As countries have struggled to find new sources of revenue over the last few years, one of the hottest topics among global leaders has been corporate tax avoidance.
In both the US and Europe, scrutiny of multinational corporations’ tax structures is mounting: In America, tax inversions have become a key issue in the presidential election and, across the Atlantic, the ongoing “Lux Leaks” investigation has sparked renewed interest in corporate tax arrangements. To tackle the issue, the G20 and the Organization for Economic Co-operation and Development (OECD) have been driving the Base Erosion and Profit Shifting (BEPS) project.
The BEPS project promises to be one of the most pressing global regulatory issues in 2016 and beyond as it recommends a fundamental rewrite of the international tax system. It has two overarching aims:
- Focus on double non-taxation (or less than single taxation) through “cracks” in the interaction of domestic tax systems resulting in stateless income; and
- Address situations where profits are perceived as geographically divorced from a firm’s activities, i.e., to deal with situations where tax liabilities in a given country do not readily correlate with the level of operations in that country.
The recommendations were first proposed in 2013 and include fifteen action plans. Although final action plans were released in October 2015, work in certain areas continues. The BEPS recommendations are designed to be implemented through domestic laws, within the network of bilateral tax treaties, or by a new multilateral instrument in development.
Despite being targeted at multinational corporations, BEPS recommendations demand the attention of the asset management industry as countries start to implement them.
BEPS Action Plans Notable to Asset Managers
Several BEPS action plans are of critical note to asset managers. First, they include recommendations to neutralize the effects of hybrid mismatch arrangements. Accordingly, global fund managers will need to review and potentially reconsider their current hybrid arrangements, be their hybrid financial instruments, hybrid transfers, or hybrid entities.
Hybrid mismatches occur when companies have different tax treatments in different jurisdictions and when the same transaction can result in different tax outcomes. They can result from a hybrid instrument viewed as debt in one country and equity in another, or from an entity viewed as a partnership in one country but a corporation in another.
Also of note, BEPS aims to prevent treaty abuse from entities that “treaty shop.” For asset managers, that means Collective Investment Vehicles (CIVs), such as mutual funds or UCITS, are likely to face more stringent thresholds to qualify for treaty benefits.
Asset managers of non-CIVs should be aware that tax treaty benefits could be denied due to reduced clarity surrounding beneficial ownership, although OECD work is ongoing in this area. Non-CIVs include real estate investment trusts, special purpose vehicles, private equity funds, and alternative funds.
Another important BEPS action plan is the widening of the permanent establishment (PE) definition and broadening of the scope of services that could give rise to one. The result could be an increase in the number of entities that fall within the scope of a PE based on their current capital raising, marketing, and distribution activities.
Even entities that do not fall within the expanded scope of PE are likely to face an increased compliance burden.
To improve transparency, BEPS recommends changes to transfer pricing documentation by introducing country-by-country (CbC) reporting. CbC requires companies to provide tax authorities with information for reliable risk assessments and examinations. This should have a notable impact on global firms and will certainly be a compliance challenge for asset managers. Asset managers should carefully monitor how each BEPS supporting country responds with its own local requirements, particularly in light of CbC’s go-live date of January 2016. The first of these reports is due at the end of 2017, and the OECD has said it plans to review their effectiveness by 2020.
CbC impact on asset managers will require that they determine at a group level whether an organization is within the scope of CbC. They must ensure that their system can efficiently capture and report the relevant information whenever it is required. Asset managers will have to be vigilant as local countries implement these measures and watch for differences from country to country.
Finally, asset managers should be aware that the OECD, through its final BEPS action plan, is developing a multilateral instrument to bypass the need to modify more than three thousand current bilateral tax treaties. This instrument, which would be legally binding only to the countries that sign it, would affect the BEPS target areas mentioned above, including hybrid mismatches, treaty access, and PEs.
The BEPS-driven clampdown on global tax-shifting will have a significant impact on asset managers, who will need to review transfer pricing policies, permanent establishment structures, treaty eligibility qualifications, and existing hybrid arrangements. The industry now eagerly awaits country-specific responses and implementation schedules of the BEPS action plans.
This article was originally published in the 2016 Regulatory Field Guide. The guide features insights from a number of our experts on key regulatory developments that will have the greatest impact for asset managers in the year ahead – and beyond. Visit bbh.com/regulatoryfieldguide to explore the guide.