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Beyond tax: how BEPS will alter entire businesses

The OECD’s goals for the project have a clear theme, but uncertainty about the details generates risks for companies.

By Dr. Paul Kielstra

At luxurious resorts such as Las Ventanas al Paraíso (“the windows to paradise”) overlooking the Sea of Cortez in Los Cabos, Mexico, leaders of G20 nations in June 2012 decided to ask the Organisation for Economic Co-operation and Development (OECD) to recommend ways to collect the 4% to 10% of global corporate tax revenue that body estimates is lost annually to tax avoidance.

“We reiterate the need to prevent base erosion and profit shifting and we will follow with attention the ongoing work of the OECD in this area,” the heads of state declared at the end of their summit.

With that, the OECD embarked on its project with urgency.

“We’ve come to a point where the international tax framework is used to plan non-taxation and this will come to an end,” Pascal Saint-Amans, Director of the OECD’s Centre for Tax Policy and Administration, told Tax Insights in 2014.

Working closely with its 34 member nations, other G20 states and various other developing economies and business groups, the OECD finalized 15 specific recommendations for action in October 2015, less than four years after the unprecedented agreement by world leaders in Mexico to work collectively on the issue.

“The major challenge and risk of the BEPS process is that we will see more disputes and double taxation as countries take opposing views and the will to resolve such disputes remains very low.“

Jesper Barenfeld — Senior Vice President and Head of Corporate Tax at AB Volvo

Now, as individual countries begin implementing the OECD’s recommendations, businesses are discovering that what the OECD recommended not only will completely reorder long-standing tax practices but also will have wide-reaching effects across the entire enterprise, touching functions such as finance, human resources, information technology and legal, to name just a few.

“Suddenly tax is a topic everybody wants to talk about and is at the forefront of many C-suite discussions,” says UK- based Chris Sanger, EY Global Head of Tax Policy.

Professor Michael Devereux, Director of Oxford University’s Centre for Business Taxation, says, “Companies need to get to grips with a huge new set of rules that may be introduced in a piecemeal fashion. The uncertainty is very great.”

Risky business?

That uncertainty creates risks.

“Countries naturally look after their own interest, which is to protect their own individual tax bases,” says Jesper Barenfeld — Senior Vice President and Head of Corporate Tax at AB Volvo.

“If the rules become more ambiguous and complex, and less aligned — all of which appears to apply to the BEPS project — this will undoubtedly lead to more conflict and double taxation.”

Businesses were invited to make comments at each stage individually and under the auspices of the OECD’s Business and Industry Advisory Committee (BIAC), which said in a December 2015 position paper it was “anxious some serious business concerns have not been sufficiently considered or addressed.”

Among those concerns were complaints that the OECD moved too quickly without proper analysis.

Barenfeld believes that “good tax policy should steer taxpayers toward certain desired behaviors by way of clear and coordinated rules. That is the idea behind the BEPS project, but a lack of sufficient analysis and need to compromise given the short time frame has given rise to a lot of ambiguity and uncertainty. This leaves a very broad range of possible interpretation and increased scope for conflicts.”

Worse still, BIAC warns too many countries may be expecting to reap additional revenues as a result, creating an “expectation gap” in their budgets that may eventually have to be filled by legislating tax increases rather than collecting revenue currently believed to escape the tax collection through BEPS.

Nonetheless, individual countries continue to move forward putting these results into practice.

How consistently they implement the recommendations remains to be seen.

The core principles

The 15 individual BEPS Actions can seem overwhelming but can be synthesized into three core principles:

The devil is in the details

Despite thematic clarity from the OECD on its goals, many of the actual recommendations lack an agreed-upon list of concrete changes.

In some areas, they contain a consensus around a range of revisions to existing international standards and new minimum standards — most of which are likely to see wide, speedy adoption.

These include actions on country-by-country reporting and transfer pricing documentation requirements for which many countries have already published or enacted new regulations.

The details in other fields, though, remain under discussion or have yielded much vaguer results, such as recommended common approaches to facilitate convergence or guidance on determining best practice.

Which recommendations, if any, each country implements is up to national tax authorities.

Moreover, how they interpret the areas of ostensible consensus will inevitably differ, sometimes markedly.

Some jurisdictions will enact only some of the relevant changes.

The recently proposed EU Anti-Tax Avoidance Directive shows that others may seek to go beyond the BEPS recommendations, either alone or as part of a regional bloc.

Beyond the tax department

Amid the undoubted uncertainty about details, one fundamental outcome has become abundantly clear.

As Barenfeld puts it, “the impact of BEPS will reach far beyond the tax department and have implications on most parts of a company.”

One example is transfer pricing and R&D.

BEPS Action 8 deals with transfer pricing and intangibles, one of the most important of which is intellectual property (IP).

Although the details are still under discussion, BEPS recommendations appear likely to prevent companies from assigning the profit arising out of IP to a group company simply because it has legal ownership. Instead, it will need to be shared between those parts of the firms that have responsibility for the development, enhancement, maintenance, protection and exploitation (DEMPE) of that IP.

“Companies will need to revisit how they look at IP ownership and how their global R&D organization is set up because the potential tax cost for the R&D function has just become more important,” explains Jürgen Lange, EY EMEIA Advisory Leader for Operating Model Effectiveness in Germany.

Another set of BEPS recommendations — around Action 7 — could lead to companies triggering tax liabilities in additional countries.

Previously innocuous sales and supply-chain-related activities might now create a “permanent establishment” in tax jargon.

“For a lot of businesses, there will be an explosion in the number of PEs around the group,” says John Connors, Group Tax Director for Vodafone Group Services Limited.

“Even where the resultant tax liability may be negligible, or already fully covered by transfer pricing adjustments, this can bring substantial compliance and accounting costs.”

Permanent establishments: new ground rules

On a basic level, companies may have to change how they sell things to avoid creating a permanent establishment.

Even something as minor as giving foreign customers the benefits of contingent inventory arrangements, for example, may trigger PE status in some circumstances.

More generally, those firms that in the past have used commissionaire sales arrangements — where a company directly employs a local sales agent in a foreign country or pays a commission for such services — will also need to be very careful lest this activity create a permanent establishment.

One option would be to restrict the independence of the local agent but some companies have already completely revised their sales model to sell to a local company, which in turn markets to customers in the country.

BEPS recommendations concerning interest deduction caps will also have far- reaching business implications.

“Tax and treasury will need to work much more closely together,” says Sanger. “How you organize financing will affect how rules apply on what is tax-deductible.”

Although details are still being discussed, put simply, interest deductions — both for intragroup loans and third-party borrowing — may soon be capped at between 10% and 30% of EBITDA.

Those overseeing capital management will accordingly need to confirm that they not source funds in ways so that a lack of tax benefit will drive up costs.

Other BEPS recommendations will likely affect the broader company.

At least seven have important implications for the treasury function alone.

Depending on the circumstance, purchasing, supply chains, logistics, IT, legal, and financial accounting will need to adjust to the new environment.

Preparing for the unexpected

Although remaining uncertainty makes it impossible to create a detailed list of steps for companies to take, some general steps are clearly necessary.

First, and most obvious, the company as a whole, not just the tax function, should have already begun to address changes that have been introduced. It can also prepare for many of the likely new regulations.

“There has been a good degree of consultation about the direction of travel,” says Vodafone’s Connors. “There is enough of a lead time to manage the transition.”

On the other hand, notes Barenfeld, the current degree of uncertainty limits just how much companies can do immediately.

“In response to BEPS, companies will need to be extra vigilant that their tax function is aligned with other parts of the business.“

John Connors, Group Tax Director for Vodafone Group Services Limited

He agrees that, when it comes to international, immediately applicable guidelines, such as those around transfer pricing, “all companies should hopefully be well advanced to comply.”

As for those where discussions are ongoing, “the devil is, to some extent, in the details [of national implementation], making it harder to be proactive. The C-suite is well aware of what is going on, but it is hard even for us tax people to know exactly how the new standards will play out.”

Accordingly, adds Sanger, businesses should monitor how countries relevant to the company plan to implement different parts of the BEPS project and work with policy makers during this process.

Current conditions provide, he says, “a real opportunity, if the details of implementation will cause a problem, to engage with officials and explain why this will be an issue.”

This is all the more important because, as regulators and companies both wrestle with what the BEPS reforms will mean in practice, disagreements will occur.

Not always straightforward

Barenfeld says that tax authorities are already asking far more detailed questions in areas such as the location of decision-making and operational activities.

Unfortunately, this is not always straightforward information gathering.

Barenfeld adds that “we have had questions about valuations made more than 15 years ago on the basis of the new BEPS guidelines. Clearly this is a long time ago when the context and knowledge about transfer pricing were completely different.”

Similarly, Connors notes, “we have already seen, in some emerging markets, tax inspectors requesting information that ordinarily you think is of no relevance but that they say they will be entitled to under BEPS. You see a more aggressive approach and greater expectation to find fault with multinationals.”

He expects a plethora of such requests and an accompanying increase in tax controversy.

This may put companies in the middle of increasingly aggressive tax authorities with contradictory views.

“The major challenge and risk of the BEPS process is that we will see more disputes and double taxation as countries take opposing views and the will to resolve such disputes remains very low,” Barenfeld says.

These may even arise from unintended error as much as principle.

Sanger points out that translation of tax data shared between national authorities using different languages, on its own provides opportunities for misunderstandings.

Unpredictable journey

Finally, businesses need to be aware that the BEPS project is likely to be not an endpoint, but an early stage on an unpredictable journey.

Oxford University’s Devereux explains that “initial implementation may take a few years, but almost every time new reforms are introduced they need tweaking. We are in for a continuous period of change as governments try to close new loopholes.”

Similarly, the attitudes that drove the BEPS reforms have not gone away and may lead to further demands.

In April, the EU proposed public country-by-country reporting requirements that include 7 of the 12 kinds of data included in the BEPS confidential reporting.

CFOs and communications departments need to be prepared for possible public scrutiny that goes beyond current BEPS recommendations.

“It will be a question of evolving rather than adopting a radically different approach,” says Connors. “In response to BEPS, companies will need to be extra vigilant that their tax function is aligned with other parts of the business.”

Key action points

  • All functions need to work with the tax function to consider the implications that BEPS reforms will have for business operations. Current supply chain, HR, treasury and other policies and strategies now bring tax risks.
  • Monitor the implementation of the BEPS recommendations in countries relevant to the company. Be prepared for inconsistencies between the regulations of different jurisdictions.
  • Engage with tax authorities during the implementation process to avoid unintended effects.
  • Be prepared for a substantial increase in tax controversy. Certain jurisdictions are already asking for nontax information in an aggressive way, which may be a sign of a future approach. Moreover, given the vagueness in some BEPS recommendations, countries themselves will likely argue as to where income is taxable, raising the risk of double taxation.

Read more: A brief BEPS project glossary

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