BEPS Action Plan 5: Countering harmful tax practices

IN LAST WEEK’S column we talked about the OECD’s BEPS Action Plan on Hybrid Mismatch Arrangements. This week’s column focuses on the OECD’s Action Plan on Harmful Tax Practices (HTP).

As the world economy continues the process of globalization and technological advances, tax authorities from various jurisdictions are inevitably faced with the issue of companies taking advantage of enhanced mobility to distort the location of capital and services. The distortion may occur where companies, particularly multinationals, move taxable profits created in one country to another country which offers a preferential tax regime at no or low tax rates. Using the OECD 1998 Report “Harmful Tax Competition: An Emerging Global Issue” as framework, the OECD Forum on HTP outlined three elements in determining whether a regime is a harmful preferential regime; these are:

• Whether a regime is within the scope of work of the Forum on HTP or if it is preferential;

• Whether a preferential regime is potentially harmful; and

• The economic effects of a regime.

Based on these, a preferential regime is considered harmful if it:

(a) Applies to geographically mobile activities, such as financial and other service activities, including the provision of intangibles;

(b) Taxes at a preferential rate compared with the general principles of taxation in the relevant country and the regime imposes no or low tax rates on the income;

(c) Is ring-fenced from the domestic economy;

(d) Lacks transparency; and

(e) Does not provide for an effective exchange of information.

The OECD’s BEPS Action Plan 5 emphasizes two important measures to counter harmful preferential regimes:

• The need for the substantial activity requirement; and

• The need to improve transparency through compulsory spontaneous exchange of rulings related to preferential regime between tax authorities.

SUBSTANTIAL ACTIVITY REQUIREMENT

Currently, OECD’s work on the substantial activity requirement is focused on intangible property (IP). According to the Report, the Forum on HTP considers three approaches to requiring substantial activities in an IP regime:

• The value creation approach, which requires the taxpayer to undertake a set number of significant development activities;

• The transfer pricing approach, which allows a regime to provide benefits to all the income generated by the IP if the taxpayer had located a set level of important functions in the jurisdiction providing the regime; and

• The nexus approach, which looks at whether an IP regime makes its benefits conditional on the extent of research and development activities of taxpayers receiving benefits.

The third approach is said to permit jurisdictions to provide benefits to the income arising out of the IP so long as there is a direct nexus between the income receiving the benefits and the expenditures contributing to that income. The Report further states that it is not the amount of expenditures that acts as a direct proxy for the amount of activities. Instead, it is the proportion of expenditures directly related to development activities that demonstrate real value-added by the taxpayer, and acts as a proxy for how much substantial activity the taxpayer undertook.

TRANSPARENCY AND EXCHANGE OF RULINGS

The second important measure discussed in the Report is the need to improve transparency through the compulsory spontaneous exchange, between tax authorities, of rulings related to preferential regime. The lack of transparency is seen as a cause that makes it harder for an affected country to take defensive measures against harmful tax practices. As such, the OECD has put together a framework that details the situations in which rulings/information should be exchanged between two tax authorities.

The Report recognizes that the information exchange between tax authorities requires a framework that legally enables the sending country to exchange the information and the recipient country to receive it. The Report mentions several international legal instruments on the basis of which information exchange for tax purposes may take place, such as bilateral information exchange instruments. It further advises that countries which currently do not have the necessary legal framework in place for information exchange will need to consider institutionalizing such a framework.

In the Philippines, we have formalized our commitment to comply with internationally agreed-upon standards on transparency and effective exchange of tax information when we passed Republic Act (RA) No. 10021 otherwise known as the “Exchange of Information of Tax Matters Act of 2009.”

In addition, the Philippines signed in September 2014 the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, an international instrument developed jointly by the OECD and the Council of Europe, to fight international tax avoidance and evasion, and also participated in the first BEPS Technical Meeting for Partner Countries in Paris, France.

Ma. Theresa M. Abarientos is an Associate Director of SGV & Co. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co.