial payments
The mobility of money makes it possible for multinational groups to achieve favorable results by shifting debt around. The reason for this is that interest is taxed differently around the world. In some cases, it is not taxed at all.
The goal of Action 4 is to ensure that net interest deductions are directly linked to the level of economic activity. The economic activity is determined based on taxable earnings, before deducting net interest expense, depreciation and amortization (EBITDA).
The final report on Action 4 recommends an approach based on a fixed ratio rule which limits an entity’s net interest deduction to a percentage of its EBITDA. As a minimum, this rule should apply to entities in multinational groups. The recommended approach proposes a range of possible EBITDA ratios between 10% and 30%.
The recommended approach is expected to impact entities with a high level of net interest expenses in combination with a high net interest/EBITDA ratio.
Action 5: Counter harmful tax practices more effectively, taking into account transparency and substance
The goal of Action 5 is to revamp the work on harmful tax practices with a priority on improving transparency. It will evaluate preferential tax regimes in a BEPS context.
The final report on Action 5 focuses on two priority issues:
- The development of a substantial activity requirement for preferential tax regimes. Preferential tax regimes are those offering special treatment to non-residents or enterprises not active in the domestic market.
- The implementation of compulsory spontaneous information exchange on certain rulings, like advance tax rulings. An advance tax ruling is a written interpretation of tax laws issued by tax authorities. These rulings provide clarity to tax payers as to how much tax they have to pay. In the past, the case has been made that countries “compete” for foreign businesses by offering them favorable advanced tax rulings.
In terms of substantial activity, the report refers to intellectual property regimes. The report endorses the “nexus approach.” Under this approach, taxpayers may only benefit from an IP regime to the extent that they incurred costs giving rise to the IP income. In addition, it mentions that this approach can also be applied to other preferential regimes.
With respect to the exchange of information on rulings, the report confirms that the spontaneous exchange applies both to future rulings (issued after 1 April 2016) and to past rulings (issued after 1 January 2010 and in effect as of 1 January 2014). The information must be exchanged with all countries involved in the transaction covered by the ruling, as well as the residence country of the immediate parent company and the group’s ultimate parent company.
BEPS Action Point 6: Prevent treaty abuse
The goal of Action 6 is to prevent the granting of treaty benefits in inappropriate circumstances. It needs to be made clear that tax treaties are not intended to be used to generate double non-taxation. In addition, countries should consider this before entering into a tax treaty with another country.
The final report on Action 6 proposes that countries include in their tax treaties either:
- a (simplified) limitation-on-benefits (LOB) provision in combination with a principal purposes test (PPT),
- a PPT alone or,
- a LOB provision supplemented by provisions that would deny treaty benefits to conduit financing arrangements.
The report contains detailed proposals for treaty provisions as well as elaborate explanatory guidance. At the same time, it is now explicitly recognized that countries will have to tailor these provisions to cater for their specific situation.
The multilateral instrument (see Action 15) provides tools for implementation of these concepts in tax treaties (see Action 15).
BEPS Action Point 7: Prevent the artificial avoidance of Permanent Establishment status
The goal of Action 7 is to develop changes to the definition of Permanent Establishment (PE) to prevent the artificial avoidance of PE status. Work on these issues will also address related profit attribution.
To recap; a permanent establishment is a fixed place of business which generally gives rise to a tax liability. For example, a company in France hires an office in the UK where activities take place.
Another example could be a company registered and operating out of the UK of which all the decisions are made by the manager who permanently lives in France.
The final report on Action 7 proposes to lower the PE threshold in the OECD Model Tax Convention. This means that a Multinational Enterprise with activities in multiple countries will establish a PE in those countries. The result is that multinational companies will become liable to tax in more countries.
Lowering the PE threshold may fuel future discussions between tax payers and tax authorities. This goes not just for the PE status, but more importantly for the PE profit attribution (and tax liability). In addition, compliance costs and administrative burdens are likely going to increase.
Action 8, 9 and 10: Aligning transfer pricing outcomes with value creation
The effects of BEPS on transfer pricing regulation is profound. We dedicated a special article to it, called The Effect of BEPS on Transfer Pricing.
BEPS Action Point 11: Measuring and monitoring BEPS
Based on a number of studies, the OECD concludes that Base Erosion and Profit Shifting is responsible for significant global corporate income tax (CIT) revenue losses. The goal of Action 11 is to ensure that the effectiveness and economic impact of the actions taken to address BEPS are effective.
The final report on Action 11 contains recommendations on improved access to and enhanced analysis of available data to measure BEPS, and on a consistent method of presentation. The report provides tools to assist countries in evaluating the effects of BEPS. Moreover, it enables them to measure the impact of efforts to prevent BEPS.
Action 12: Require taxpayers to disclose their aggressive tax planning arrangements
The goal of Action 12 is to develop recommendations regarding the design of mandatory disclosure rules for aggressive tax planning arrangements. In short, it should be clear what tax payers are doing. If they use aggressive tactics to lower the tax burden, tax authorities have a means to address this.
The final report on Action 12 sets out options and provides best practice recommendations. It provides a modular approach that gives countries wishing to introduce a mandatory disclosure regime the option to choose what best fits their needs.
The report also makes specific recommendations for disclosure rules in relation to international tax schemes.
Finally, it identifies opportunities to enhance the exchange of information obtained by countries through such rules.
BEPS Action Point 13: Re-examine transfer pricing documentation
The effects of BEPS on transfer pricing regulation is profound. We dedicated a special article to it, called The Effect of BEPS on Transfer Pricing.
Action 14: Make dispute resolution mechanisms more effective
It might happen that two jurisdictions seek to tax the same transactions or activities. Generally, tax treaties directly resolve most such cases. However, two jurisdictions might disagree on the interpretation or application of a tax treaty. The mutual agreement procedure (MAP) article of a tax treaty provides a mechanism to resolve these cross-border tax disputes.
The goal of Action 14 is to address obstacles that prevent countries from solving treaty related disputes under MAP.
In the final report on Action 14, the OECD recognizes that dispute resolution mechanisms should be improved. The plan is to develop a minimum standard. The goal of this standard is to ensure that treaty-related disputes are resolved in a quick, effective and efficient manner. This is needed badly. We wouldn’t be surprised if we’ll soon see a rise of treaty- related disputes because of all the changes caused by all these BEPS Action points…
In practice, these new minimum standards require amendments to both the OECD Model Tax Convention and its Commentary, domestic law and regulations, and administrative procedures.
The Multilateral Instrument (Action 15) as published on 24 November 2016, establishes a separate mandatory binding arbitration route. For now, countries are free to adopt this procedure.
BEPS Action Point 15: Develop a multilateral instrument
Most countries have Double Tax Treaties (DTT) in place with other countries. These DTT’s provide clarity as to where a company has to pay taxes, if activities are spread over two or more countries.
Although a lot of these treaties are based on the OECD Model Tax Treaty, almost all treaties are the result of bilateral negotiations. If BEPS is to be implemented correctly, these treaties have to be renegotiated one by one. This would take ages.
Instead, Action point 15 aims to develop a Multilateral Instrument (MLI). The MLI is expected to be adopted by 100 countries. This MLI allows countries to swiftly modify their bilateral treaties to implement BEPS measures.
On 24 November 2016, the OECD issued the agreed text of the MLI which, when adopted, includes BEPS measures into more than 2,000 existing tax treaties worldwide. These measures relate to the following BEPS action points:
- Action 2 (Hybrid mismatches)
- Action 6 (Treaty abuse)
- Action 7 (Artificial avoidance of Permanent Establishment (PE) status)
- Action 14 (Improving dispute resolution)
The MLI, gives countries the flexibility to specify which treaties are covered. They can decide how they meet the minimum standards. If desired, they can opt out of all or part of the provisions which extend beyond the minimum standard.
This flexible approach means that each bilateral treaty will be changed in a unique way, depending on how the parties to the bilateral treaty adopt the MLI provisions. Only when both parties agree to amend their treaties in the same way for that particular article (when there is a “match”), a treaty article will be amended.
It is anticipated that during summer 2017 many countries will participate in match-making events. These events are aimed at reaching agreement between countries on which minimum standards will apply in their DTT relations. If an agreement is reached, this will be binding for the purposes of the application of the DTT.
15 Action Points BEPS – Conclusion
The OECD has created an ambitious framework to combat Base Erosion and Profit Shifting.
For this, 15 Action Points BEPS have been created, which were summarized in this article.
The result? Let us give you just one example.
Up until now, in order to correctly establish a tax liability for a MNE operating in two countries you used to be able to look at the local laws and the applicable tax treaty. After all these rules are implemented, you also have to look at the MLI, the 86 page “Explanatory Statement To The Multilateral Convention” and compare the level of implementation of the MLI in the respective countries.
And in addition to that, there is the forced transparency, tougher rules and more extensive reporting requirements.
The practical result of all of this will likely be a lot of confusion, discussions with tax authorities and a lot more paperwork. And of course, a higher tax bill (this is where it’s all about, after all). And who knows what bells and whistles will be added to these regulations. Especially, after the first “MLI” has been established. That snowball has started rolling.
If you want to know how these 15 BEPS Action Points effect the transfer pricing policy of your company, please contact us.