Although the Organisation for Economic Co-operation and Development (OECD) has called its project to prevent base erosion and profit shifting (BEPS) the most significant change in cross-border tax policies in 100 years, it might be more accurately called the most significant such change in history.
The rise of tax treaties spurred by the League of Nations almost a century ago affected only tax liabilities.
“It is increasingly clear that a company’s tax position can have a significant PR impact. Conversely, a company’s public information can have a significant impact on the company’s tax position.“
Alex Postma, EY Global International Tax Services Leader
The BEPS project, on the other hand, will not only affect tax rules but also impact the tax function itself and may trigger tax consequences in almost any nontax aspect of business operations.
The potential effects — and related risks — are almost limitless.
The uncertainties also seem almost limitless.
To date, OECD-inspired BEPS-driven legislation has been enacted in relatively few jurisdictions, so it is still unclear what legislation will be enacted where or when or how tax authorities will interpret changes.
On the other hand, a number of countries enacted their own legislation even before the OECD BEPS action items were finalized, such as the UK’s Diverted Profits Tax.
Another unknown is what public disclosures might be mandated, such as a recent EU draft directive.
Watching and waiting
Given so many uncertainties, some companies are taking a “wait and see” approach.
While this may avoid inefficiencies and extra costs, it could lead to more dramatic changes being forced on them in the future, with timetables dictated by tax authorities.
Taking a strategic approach instead, by assessing and planning for the impacts of the BEPS recommendations, will allow companies to better navigate a new environment likely to be marked by more tax controversy and greater exposure to risk in more areas than ever before.
The early birds
Companies that began preparing early for these changes have found the effort unquestionably valuable.
One such area is country-by-country (CbC) reporting, which is intended to apply to multinationals with revenue over €750 million and is required in a growing number of jurisdictions.
Companies report that significant time and resources were needed to put CbC reporting in place.
“Implementing CbC was our most challenging effort,” says Susana Bokobo, Global Head of Tax Institutional Relations for Repsol, an integrated global energy company based in Madrid.
“Just making the necessary IT changes was a huge project because of all the lines that accounting systems have and because of the need to interpret what the CbC line items mean and apply that meaning to business.”
Getting CbC reports and related master and local file requirements right is more than just a compliance exercise, since the purpose is to help tax authorities prioritize which companies to audit and more easily identify potential issues.
“MNCs [multinational corporations] are advised to do a dry run of the data,” says London-based Jay Nibbe, EY Global Vice Chair Tax, “and look at the results from a tax strategic and tax controversy point of view, applying the sorts of evaluation criteria that the tax authorities around the world will likely use.”
The potential implications of the BEPS project go far beyond CbC reporting.
Companies that have already looked at their businesses through a BEPS reform lens say the effort has been valuable in identifying areas that may need to be addressed, even if cross-border transactions have always been consistent with business substance and arm’s-length pricing.
“For example, BEPS has changed the view of transfer pricing and the value chain, hybrids and permanent establishments,” says Bokobo, “so we have been evaluating the impact of these areas, as well as all the other BEPS action items.”
Catherine Henton, VP Tax of Sanofi, a global pharmaceuticals firm based in Paris, adds: “I would imagine that many companies are confronting their tax strategies in light of the content of many BEPS actions, and Sanofi is no exception. We are, even if we haven’t finished yet.
“We are also revisiting transfer pricing, and we’re simplifying cross-border transactions so that fewer entities and countries will be involved in order to minimize the number of jurisdictions involved in potential future litigation as BEPS is implemented.”
The tax implications of the BEPS project may play out across almost all aspects of a multinational’s operations, from every stage of the supply chain to the way MNCs value intellectual property.
One high-profile area is transfer pricing.
Companies must assess whether the allocation of profits to business functions is in line with the new guidelines and, if there are discrepancies, assess the risk of challenge. Another issue is whether companies should consider a global view of transfer pricing, especially in light of information sharing under BEPS.
“While differences in products and markets may in some cases justify differences,” says Alex Postma, EY Global International Tax Services Leader, based in Tokyo, “those differences will attract attention and there will be growing pressure to justify them.” However, he says, “many differing interpretations of guidelines are expected, so the desire of companies to be consistent may not be as easy to achieve as they would wish.”
Sanofi’s Henton points out another challenge related to transfer pricing.
“The intent of the guidelines is to mimic what third parties will do, but for multinationals, many functions are globalized and verticalized. One significant challenge ahead is the degree of granularity that seems to have been retained in the Actions 8–10 analysis when compared to the delineation of strategic vs. operational roles within our global functions,” Henton says.
“In our view, a level of granularity that is too low would expose MNCs to one-sided interpretations that will lead to an increase in controversy, not based on pricing but on the characterization of the parties to a transaction. As with other elements of BEPS, it is critical that additional guidance is provided during the interpretation and implementation phases of the project. The OECD has said a group will monitor interpretation, but it does not have the power to prevent any jurisdiction from having its own interpretations.”
She also notes that it is also important to hire the right people to address the BEPS recommendations.
“For transfer pricing,” she says, “we are hiring people with enhanced economic and value chain capabilities and that are familiar with transfer pricing controversy.”
“We used to deal with controversy more or less country by country, but now companies need to think about controversy on a global basis, which is a fundamental change in approach.“
Mat Mealey, EY EMEIA Leader of International Tax Services
Many company functions have not received as much attention as transfer pricing when it comes to the BEPS project, but are equally important.
One such area is the global workforce, since consequences of some BEPS recommendations can impact people:
- What they do
- When they do it
- Where they do it
For example, as a result of the lower permanent establishment (PE) thresholds proposed by the BEPS project, many companies will need to look more closely at their entire internationally mobile workforce population, says Ingo Todesco, EY Mobility Services Leader for Germany, Switzerland and Austria based in Düsseldorf.
Todesco explains, two popular groups of international employees particularly can inadvertently trigger a PE: frequent business travelers and workers who physically remain in a single jurisdiction but who have certain cross-border responsibilities.
Additionally, in terms of substance, multinational organizations need to verify that the right people are doing the right work at the right place to avoid the risk of adjustments to income allocation.
- Organizations need to develop processes, proper documentation and a governance structure with clearly defined roles and responsibilities for their global workforce.
- Employees need to understand what activities they can or cannot perform in different jurisdictions.
- It is also important to develop a mechanism that tracks where employees are working and when, and what they are doing.
- If tracking systems are in place, they should flag when an employee is reaching relevant risk thresholds and those thresholds should be BEPS-ready.
With BEPS reforms and other pressures for more disclosure comes greater reputational risk.
“We are going through a paradigm shift in international tax,” says Postma. “It is increasingly clear that a company’s tax position can have a significant PR impact. Conversely, a company’s public information can have a significant impact on the company’s tax position. In my view, boards need to actively develop a tax strategy that is integrated in all other aspects of their business.”
Coordinated, well-considered communication is also key. Mat Mealey, EY EMEIA Leader of International Tax Services, points out that all companies need a communication strategy around taxation that clearly articulates how their approach to taxation works globally and that also emphasizes the other ways that they contribute to the countries that are stakeholders for them.
Although the BEPS project was intended to create more consistency in cross-border taxation, the potential for some inconsistency is embedded in BEPS itself because some technical areas were structured as a menu of options for jurisdictions to choose from.
Legislation is also expected to be inconsistent across jurisdictions for other reasons.
One is that it is “difficult to realistically expect a country to surrender its national interest because of a world interest,” says attorney David Rosenbloom, Director of the International Tax Program at New York University School of Law, and former International Tax Counsel and Director of the Office of International Tax Affairs in the U.S. Department of the Treasury.
One of the most important things MNCs can do for now, he and others say, is to know what is in the OECD action plans and monitor on a real-time basis what is being said about next steps to be able to react on a timely basis.
Companies can also expect more tax disputes.
“The environment is much more difficult and demanding than pre-BEPS,” says Mealey.
“Countries feel enabled by the changes to tackle controversy more aggressively and effectively than before, one country’s actions will affect another’s and there is a huge increase in information exchange. We used to deal with controversy more or less country by country,” says Mealey, “but now companies need to think about controversy on a global basis, which is a fundamental change in approach.”
An effective approach to a post-BEPS environment also depends on a robust tax function.
Adequate automation is needed since tax information preparation increasingly relies on company systems and service providers, says Postma.
The optimal position for CbC reporting is to have system-generated data, and the BEPS recommendations provide the tax function with an opportunity to create a compelling business case to improve systems and data to mitigate risks and streamline the CbC process.
The value of centralizing
There is also a growing need to centralize the tax function, Postma says.
One reason is that effective automation requires a coordinated approach.
Centralization also promotes consistency, which will become significantly more important because of increased transparency, information sharing and controversies involving multiple locations.
For example, he says, “The increased flow of information to tax authorities will give rise to questions as they try to understand how different data points connect, and it is important that the picture they put together conforms to the enterprise’s own interpretation. The more those align, the less controversy there will be. Creating this alignment requires thoughtful and thorough consideration of a company’s tax information strategy.”
Effective ongoing communication between a company’s tax leaders and operations people, the C-suite and the board is also essential.
A paradigm shift
The strategic issues that arise from eradicating BEPS are extensive, from an evaluation of the impact of the BEPS recommendations on the business environment and the business model to matters such as management of reputation and brand and even decisions about acquisitions and divestitures.
To effectively anticipate, implement and manage these diverse issues, a proactive, strategic approach is essential.
The environment has changed and the stakes are high.
Key action points
- Drive the ownership of BEPS issues at a centralized level
- See that all internal stakeholders communicate and coordinate
- Understand the impact of BEPS changes on the overall business
- Understand the impact of BEPS reforms compared with competitors and peers
- Have a clear communication strategy to external stakeholders about the company’s approach