How You May Be Double Taxed Under BEPS Recommendations
By Tom Lickess, Director, International Tax
BEPS Transition Period and the Possibility of Double Taxation
So far this year, Radius’ most popular 2016 blog post is “Global Business Trends to Watch For in 2016.” It contains a section on why the OECD’s Base Erosion and Profit Shifting project (BEPS) is fundamentally changing the global tax landscape. My colleague Lee Sheehan explains in the post that BEPS recommendations are “creating a model that taxes a multinational’s profits based on where the economic value is created, rather than on the location of corporate headquarters.”
As it happens, a tax columnist for a well-known business magazine read that post last month and asked Radius’ tax advisory group to expand on the following passage (italics added): “All countries will continue to maintain their own unique tax regulations, and BEPS measures will be implemented on a country-by-country basis. … multinationals will need to navigate a complex path, staying abreast of variations in interpretation and application of new laws by jurisdiction, including the very real potential for double-taxation during the transition period.”
Basically, the columnist asked us to give some examples showing when double taxation may arise for companies operating in multiple countries. Admittedly, this is a technical subject area, and about as far as you can get from clickbait fodder. Still, it’s worth describing a couple of scenarios in which a multinational’s income is unexpectedly taxed by authorities in multiple jurisdictions. There is, after all, widespread interest in the subject of multinational corporate taxation. This is evidenced not just by the interest in Radius’ 2016 trends post, but by headline-stories around the world involving the taxation of such companies as Google and Facebook.
Readers should note that companies of all sizes — not just behemoths like Google and Facebook — are under increased scrutiny from tax authorities. We are in a time when corporate tax laws around the globe are evolving at a quick pace, and this understandably leaves many corporations uneasy and looking for clarity.
So let’s look at two scenarios involving how a multinational might be taxed by two sets of tax authorities on the same income. Equipped with this knowledge, you may be able to avoid these kinds of pitfalls, or at least be prepared for the possibility that they may arise.
Double Taxation Scenario 1 of 2: Vanilla Transfer Pricing
Let’s say a UK-based company (“UK Co”) has a subsidiary in Singapore (“Singapore Sub”) that carries out marketing and sales activities. UK Co compensates Singapore Sub on a “cost plus 20%” recharge basis. This recharge is taxed in Singapore at the Singapore tax rate of 17%, with UK Co taking a tax deduction at the UK tax rate of 20%.
The UK tax authorities review this transfer priced recharge. In the course of the review the authorities deem that Singapore Sub is limited to acting at the direct instruction of UK Co. As a result, the recharge is ineligible for any mark-up and should be limited solely to covering the costs of the Singapore operations. That is, for UK tax purposes, the recharge must have a 0% mark-up.
The UK tax authorities then issue an amended assessment, reducing UK Co’s tax deduction from “cost plus 20%” to “cost plus 0%.”
Assuming UK Co does not begin the long, often costly process of engaging UK and Singapore competent authorities to agree on what should be an appropriate arm’s length recharge, Singapore Sub will pay tax on the cost-plus-20% recharge at the Singapore tax rate of 17%, with UK Co’s tax deduction being limited to cost at the UK corporate tax rate of 20%, with no cost-plus deduction.
The charts below show the potential impact of the UK tax authority not giving a tax deduction for any “plus” element of the recharge, whilst the same cost-plus recharge is taxed in Singapore.
Original position – based on $100 recharged expenditure
|Entity||Calculation of "Cost Plus"||Tax Effected||Tax Impact|
|$100 x 1.2 = $120||$120 x 20% = $24||$24 (tax reduction) against tax payable|
|$100 X 1.2 - $120||$120 x 17% = $20.40||$20.40 tax payable|
|Net Difference||$3.60 tax reduction against tax payable|
New position – based on same $100 recharged expenditure
|Entity||Calculation of "Cost Plus"||Tax Effected||Tax Impact|
|$100 x 1 = $100||$100 x 20% = $20||$20 (tax reduction) against tax payable|
||$100 x 1.2 = $120||$120 x 17% = $20.40||$20.40 tax payable|
|Net Difference||$0.40 tax payable|
Double Taxation Scenario 2 of 2: UK Diverted Profits Tax, or “Google Tax”
In this scenario, a US company has a Dublin-based Irish subsidiary (“Irish Co”). Irish Co has a sales team based outside Ireland in the UK, but the team does not engage in contract negotiations and is not authorised to enter into contracts. However, Irish Co owns and hosts a server in Ireland and contracts with UK-based customers using this server.
Irish Co has received professional advice indicating that because its UK sales are concluded in Ireland on the Irish server, it does not have a taxable presence, or permanent establishment (PE), in the UK.
The UK tax authorities review the activities of Irish Co and conclude that they constitute a UK PE. The authorities further determine that the arrangements of Irish Co have been deliberately designed to stop short of concluding contracts in the UK, thereby artificially avoiding triggering a PE and paying the company’s fair share of UK corporate taxes. Accordingly, the UK tax authorities seek to impose the 25% UK diverted profits tax on the taxable income of Irish Co attributable to its UK activities.
Although the UK diverted profits tax is not strictly speaking a “corporate tax,” after the UK tax authority’s ruling in this scenario, Irish Co will have paid tax on the same UK-attributable income at 12.5% and 25%. There may relief options in this scenario — such as invoking the Irish and UK tax authorities to discuss the application of the UK-Irish double tax treaty — but they can be costly and time-consuming, with no guarantee of success. Assuming those options aren’t pursued, Irish Co will bear an effective tax rate of 37.5%, which is vastly in excess of both the UK and Irish corporate tax rates.