Tax: What BEPS is and what BEPS shouldn’t be

comment - 25 February 2014

Tax: What BEPS is and what BEPS shouldn’t be

“Base-erosion” describes an arrangement which has the effect of reducing the level of taxable profits in one jurisdiction (for example, through the payments of management fees or royalties) and “profit-shifting” (similar to transfer pricing) describes the process of moving the profits on an activity, such as the use of IP rights, from a high tax jurisdiction to a low tax one. These concepts are commonly linked and made use of by international groups to reduce taxation. They are less relevant in a private equity investment context.

On 19 July 2013 the OECD published its ambitious action plan for combatting Base Erosion and Profit Shifting (BEPS). This plan was originally commissioned by the G20 in response to widespread concern over the low level of tax being paid by multinationals as a result of aggressive tax planning. The plan itself does not propose any fundamental changes but rather identified a number of key action points relating to globalisation and co-operation.

BEPS is essentially politically driven and the Dutch government has already responded by acknowledging it is appropriate to take pro-active measures to combat the mis-use of conduit structures.

In particular, they have announced that minimum substance requirements should apply to all companies that receive royalties and interest from foreign entities and pay royalties and interest to other foreign entities. These requirements are all standard and not dissimilar to those announced by Luxembourg tax authorities in Circular (LIR no. 164/2) on Transfer Pricing.

The Netherlands

  • At least 50% of the members of the board of directors with decision taking powers must be resident of the Netherlands.
  • The board members must be sufficiently competent and qualified to perform their tasks.
  • The (most important) board decisions must be taken in the Netherlands.
  • The (main) bank account of the Dutch company is in the Netherlands.
  • The bookkeeping of the Dutch company must take place in the Netherlands.
  • The Dutch company must comply with all its tax obligations.
  • The Dutch company must have its registered address and office in the Netherlands and is not treated as a tax resident of another country.
  • The Dutch company must have a level of equity which fits with its functions.

Luxembourg

  • A majority of the directors should be Luxembourg residents.
  • Members of the board need to have the required professional knowledge and oversight to fulfil their duties correctly.
  • Key decisions concerning the entity's management have to be taken in Luxembourg.
  • The entity needs to have at least a bank account in its own name at a financial institution based in Luxembourg.
  • Tax returns must be up to date when seeking rulings.
  • The entity should not be considered as tax resident in another State.
  • The company’s capital should be appropriate with regards to the functions performed (broadly 1%).


None of this appears unreasonable and represents a balanced response to an issue that is particularly relevant for lower tax jurisdictions. That said, it would be illogical if these substance requirements were applied where there was no additional base-erosion or profit-shifting. There are other reasons for establishing holding companies and each such company should be assessed on the particular facts. In this context, the Luxembourg authorities should urgently revisit their transfer pricing rules which are inaccurate in scope and application.

In a private equity context, the use of intermediary holding companies often results in no additional base erosion or profit shifting and insofar as private equity investment has this effect more generally, it is only as a consequence of the laws of the jurisdiction of the particular target group. It has nothing to do with the particular low tax jurisdictions that are neutral in the tax equation (if anything increasing the taxation of income streams).

It will be critically important to clarify the nature of private equity investment in a BEPS context because OECD proposals, a draft of which was published on 30 January 2014, are likely to result in significant new reporting obligations that could result in unprecedented levels of scrutiny by different tax authorities. The burden of this, on top of the unhelpful regulation, would only deter further crucial investment in industry. The proposals are out for consultation until late February, and the OECD plans to finalise its guidance in May 2014.

Industry should be able to expect that any final proposals focus on cases of abuse only to ensure certainty and predictability and that international tax rules are coherent. In short, the OECD must ensure that substance prevails over the obvious politics of this topic.
 

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