2nd IBFD International Tax Seminar

Substance and Transparency in

International Taxation

BEPS Action 5: Countering Harmful Tax Practices More

Effectively, Taking into Account Transparency and

Substance

Barry Larking, IBFD Special Counsel

4 September 2019

Training Institute, Ministry of Finance, Taipei, Taiwan

Who is involved

2 © 2019 IBFD

BEPS action 5: substance and transparency

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Objectives:

Combats profit shifting by aligning tax with substance

Improves transparency though exchange of tax rulings

Ensure level playing field/prevent race to the bottom

-> Inclusive Framework

How are objectives achieved:

Develops existing rules on “harmful preferential regimes”

Requires substantial activity for preferential regimes

Requires substantial activity for no/nominal tax jurisdictions

(2018)

Requires information exchange on ‘BEPS’ rulings

© 2019 IBFD

BEPS 5: what is a harmful preferential regime (1)

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Preferential regime

Applies only to “geographically mobile activities”

Gives better tax treatment in comparison to normal tax rules

“no or low effective tax rate”

what is low?

not (yet) about minimum tax rates

A “potentially harmful regime”

Ring-fences, or

Is not transparent, or

Does not exchange information, or

Does not require substance

plus supplementary factors e.g. ‘bad’ transfer pricing,

territorial regime

© 2019 IBFD

BEPS 5: what is a harmful preferential regime (2)

5 © 2019 IBFD

A regime is “actually harmful” if it creates “harmful economic effects”, e.g.

0%TAX

Which companies must satisfy substance?

6 © 2019 IBFD

Companies earning income from “geographically mobile activities”

headquarters, distribution centres, service centres, financing, leasing, fund

management, banking, insurance, shipping, holding companies and the provision of

intangibles (IP)

No/Low taxed

Regime (2015)

No/Nominal tax

Jurisdiction (2018)

In an Inclusive Framework

jurisdiction or “jurisdiction of

relevance”

What substance is required for IP?

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No/low tax regimes

BEPS principle: tax should reflect substance

IP substance = the activities that created the IP (R&D)

So only income from IP created by taxpayer can have tax

benefit (= nexus principle)

Non-qualifying income taxed at standard tax rate

Qualifying income = income derived from IP that relates to

taxpayer’s own (R&D) expense

So not acquired IP or related party outsourcing

Level playing field with no/nominal tax jurisdictions?

Nexus principle does not work if no tax at all

So “Core Income Generating Activities” + enforcement

© 2019 IBFD

What CIGA is required for IP income in no/nominal tax

jurisdictions?

8 © 2019 IBFD

Patents etcMarketing Intangibles

R&DBranding, marketing,

distribution

Otherwise:

Strategic decisions

Risk management

Trading

But reversed burden of proof if high risk i.e. involvement of foreign related parties

e.g. for acquired IP, licensed IP, outsourced R&D

Passive IP holding created/exploited outside jurisdiction X

Non-resident board decisions taken locally X

What CIGA is required for non-IP income (preferential

regimes or no/nominal tax jurisdictions)?

9 © 2019 IBFD

Regime/activity Core Income Generating Activities

HQ Management, expenditure, coordination

Distribution and

service centre

Transportation and storage; order fulfilment;

administrative services

Banking Fund raising; risk and capital management;

treasury; lending; reporting

Insurance Risk analysis, insuring/re-insuring, client services

Shipping Crew management; maintenance; goods and

voyage logistics

(Pure equity) Holding Corporate law filing; “necessary” people and

premises

How are substance requirements applied?

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Key CIGA rules (IP and non-IP)

CIGA must be performed by the taxpayer/entity or outsourced

in same jurisdiction

CIGA must be carried out with

“adequate” number of qualified employees, and

“adequate” operating expenditure

Jurisdictions must have legislation to

Define CIGA for each activity

Ensure CIGA carried out

Ensure employee/opex conditions met

Monitor and enforce

Reporting requirements

© 2019 IBFD

Special enforcement rules for no/nominal tax

jurisdictions

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Entity must report information on

type of activity and CIGA

type and amount of income and expenses and assets

employees

Sanction mechanism for non-compliant entities

taxation not applicable

example: striking off register

information exchange with immediate/ultimate parent and

ultimate beneficial owner jurisdiction

Information exchange even if compliant entity

With same jurisdictions

Details depend on whether high-risk activities and whether

effective monitory process in place© 2019 IBFD

Which no/nominal tax jurisdictions have been reviewed

under BEPS substance/CIGA rules?

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Anguilla

Bahamas

Bahrain

Barbados

Bermuda

British Virgin Islands

Cayman Islands

Guernsey

Isle of Man

Jersey

Turks & Caicos Islands

United Arab Emirates

© 2019 IBFD

All have introduced Economic

Substance legislation from 2019

All satisfy OECD rules so not harmful

Will be annually monitored

What if a country does not satisfy the substance rules?

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Country is “invited” to abolish/amend harmful regimes:

Close off to new entrants (2016/2018)

Grandfathering: 30 June 2021

Yearly monitoring of potentially harmful regimes (e.g. to see

if economic circumstances change)

Latest peer review: July 2019

Other countries can take “defensive measures”

Don’t forget other BEPS actions:

OECD BEPS actions 8-10 (transfer pricing)

BEPS action 13 (country-by-country reporting)

© 2019 IBFD

Transparency rules

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Rulings

Preferential regimes

Unilateral APAs

Downward adjustments (e.g. info cap)

Permanent establishments

Conduits

Other to be agreed

Exchange with residence country of

Related parties involved

Immediate and ultimate parent

Summary may be followed by full ruling on request

Ruling best practices

EU equivalent© 2019 IBFD

EU-listing of non-cooperative jurisdictions

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► EU has equivalent rules to OECD Harmful Tax Practices for EU

member states including Economic Substance requirement

(Code of Conduct)

► EU non-cooperative jurisdiction initiative (Dec 2017):

► Transparency (information exchange)

► Fair taxation (= harmful preferential measures + substance)

► BEPS minimum standards

► If not and no commitment -> blacklist

American Samoa, Belize, Fiji, Guam, the Marshall Islands,

Oman, Samoa, Trinidad and Tobago, the United Arab Emirates,

the US Virgin Islands, and Vanuatu (June 2019)

► Commitments include:

► Economic substance legislation

► Monitoring and enforcement/sanctions

► Exchange with relevant EU Member States © 2019 IBFD

EU economic substance requirements

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► Key substance elements:

► local directors and management

► local Core Income Generating Activities (CIGA)

► ‘adequate’ local people, premises and expenditure

► Focus on ‘geographically mobile business’ e.g. group

finance, IP, HQ, distribution, fund management (not CIVs),

holding

► Specific requirements for High Risk IP (based on OECD)

© 2019 IBFD

Tax Haven

EU Co

EU-listing of non-cooperative jurisdictions

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Interest,

royalty etc.

a) Non-deductibility of costs;

b) Controlled Foreign Company (CFC) rules;

c) Withholding tax measures;

d) Limitation of participation exemption;

e) Switch-over rule;

f) Reversal of the burden of proof;

g) Special documentation requirements;

h) Mandatory disclosure by tax intermediaries

+ reputational damage

EU Blacklist: POSSIBLE ‘Defensive’

Measures

Non-cooperative

jurisdiction

Next steps on substance and transparency

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Ongoing peer reviews and monitoring

Consideration whether no or low tax rate could be harmful

per se

Consideration whether territorial tax systems should

introduce economic substance requirements

Will low tax regimes and no/nominal tax jurisdictions survive

OECD Global Inclusion initiative?

EU plans to add exchange of beneficial ownership

information as part of transparency blacklisting criteria

EU may include information exchange, beneficial ownership

and mandatory disclosure rules as part of blacklisting

substance criteria

© 2019 IBFD

© 2019 IBFD 19

Thank you for your attention!