Daily Tax Report ® Reproduced with permission from Daily Tax Report, 178 DTR J-1, 9/15/14. Copyright 姝 2014 by The Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com P r o fi t S h i f t i n g Clark Chandler, Stephen Blough and Michael Plowgian of KPMG write that the OECD guidance on base erosion and profit shifting expected Sept. 16 will affect U.S. multinationals regardless of whether changes in U.S. rules or practices result. Beyond simple compliance with local law changes for MNEs’ foreign operations, also likely to be affected are transfer pricing, intangibles ownership and other aspects of global operations. Why U.S. Multinationals Need to Care About BEPS Even if the U.S. Doesn’t Change Anything BY CLARK CHANDLER, STEPHEN BLOUGH AND MICHAEL PLOWGIAN he Organization for Economic Cooperation and Development (OECD) is scheduled Sept. 16 to release specific guidance with respect to various base erosion and profit shifting (BEPS) initiatives (transfer pricing documentation, intangibles, hybrid instruments, treaties). It is entirely possible, however, that there will be few—or no—changes in U.S. regulations or practices as a result of this, which raises the obvious question: Why should U.S.-headquartered multinational enterprises (MNEs) be focused on BEPS? T Clark Chandler is a principal in and Stephen Blough is the principal-in-charge of the Economic and Valuation Services-Transfer Pricing group in KPMG LLP’s Washington National Tax office. Michael Plowgian is a principal in the International Tax group of WNT. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP. COPYRIGHT 姝 2014 BY THE BUREAU OF NATIONAL AFFAIRS, INC. The short answer is that the OECD’s BEPS guidance is likely to have a significant impact upon U.S. MNEs with overseas operations, whether or not the U.S. acts. Moreover, this impact goes beyond the simple observation that the foreign operations of MNEs will obviously have to comply with changes in the local laws of the countries in which they operate. The changing direction of transfer pricing documentation provides one example of this effect. Historically, transfer pricing documentation rules required a company operating in Country X to provide the tax authorities of Country X with the information needed to support its local intercompany transactions. There was no presumption that the local controlled foreign corporation or branch would, as a matter of course, provide the tax authorities with detailed information on the overall global operations of the MNE when that information wasn’t relevant to the transactions at issue, especially if that information was only available to the headquarters company. Changes in foreign regulations can be expected to have a significant impact upon tax planning even if there is no change in U.S. rules. The new guidance expected to be issued by the OECD would fundamentally change that paradigm. The ISSN 0092-6884 2 tax authorities in Country X will be presumed to have the right to obtain data on profits in all the countries in which the MNE operates, and to be provided with an understanding of the MNE’s overall approach to managing intangibles ownership and its overall intercompany financing—regardless of the size and nature of its operations in Country X and regardless of whether this information is available to the legal entity operating in Country X. As a result, at least conceptually, an MNE will be obligated to prepare this information as soon as any country in which it operates adopts the new OECD guidance on documentation. More practically, MNEs will be forced to prepare this documentation if several countries in which they have material operations adopt the new OECD guidance. And while the U.S. may lag in adopting the new rules, there are a number of major European countries that are expected to be very quick early adopters. Finally, as a practical matter, once tax examiners know that this information has been provided to a number of tax authorities, it may be difficult for companies not to provide the same information when asked. Even if providing the information isn’t required under local law and even if there is no local legal obligation, refusing to provide a local tax inspector with information that the tax inspector knows exists and knows is provided to other tax authorities may adversely affect the overall relationship between the taxpayer and the local tax inspector. Beyond Documentation The impact of the BEPS project goes well beyond documentation. A substantial part of international tax planning involves using differences in the rules that apply in different countries to create either legal entities that have different attributes in different countries (planning around U.S. check-the-box rules) and creating other arrangements that are treated one way in one country and a different way in another country (e.g., hybrid debt instruments). A large focus of the BEPS initiative is to make such planning more difficult or impossible, and the guidance coming out Sept. 16 is expected to adopt various rules targeted at such planning. A key feature of some of these rules is that they will, in effect, allow enforcement by either country: If Country A doesn’t require the inclusion of interest income that it receives from a hybrid instrument, then Country B would be allowed to deny the deduction of such inter- 9-15-14 est. Once again, there is no need for the U.S. (or Luxembourg, the Netherlands or Switzerland, for example) to change its rules; all that is required is for one of the two countries involved in the transaction to adopt the new guidance. As with the transfer pricing documentation guidance, we can expect a number of countries to be early adopters, and indeed some countries (Mexico, France) have pursued rules targeting hybrid mismatches in advance of the OECD guidance. Finally, there are the expected changes in the rules around intangibles. The evaluation of which legal entity is entitled to earn income from intercompany transactions has typically focused on an analysis of functions, assets and risks. In this regard, tax planning has generally been based on the assumption that, within certain limits, the remuneration of the performance of functions could be separated from the remuneration of financial and intangible assets and the assumption of risk. This assumption is being actively challenged by a number of tax authorities, and the new guidance issued by the OECD (both Sept. 16 and, more importantly, in the guidance that is expected in 2015) can be expected to place important restrictions on MNEs’ ability to split the performance of functions from the ownership of assets and the assumption of risk. While there is a substantial amount of uncertainty as to how far this shift will go, and while there is a reasonable chance that this won’t lead to a change in U.S. rules, there is every expectation that a number of foreign tax authorities won’t only adopt the new OECD guidance on intangibles, but also will interpret that guidance in a way that makes it much more difficult to provide a significant return to financial/intangible assets and risks without housing a significantly higher level of control and other functions in the legal entity realizing such returns. Once again, changes in foreign regulations can be expected to have a significant impact upon tax planning even if there is no change in U.S. rules. The above description of the potential impacts of the OECD guidance around BEPS is incomplete—changes concerning treaties, potential changes in views on permanent establishments and the digital economy, and changes in competent authority and international dispute resolution are also expected. All these changes may also have an important impact upon a number of MNEs. The core message, however, is that these changes will have a significant impact upon U.S.headquartered MNEs regardless of whether or not these changes are embraced by the U.S. COPYRIGHT 姝 2014 BY THE BUREAU OF NATIONAL AFFAIRS, INC. DTR ISSN 0092-6884