In this article, I have provided a summary of the key happenings in the world of transfer pricing over the past three months.
Canada Ratifies the BEPS MLI
On June 21, 2019, the Department of Finance announced the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting had passed the first reading in the House of Commons. This essentially means that Canada has now effectively signed onto the BEPS initiative, which involves over 120 signatory countries. Canadian treaties with other countries who have signed the MLI can now be revised to incorporate recommendations from this work. The BEPS initiative has been organized by the OECD with much of the initial commentary incorporated into the 2015 final reports. These additions were ultimately included in the 2017 version of the OECD Transfer Pricing Guidelines.
For more information, please click here: http://bit.ly/2XxFNYi.
OECD Issues Work Plan to Reform International Tax Regime
On May 31,2019, the OECD issued its BEPS workplan regarding international tax reform. The discussion has been broken down into two “pillars”:
- Pillar One discusses potential methodologies to allocate profits to international jurisdictions based on factors such as user location, overall group profitability, and local sales & marketing efforts.
- Pillar Two relates to discussions on the global implementation of a potential alternative minimum tax to disincentivize profit shifting
At this stage, numerous methodologies are being considered for both Pillars and the OECD intends to issue final reports on these matters by the end of 2020.
This endeavor by the OECD is an extension of the BEPS initiative that began in 2013 to address concerns over the payment of taxes by multinational entities. Over the past few years, some countries have begun implementing unilateral “digital taxes”. However, the concern of many is the potential chaotic fallout from inconsistent taxation across various countries as this could lead to double taxation and a potentially adverse impact on capital flows. In addition, the recent Tax Cuts and Jobs Act in the United States implemented a type of alternative minimum tax through its GILTI (“Global Intangible Low Tax Income”) provisions that adds an additional tax on foreign-sourced income taxed at low rates.
Obviously, the complications surrounding such multilateral discussions will be numerous. Do these initiatives mean the end of the traditional arm’s length standard? No, however, they may add to the complexity of transfer pricing management for both taxpayers and practitioners. An example of what may occur in the near future, should these changes be implemented, might see a limited risk distributor, who under conventional transfer pricing rules would normally earn a low return, now have additional profit allocated to it under the following circumstances:
- The corporate group as whole is extremely profitable;
- The end-users of the “limited-risk” entity may be deemed to be valuable based on certain formulae (i.e. in a Netflix or Uber scenario);
- The “limited-risk” entity is deemed not be limited-risk based on specific criteria applied such as amount of sales and marketing activity occurring in-country.
The hope of coming to an international consensus is to avoid the chaos surrounding each country applying its own rules that may contradict the tax regulations in other countries. Also, if foreign tax credits are misaligned, the risk of double taxation (or potentially worse) is a real possibility. While the reports are due out by the end of 2020, it is hard to envision a scenario where final consensus is reached until afterwards, along with a delay to formally ratify such changes in local tax codes and international tax treaties. As an example of such a delay, Canada just ratified the MLI on BEPS in May 2019, almost four years after the final BEPS reports were issued. The final recommendations could be numerous, and it is hard to pinpoint specific avenues that will be taken, not to mention the unforeseen issues that may crop up with these plans. As this represents a hybrid formulary approach that is intertwined with the arm’s length standard, the only sure point is that international transfer pricing will become even more complex than before. For more information, see http://bit.ly/2Lgz6Dd.
Consensus Reached on Related Financial Transactions
MNE Tax is reporting that the OECD Working Party 6, charged with discussions on related party financial transactions, has essentially reached a consensus on all the critical matters relating to the topic (Source: mnetax.com). However, details have not yet been released by the OECD. One of the critical tasks addressed by the working party was how the credit rating of the corporate group as a whole should impact a stand-alone entity, especially when such entities would normally be rated poorly based on its cash flows or assets. Other matters discussed include whether arm’s length debt-to-equity structures should be recognized along with whether domestic law should take priority over the proposed OECD recommendations. At this time, the OECD is aiming to release a final report on financial transactions by the end of the year.