How BEPS Is Changing US Tax Regulations
By Sonia Kanjee, US Corporate Tax Manager, Radius
Vistra has published various informational pieces on the subject of base erosion and profit shifting (BEPS), from a 2013 Country Compliance Alert to a recent blog post on country-by-country reporting requirements. Until now, these resources have tended to focus on how the Organization for Economic Cooperation and Development’s BEPS recommendations have affected jurisdictions outside the US. This post addresses how OECD guidance is changing US corporate tax regulations.
As the OECD website explains, “BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity. … This undermines the fairness and integrity of tax systems because businesses that operate across borders can use BEPS to gain a competitive advantage over enterprises that operate at a domestic level.” The OECD and G20 have developed 15 BEPS actions that can be used by governments to ensure “that profits are taxed where economic activities generating the profits are performed and where value is created.”
The BEPS framework encompasses many consensus-based tax rules designed to curb tax avoidance. The implementation of BEPS will take many different forms depending on each country’s current tax laws, and the enacting of new legislation may be staggered. But while each tax jurisdiction will implement BEPS guidelines differently and at its own pace, there is one certainty: multinationals everywhere are under increased scrutiny from tax authorities around the globe.
As a result, multinationals must be vigilant about the changing regulations in all the jurisdictions where they operate and be aware that there may be timing gaps in the application of the BEPS framework by country.
The Impact of BEPS on US Tax Rules
As for the US tax landscape as it relates to BEPS, multinationals should keep apprised of two critical areas:
- The implementation of a country-by-country reporting requirement
- Changes to income tax treaties between the US and non-US countries
Country-by-country reporting (CbCR) requirements have already begun to be implemented by US tax authorities. As of June 2016, final regulations were established detailing the new filing requirement for CbCR. The highlights are:
- Form 8975 will need to be filed for entities with tax years beginning after June 30, 2016, with a voluntary filing possible for those with tax years beginning between January 1 and June 30, 2016. This form must be filed attached to the entity’s income tax return.
- The filing requirement applies to US entities that are the ultimate parent of a multinational enterprise (MNE) group that collectively has revenue of at least $850 million.
- Aggregate amounts must be reported by country for a number of informational items including revenue, profit, tax, capital, employees and assets.
- Penalties will apply for noncompliance either in monetary form or in the reduction of potential foreign tax credits.
The US Treasury proposed changes to the US Model Income Tax Convention (referred to as the "US Model") in February 2016. A principal focus of the proposed changes is to limit the availability of treaty benefits in order to prevent the double non-taxation of cross-border transactions.
"Double non-taxation" refers to a taxpayer’s use of income tax treaties and preferential tax regimes to yield very low or zero tax liability.
Currently, there is opportunity for taxpayers to exploit provisions of income tax treaties between countries. The BEPS framework aims to prevent:
- Treaty shopping
- Shifting income to various countries in an effort to erode tax base in higher tax-rate countries
- Creating permanent establishments in a low- or no-tax location
- Double non-taxation by claiming deductions in one jurisdiction and preferential tax rates in another
The US Treasury’s discussion of exempt permanent establishment (PE) and special tax regimes are key items to note among the proposed changes to the US Model.
In the proposed US Model, the Treasury aims to disallow treaty benefits with respect to income derived by a resident of a contracting state if that income is attributable to a PE situated outside of the residence state and either
- The residence state or third jurisdiction is subject to very low or zero tax liability, or
- The PE is situated in a country with which the US does not have a treaty in force and the income is excluded for the residence state’s tax base.
Special Tax Regime
Per the Treasury’s proposed changes, a “special tax regime” is defined as any legislation, regulation or administrative practice that provides a preferential effective rate of tax to income, including through reductions in the tax rate or the tax base, unless an exception applies. Treaty benefits will only be disallowed with respect to interest, royalties or other income if a special tax regime applies with respect to that class of income. This initiative is aimed at preventing related-party income from claiming a deduction in one country and taxing the income at a preferential rate in the other country.
For companies operating in the US, then, now is the time to review your tax structures and your cross-border activities, including your transfer-pricing practices, documentation and intercompany agreements. Even if you do not meet the US’s current CbCR collective revenue requirement, your transfer-pricing activities could come under scrutiny by US authorities or the authorities from your other countries of operation.
Also, don’t assume that any former advice you may have received related to permanent establishment under an existing tax treaty is either still applicable or will be applicable for much longer. You should review your operations and cross-border activities in light of the proposed US Model Income Tax Convention. You should then be prepared to defend your deductions and to explain why your income is taxed in any particular jurisdiction.