The idea is that profits should increasingly be taxed where the economic activity actually takes place. The OECD has identified the key issues in a total of 15 main areas to be addressed, which it terms “actions.”
To date, 44 countries accounting for some 90% of global output have signed on to the BEPS project. In addition to the OECD member states, their ranks include major emerging economies such as China, India, Brazil, and Russia. The OECD has already published reports on seven of the 15 total action items, and these have been unanimously embraced by the participating countries. Reports and recommendations on the remaining actions are expected to be completed by the end of 2015.
In particular, the effort to introduce country-by-country reporting, the rules on hybrid mismatch arrangements, and the anticipated expansion of the definition of what constitutes a permanent establishment will be of practical relevance for German companies doing business internationally.
Country-by-country (CbC) reporting is an effort by tax authorities in various countries to obtain much more information than before about the business relationships of multinational enterprises in each country. The key data here concerns the distribution of profits, taxes, employees and the functions they carry out in individual countries, along with information about an enterprise’s capital and assets. The required information for CbC reporting can generally be derived from the existing reporting processes in place at companies or in corporate groups. The companies affected by this rule must allow sufficient time to determine the extent to which the required data is actually available. Moreover, the data must be reconciled with existing transfer pricing documentation to avoid inconsistencies.
There are already noticeable signs in Germany that certain BEPS topics have caught the attention of federal lawmakers. German tax law already includes rules on hybrid mismatch arrangements that exploit (legal) tax advantages arising from differences in the tax regimes of various countries. These will be spelled out in greater detail this year. The OECD aims to prevent double non-taxation or double deductions of business expenses in two countries by using linking rules to make taxation in one country dependent on the tax treatment of the transaction in the other country. As a rule, business expenses associated with a hybrid financial instrument will then no longer be deductible in the source country if the corresponding income is not reported for tax purposes by the recipient of the payment in the other state. Identifying and documenting these cases will substantially increase the effort required to calculate and declare taxes.
The country in which a permanent establishment is located generally has the right to tax the profits generated by that permanent establishment. In most cases, the state in which the parent company is located exempts from tax the profits generated by the permanent establishment. This is the approach taken by many current double taxation treaties based on the OECD Model Convention. Now, the OECD is working on ways to prevent the artificial avoidance of permanent establishment status. In the current discussion draft dated October 31, 2014, the OECD favors expanding the definition of a permanent establishment. It also calls for narrowing the set of circumstances allowing for exceptions. If this view is in fact accepted by the countries participating in the Action Plan on BEPS and finds its way into the wording of individual double taxation treaties, then business activity abroad would be classified as a permanent establishment more frequently than before. Companies that conduct their business abroad through independent representatives or using commission structures would be particularly affected.
If the OECD rules are transposed into national law, there is also a risk that German lawmakers would be interested principally in one-time domestic taxation or even in adding a new tax base. The most recent foray into this territory here in Germany was made by the Bundesrat in the 2015 Annual Tax Act, which contains a prohibition on deducting business expenses that, as worded, goes far beyond what is suggested by the OECD. This rule has not (yet) been approved by the federal government. However, the discussion during the legislative process indicates that BEPS is already a high priority among the lawmakers deciding tax policy in Berlin. As early as 2013, Germany’s legislative branch pressed ahead with specific measures in the same vein as the OECD’s recommendations - although not yet under the official banner of BEPS - such as making the recognition of losses within a domestic consolidated tax group dependent on the loss not reducing taxes abroad. In view of the international negotiations continuing at full steam, additional moves such as this can be expected shortly.