August 8, 2019 | By Vinod Kalloe, KPMG Meijburg & Co (Netherlands), and Michael Plowgian, KPMG in the United States
This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP.
Companies are facing increasing tax complexities. Tax policy makers globally have managed to agree on profound international tax changes in the context of the Organisation for Economic Co-operation and Development (OECD) base erosion and profit shifting (BEPS) project. Since the final BEPS recommendations were endorsed by the G20 and European Union (EU) in 2015, they have gradually been implemented in a phased approach that is set to continue to 2022 and in some cases even beyond. The recommendations not only include substantive tax law changes but also new disclosure requirements for companies and automatic information exchanges between tax administrations. And, on top of that, public pressure continues to drive towards more corporate tax transparency to the public.
These BEPS-inspired tax measures will continue to put tax departments of multinational companies to the test: determining group tax impact, finding alternative tax solutions, implementing new reporting lines (internal and external), updating internal company tax policies including tax (reputational) risk management, and establishing the extent of public corporate tax disclosure.
BEPS measures were intended to combat international tax planning strategies that exploit gaps and mismatches in the tax rules of the jurisdictions involved to shift profits artificially to low or no-tax locations where there is little or no economic activity (according to the OECD) and to fight against aggressive tax planning taking a multitude of forms, including artificial and complex arrangements that do not reflect economic reality (according to the EU). These abstract goals are becoming more clearly defined in the ongoing BEPS implementation process.
The OECD Inclusive Framework has managed to bring more than 125 countries and jurisdictions together, ensuring the effective implementation of the four BEPS minimum standards.1 Simultaneously, the EU has decided to take a “hard law” approach for significant parts of the BEPS package, even including actions that were not considered a minimum standard by the OECD and G20. Combining the OECD and EU BEPS implementation efforts, several key elements can be identified.
A first cornerstone element of the BEPS recommendations contains substantive corporate tax law changes, on a global scale, including preferential corporate tax regimes (BEPS Action 5) and tax treaty abuse (BEPS Action 6). The EU has also adopted legally binding anti-tax avoidance measures targeting hybrid mismatches (BEPS Action 2), interest deductions (BEPS Action 4), and controlled foreign companies (BEPS Action 3) and has added EU-specific rules on exit taxation and general anti-abuse.2 These measures are to be phased in over the period from 2019 to 2022, and the EU and OECD are now both discussing further options to fight perceived undertaxation of digital business models (BEPS Action 1).
However, these changes of substantive tax law are only part of the BEPS legacy. A second key element of BEPS measures relates to increased tax transparency: the OECD and the EU have established new rules for the disclosure and automatic exchange of information on tax rulings, country-by-country tax reports, aggressive tax arrangements, and corporate beneficial ownership information. A third significant element can be identified in the form of new standards on good tax governance for countries: the OECD and EU Member States are reviewing, assessing, and blacklisting countries in cases of noneffective exchange of information or offering preferential tax regimes or zero tax rates without proper substance requirements. Furthermore, in the EU context, the European Commission (EC) is targeting preferential arrangements by EU Member States via EU state aid decisions on corporate tax arrangements. And, a fourth element is emerging: public tax disclosure on corporate tax governance requested by civil society, (institutional) investors, and external auditors.
The OECD Global Forum on tax transparency, now including 154 member countries, has worked for a decade to ensure the implementation of the internationally agreed standards of tax transparency and exchange of information. The OECD BEPS project has now added several new layers of transparency that the EU, as a leading example, has implemented as a comprehensive set of legal standards in a very short timeframe between 2015 and 2019.
The starting point for the EU expansion of disclosure requirements is provided by the EU Directive on Administrative Co-operation (DAC) enabling the sharing certain tax information in relation to residents of other EU Member States on request or spontaneously.3 The DAC was expanded in 2014 (DAC 2) to include automatic exchange of financial accounts information to allow for the OECD-developed Common Reporting Standard (CRS) to be imported into EU legislation.4 The EU published data on the effectiveness of DAC 2 and concluded that EU Member States exchanged information concerning more than 8 million accounts and financial income amounting to EUR2,919 billion in total.5
In 2015, the DAC was further amended (DAC 3) to include mandatory automatic exchange of information on advance cross-border rulings and advance pricing agreements in swift response to the BEPS Action 5 recommendation of exchanging tax rulings.6 Tax rulings include (i) rulings related to preferential regimes, (ii) cross-border unilateral advance pricing arrangements, (iii) rulings giving a downward adjustment to profits, (iv) permanent establishment rulings, (v) conduit rulings, and (vi) any other type of ruling where the absence of exchange would give rise to BEPS concerns. The EU recently found that almost 18,000 tax rulings were recorded in the central EU directory, from which the automatic exchange is taking place, compared to hardly any being spontaneously exchanged in the years up to 2015.7 The OECD is working simultaneously in the Inclusive Framework on a peer review of the commitment regarding compulsory spontaneous exchange of relevant information on taxpayer-specific rulings.
In 2016, DAC 4 was introduced to allow for the automatic exchange of country-by-country reporting by multinational companies, in response to BEPS Action 13, which provides a template for multinational companies to report key financial and tax data annually and for each tax jurisdiction in which they do business.8 Under these rules, multinational groups, with minimum consolidated revenue of EUR750 million, are obligated to file a country-by-country report. The report includes information for every tax jurisdiction in which the group is active, such as, amount of revenue, profit before income tax, income tax paid (on cash basis), income tax accrued (current year), stated capital, accumulated earnings, number of employees, tangible assets other than cash, and cash equivalents. The report is filed in the Member State in which the ultimate parent entity of the group or any other reporting entity is a resident for tax purposes and will be automatically exchanged to any other Member State in which one or more constituent entities of the multinational group are resident for tax purposes. Since it is still early days after the actual exchange of information has taken place, there is some uncertainty about the assessment and interpretation by tax administrations; however, it is widely expected that these reports will be used by recipient tax administrations as the starting point for further BEPS-related scrutiny and inquiries.
In 2015, the continued public pressure for corporate tax transparency led to the introduction of the EU Fourth Anti-Money Laundering Directive (AMLD 4), designed to combat money laundering and terrorist financing.9 The AMLD 4 included the requirement for EU Member States to set up registers of the ultimate beneficial owners (UBO) of legal entities becoming available to the relevant authorities, including financial intelligence units, from 2017 onwards. In late 2016, this was followed by the adoption of DAC 5 to grant tax authorities access to information collected under AMLD 4 for the identification of ultimate beneficial owners.10 As a reaction to the Panama Papers revelations in 2016, the EU adopted AMLD 5, granting public access to beneficial ownership registers on companies and business-related trusts.11
Last but not least, in 2018, DAC 6 was adopted in the EU, expanding the DAC scope further to include automatic exchange of information regarding reportable cross-border arrangements for tax intermediaries and tax payers.12 DAC 6 introduces an obligation on intermediaries (and in certain cases taxpayers) to disclose potentially aggressive tax planning arrangements and provides for the automatic exchange of this information between tax administrations. This EU legislation was based on the OECD BEPS Action 12, which only provided modular recommendations of a general nature leaving countries free to choose whether or not to introduce such a mechanism. In defining reportable arrangements, DAC 6 provides for certain hallmarks indicating a potential risk of tax avoidance, ranging from generic hallmarks (including confidentiality conditions, contingent fees, and standardized documentation) to specific hallmarks (including utilization of losses, conversion of income, circular transactions, preferential regimes, mismatches, double depreciation, double tax relief, circumvention of exchange of information, and transfer pricing).
A third element of BEPS-related measures can be found in the new tax standards by which governments worldwide have to abide. The OECD BEPS Action 5 minimum standard placed jurisdictions all over the world under scrutiny for preferential corporate tax regimes. These regimes are being assessed in the OECD Inclusive Framework, under a peer review system, and gradually regimes worldwide are being abolished or amended. The EU went one step further in 2017 by publishing its first list of so-called “noncooperative jurisdictions” that failed to meet tax good governance standards for countries. Originally, 17 countries were mentioned in this EU noncooperative jurisdictions blacklist. In addition, 47 countries committed to addressing deficiencies in their tax systems and to meet the required criteria. This unprecedented EU exercise was presented as improving the level of tax good governance globally and preventing tax avoidance and tax evasion as highlighted in the “Paradise Papers.” In the context of EU noncooperative jurisdiction blacklisting, the criteria for tax good governance for countries include (i) tax transparency, including legal framework on exchange of information, both automatic and on request; (ii) “fair” tax competition, including the absence of harmful tax practices according to EU and OECD standards developed in the past 20 years by the EU Code of Conduct Group and the OECD Forum on Harmful Tax Practices; (iii) for countries without corporate income tax or a zero rate, the development of regime-specific substance requirements; and (iv) compliance with the OECD BEPS minimum standards. This EU listing process is dynamic in nature and quarterly updates are published where countries are being assessed and moved from blacklist to greylist (monitoring) or vice versa. The EU is set for 2019 to continue monitoring commitments made by non-EU Member States countries; moreover, the EU will start with periodic screening of non-EU Member State country tax developments on an annual basis. Multinational companies should monitor and assess the impact of tax arrangements where group companies are established in either “greylisted” or “blacklisted” countries, taking into account reputational risks associated with being present in those locations and potential defensive tax measures taken by other countries related to blacklisted countries.
The EU is certainly not going after only non-EU Member States: another form of EU scrutiny is targeting preferential tax arrangements granted by EU Member States through the current wave of EC state aid investigations and decisions on aggressive tax arrangements in EU Member States. The press usually focuses on the high-profile company names involved, but EU state aid proceedings are actually targeted at the EU Member States, allowing preferential tax treatment for certain companies, groups, or sectors. According to the EC, the granting of tax rulings must respect state aid rules, meaning that tax rulings cannot result in a selective advantage for a certain taxpayer compared to companies in a similar factual and legal situation. From 2014 onwards, the EC, under EU state aid rules, for the first time started horizontally and proactively investigating individual corporate tax arrangements granted to multinational companies by EU Member States. This has led to groundbreaking state aid decisions and litigation before the European Courts, including multibillion euro claims for recovery of the aid granted. From all these new cases, it is clear that the EC is going into uncharted territory in defining its ambitions for state aid and corporate taxation.
The state aid cases involved are expected to have wider implications for corporate tax planning practices in the EU and, so far, several lessons learned can be identified. The EC seems to have serious concerns regarding (i) intragroup transactions and profit allocations that do not comply with the arm’s-length principle as interpreted by the EC, including the absence of proper transfer pricing substantiation and documentation; (ii) internal mismatches and other inconsistent applications of national law, giving rise to situations of discretionary double nontaxation or creation of stateless income (double deductions, deduction no-inclusion, dual noninclusion, notional and deemed deductions); (iii) intellectual property (IP) related tax arrangements that involve onshoring and offshoring, related debt-funding, and royalty payments that do not seem in line with IP-related functions and substance; and (iv) discretionary powers for tax administrations in determining a fixed taxable base or a fixed effective tax rate (negotiating or reverse engineering towards a certain tax rate or base or linking the effective tax rate to minimum employment or investment conditions).
Multinational companies should monitor and assess the impact of these state aid cases to their own tax arrangements and, where potentially targeted features exist, establish how and to what extent this can be changed or avoided going forward. A noteworthy element is the role of external auditors who are increasingly becoming aware of the financial and reputational risks attached to aggressive tax planning for audited companies. Therefore, in the process of auditing the tax liability of multinational companies, deep-dive analyses are more frequently being required relating to tax arrangements that might be perceived as aggressive tax planning. External auditors are starting to question whether tax arrangements of the audited company are “more likely than not” sustainable when reviewing EU state aid precedent case law. The difficulty here is that, in most cases, the facts and circumstances of the company tax arrangement is not exactly the same but might contain comparable features of an EU state aid precedent case. Tax departments of multinational companies have to be ready to provide such disclosure and analysis to the external auditor.
BEPS implementation and continued public scrutiny of corporate tax arrangements has resulted in the emergence of a fourth BEPS element: initiatives where companies are being urged to disclose information not only to tax administrations but also on a wider and more public scale.
For example, in 2016, the EC proposed the introduction of public country-by-country reporting.13 The proposal includes information on group entities’ activities, number of employees, net turnover, profit or loss before tax, and tax accrued and paid. The proposal was inspired by BEPS developments, ongoing press revelations about aggressive tax planning by multinational groups, and evermore vocal civil society finding its way into European Parliamentary scrutiny of corporate tax affairs. The EU Council negotiations are not finalized yet due to differences of opinion between EU Member States on legal base, extent, impact, and rationale of the proposal; however, it is clear that this topic fits a wider trend towards companies having to disclose more tax information to the public. EU public country-by country reporting has already been achieved for banks and the extractive industry.14
When it comes to public tax disclosures by companies, a convergence seems to exist between civil society on one hand and investors on the other, bringing corporate tax governance of multinational companies into the spotlight. Civil society has, for years, been demanding more public insight in corporate tax affairs, ranging from tax arrangements, rulings, effective tax rate explanations, country-by-country tax reporting, tax principles, and more. Since 2014, this request has found its way into (sustainable) investor-level scrutiny of companies, the basic premise being that corporate sustainability, translated into environmental, social, and governance criteria, should include proper corporate tax governance. A striking example is given by the Dow Jones Sustainability Index (DJSI) requirements that detail specific questions on public disclosure of a company’s tax strategy, tax reporting, and effective tax rate. Several countries have also introduced practices of public disclosure of tax information (such as the United Kingdom, Spain, Denmark, Norway, Sweden, Finland, and Australia), including elements of taxes paid and more generic information on tax governance, risk management, and attitude towards tax planning.
Based on these developments, companies have started developing, strengthening, and fine-tuning internal corporate tax governance in the form of tax policies, principles, codes of conduct, updated tax (reputational) risk management policies, and internal reporting lines. And, there are many examples where companies have decided to publish parts of their internal corporate tax governance on their public website, without a clear legal obligation to do so, as part of annual reporting or separately in a corporate social responsibility report. Such public disclosures often show that the company’s approach to tax includes statements on (i) legal compliance such as “compliance with the spirit as well as the letter of the tax laws,” (ii) transparency and a positive relationship with tax authorities, (iii) tax principles such as “not to transfer value created to low tax jurisdictions” or “not to use tax structures intended for tax avoidance” or “not to use secrecy jurisdictions or tax havens,” (iv) approach to transfer pricing in line with the arm’s-length principle and value creation, and (iv) the company's approach to (reputational) risk management.
The impact of BEPS on multinational companies has been, and will continue to be for the foreseeable future, significant and comprehensive. OECD and EU BEPS-related substantive corporate tax law changes cover a wide range of the international tax landscape, including the use of low-tax jurisdictions, hybrid entities, hybrid financing, holding companies, (captive) insurance, conduit companies, royalty payments, principal structures, contract manufacturing, deemed permanent establishments, centralization of procurement, and many more. As a result, companies worldwide are reassessing all corporate tax arrangements, including financing, profit repatriation, capital gains, loss utilization, intellectual property, and transfer pricing. In addition, BEPS-inspired rules on tax transparency requiring new forms of disclosure and the effective sharing of information between tax administrations globally are forcing companies to perform internal tax risk assessments in anticipation of increased tax scrutiny and audits. Companies should pay particular attention to tax arrangements that may implicate the new tax good governance standards for countries, such as those involving harmful preferential regimes, explicitly blacklisted countries or fact patterns similar to those addressed in the EU state aid decisions. The potential tax technical, financial, and tax reputational impact of such arrangements needs to be assessed. Companies are also having to contend with increasing public and investor demands for more public corporate tax disclosures explaining details of corporate tax governance, risk assessment, reputational tax management, effective tax rates, and country-by-country taxes paid.
These developments are pushing tax departments of multinational companies to answer important questions relating to (i) the financial (tax) cost of the substantive tax law changes; (ii) availability of alternative BEPS-sustainable tax solutions; (iii) new “substance” requirements for holding, conduit, and noncooperative jurisdiction entities; (iv) organizational complexity and/or potential misalignment of functions and profits; (iv) consequences and potential red flags of country-by-country reports; (v) consequences of disclosure on tax rulings, including audits and ongoing viability of requesting advance certainty from governments; (vi) consequences of disclosure of aggressive tax planning arrangements, leading to changes in corporate tax behavior; (vii) more public corporate tax disclosures connected to reputational concerns; and (viii) how to capture all of the above into revised corporate tax governance and reporting policies.
Tax departments of multinational companies are in the spotlight: the outside world is watching and requiring more information and, at the same time, the inside world is watching in the form of management, supervisory boards, and audit committees. Corporate tax governance must grow and evolve in order to meet the new tax transparency rules, and only cross-divisional cooperation with other internal departments, such as finance and accounting, risk management, public affairs, and corporate sustainability, can provide for a well-balanced approach for safely venturing into the highly volatile and ever-changing international taxation landscape.
[1] BEPS Action 5: Counter harmful tax practices more effectively, taking into account transparency and substance; BEPS Action 6: Prevent treaty abuse; BEPS Action 13: Re-examine transfer pricing documentation (including country-by-country reporting); BEPS Action 14: Make dispute resolution mechanisms more effective
[2] EU Anti-Tax Avoidance Directive 2016/1164
[3] EU Directive 2011/16/EU
[4] EU Directive 2014/107/EU
[5] European Commission COM(2018) 844 final
[6] EU Directive 2015/2376/EU
[7] European Commission COM(2018) 844 final
[8] EU Directive 2016/881/EU
[9] EU Directive 2015/849/EU
[10] EU Directive 2016/2258/EU
[11] EU Directive (EU) 2018/843
[12] EU Directive 2018/822/EU
[13] Amending Accounting Directive (2013/34/EU)
[14] Capital Requirements Directive (2013/36/EU ‘CRD IV’) and Accounting Directive (Directive 2013/34/EU)
