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What is the Economic Activity Requirement that Offshore Financial Center’s Agreed to Adopt into Law?



William Byrnes, Tax Advisor

Fair Tax Competition: The country should not have harmful tax regimes, which go against the principles of the EU’s Code of Conduct or OECD’s Forum on Harmful Tax Practices. Those that choose to have no or zero-rate corporate taxation should ensure that this does not encourage artificial offshore structures without real economic activity. In the context of the screening process, the Code of Conduct Group invited each jurisdiction where concerns were identified to commit to address such concerns. The large majority of jurisdictions have decided to introduce the relevant changes in their tax legislation in order to comply with the EU screening criteria.  The following jurisdictions are committed to addressing the concerns relating to economic substance by 2018: Bermuda; Cayman Islands; Guernsey; Isle of Man; Jersey; and Vanuatu.

What is “economic reality”, according to BEPS?  Lot’s of mention of “economic” reality and substance. but no actual definition.  Albeit the transfer pricing BEPS project defines it by defining what it is not.  Economic activity includes ‘capital rich entities’ but mere capital is not enough for economic substance to justify premium returns.

Capital-rich entities without any other relevant economic activities (“cash boxes”), and therefore unable to exercise control over investment and other risks, will not be entitled to any premium returns.

128. How will the BEPS Project affect “tax havens”?

The BEPS Project aims to end the use of shell companies used to stash profits offshore or unduly claim tax treaty protection and neutralise all schemes that artificially shift profits offshore. Though the BEPS Project is not about dictating whether countries should have a specific corporate income tax rate, it will have an impact on regimes that seek to attract foreign investors without requiring any economic substance.

5.  Do the BEPS measures increase the risk of double taxation?

The aim of the measures is to realign taxation with economic substance and value creation, while preventing double taxation. The BEPS package represents the first substantial renovation of the international tax rules in almost a century. This renovation is necessary not only to tackle BEPS, but also to ensure the sustainability of a consensus-based system aimed at eliminating double taxation. As new rules always raise interpretation issues, Action 14 on improving dispute resolution is a key part of the BEPS Project.

6. Will MNEs have to restructure their business in light of the BEPS outputs?

This should not be the case for groups whose legal and tax structures reflect the underlying economic reality.

55. What are the main revisions in transfer pricing rules?

The work has focused on strengthening the guidance on applying the arm’s length principle to ensure outcomes where profits are aligned with the value created through underlying economic activities. This work has focused on several key areas, such as:

  • Transactions involving intangibles, since misallocation of the profits generated by valuable intangibles has contributed to BEPS;
  • Contractual allocation of risks, and the resulting allocation of profits to those risks, which may not correspond with the activities actually carried out;
  • The level of returns to funding provided by a capital-rich MNE group member, where those returns do not correspond to the level of activity undertaken by the funding company;
  • Recharacterisation of transactions which are not commercially rational; and
  • Service fees and commodity transactions.

64.  How will the profits of “cash-boxes” be determined?

Capital-rich entities without any other relevant economic activities (“cash boxes”), and therefore unable to exercise control over investment and other risks, will not be entitled to any premium returns. The profits that the cash box is entitled to retain will be equivalent to no more than a risk-free financial return. Moreover, if this return qualifies as interest or an economically equivalent payment, then those already marginal profits will also be targeted by the interest deductibility rules of Action 4.

70.  What do the BEPS Indicators show?

A “dashboard of BEPS indicators” highlights BEPS behaviours using different data sources, employing different metrics, and examining different BEPS channels. The six indicators provide indirect measures of BEPS and are designed to be used to track changes in BEPS over time and in the future to monitor the effectiveness of BEPS measures adopted by individual countries. The indicators show the disconnect between financial and real economic activities, profit rate differentials within top global MNEs, tax rate differentials between MNEs and comparable non-MNEs and profit shifting through intangibles and interest.  No single indicator is capable of providing a complete picture of BEPS, but when taken together, these BEPS indicators give a strong indication of the existence of BEPS and the likelihood that it has been increasing over time. These indicators are complemented by the more than one hundred academic empirical analyses that also find evidence of BEPS.

126. Is the BEPS Project meant to stop tax competition?

Taxation is at the core of countries’ sovereignty, and each country is free to set up its corporate tax system as it chooses, including charging the rate it chooses.  The work is not aimed at restricting the sovereignty of countries over their own taxes; instead, it is aimed at restoring and strengthening sovereign taxing rights by ensuring that countries can tax the profits arising from the economic activities undertaken there. The project achieves this in a number of ways such as by addressing regimes that apply to mobile activities and that unfairly erode the tax bases of other countries, potentially distorting the location of capital and services.

128. How will the BEPS Project affect “tax havens”?

The BEPS Project aims to end the use of shell companies used to stash profits offshore or unduly claim tax treaty protection and neutralise all schemes that artificially shift profits offshore. Though the BEPS Project is not about dictating whether countries should have a specific corporate income tax rate, it will have an impact on regimes that seek to attract foreign investors without requiring any economic substance.

Have a question? Contact William Byrnes

Your comments are welcome!

William H. Byrnes has achieved authoritative prominence with more than 20 books, treatise chapters and book supplements, 1,000 media articles, and the monthly subscriber Tax Facts Intelligence. Titles include: Lexis® Guide to FATCA Compliance, Foreign Tax and Trade Briefs, Practical Guide to U.S. Transfer Pricing, and Money Laundering, Asset Forfeiture; Recovery, and Compliance (a Global Guide). He is a principal author of the Tax Facts series. He was a Senior Manager, then Associate Director of international tax for Coopers and Lybrand, and practiced in Southern Africa, Western Europe, South East Asia, the Indian sub-continent, and the Caribbean. He has been commissioned by a number of governments on tax policy. Obtained the title of tenured law professor in 2005 at St. Thomas in Miami, and in 2008 the level of Associate Dean at Thomas Jefferson. William Byrnes pioneered online legal education in 1995, thereafter creating the first online LL.M. offered by an ABA accredited law school (International Taxation and Financial Services graduate program).

One comment

  1. Swisstechie says:

    Why can’t BEPS also eliminate double-taxtion for US emigrants?

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