An OECD discussion draft scheduled to be released this week includes a proposal to put limits on an MNE’s net interest deductions based on worldwide net third party interest expenses, OECD officials said December 15 during a webcast updating work on the OECD/G20 base erosion and profit shifting (BEPS) project.
Officials also said that the OECD intends this week to release BEPS discussion drafts on transfer pricing risk and recharacterization, transfer pricing aspects of commodity transactions, the use of profit splits in the context of global value chains, and improving the effectiveness of dispute resolution.
Further, officials provided an update of the progress on other BEPS action items, and discussed the OECD’s efforts to include developing countries in the BEPS process.
Interest deduction limits
Achim Pross, OECD head of the International Cooperation and Tax Administration Division, said that an OECD draft under action 4 of the BEPS plan, to be released in the next few days, will recommend that governments limit MNE interest deductions through either a group-wide test, a fixed ratio test, or through some combination of the two tests.
Under the group-wide test, a company’s net interest deduction would be limited to a proportion of the MNE group’s net third-party interest expense. The deduction would be allocated among countries based on a measure of economic activity, such as earnings or asset value, Pross said.
Pross said that the method achieves two objectives: “you give companies the deduction equal to the real cost of funds, [namely,] what is actually paid to third parties, while at the same time you protect countries from excessive deductions.”
He added that if a group-wide test is adopted, companies can continue to centralize their borrowing activities in a single location to gain efficiencies, but interest deductions would be matched with economic activities.
A second approach recommended in the guidance, the fixed ratio test, would operate by applying a fixed benchmark ratio to an entity’s earnings or asset value. Pross noted that many countries currently use variants of this approach to limit interest deductions, and said that a benefit is that it is more straightforward for groups and tax authorities.
A downside of a fixed ratio test, though, is that the same benchmark ratio applies to all entities and sectors irrespective of their third-party debt. He said it is also difficult to determine what the correct benchmark should be.
Pross said that data suggests that some countries that currently restrict interest deductions based on a fixed interest/EBITDA ratio may be setting the ratio too high, not effectively combating BEPS. He said that a review of the 79 largest companies (excluding financial companies) showed that virtually all had net interest expense/EBITDA ratios of 20 percent or less with respect to borrowing from third parties, and most had ratios below 10 percent. Those ratios are lower than the ratios typically set by countries that seek to limit excessive interest deductions, he said.
The OECD is also exploring the idea of using a combination of the group-wide and fixed ratio tests, Pross said. For example, one approach would be to have a group-wide test as the main rule coupled with a safe harbor that applies a low fixed ratio. Alternatively, the fixed ratio test could be the main rule, paired with a rule allowing greater interest expense deductions under a group-wide test.
Other BEPS projects
Marlies de Ruiter, OECD Head of Tax Treaty, Transfer Pricing, and Financial Transactions, said that guidance on implementation of country-by-country reporting rules will be provided as early as February 2015.
The OECD is working on determining when the first country-by-country reports should be filed, de Ruiter said. She noted that BEPS guidance on country-by-country reporting specifies that before 2020 the country-by-country standards will be reviewed by the countries participating in the BEPS project. “We will need to have a couple of years of experience before then,” and this will effect the timing of the first reports, she said.
De Ruiter also said that the OECD is still considering excluding small and medium sized entities from the requirement to file, but has made no decision yet.
She acknowledged that developing countries have a “huge interest” in receiving country-by-country reports, and in receiving them quickly. The intention is to make the reports available to all governments that need them and that commit to consistency, confidentially, and the appropriate use of information, she said.
Responding to audience questions, Pascal Saint-Amans, OECD Director at the Center for Tax Policy and Administration, defended OECD work on harmful tax regimes which requires “compulsory spontaneous” of private rulings of harmful regimes. He was asked why the OECD did not support automatic exchange of all tax rulings.
Saint-Amans said that that compulsory spontaneous exchange of rulings is the same as automatic exchange. He also said that it is more beneficial for tax administrations doing risk assessment to receive selected, targeted, information as opposed to being deluged with all of a tax administration’s private tax rulings. “We can trust our governments — the G20, OECD governments — to make sure that the relevant information comes to them,” he said.
De Ruiter added that companies must disclose the existence of rulings relating to transfer pricing in both the global master file and the local file, so tax administrations will have this second method of being apprised of private rulings.
Saint Amans agreed, stating that this mechanism will allow countries to monitor if their partners properly exchange information.
Developing nation input
Saint-Amans said that the OECD is giving developing nations voice in shaping the BEPS output, permitting countries to participate in OECD Committee on Fiscal Affairs (CFA) working parties. The developing country members, though not legally on an equal footing with other members, will be heard in practice, Saint-Amans said. “We will make sure that we do not move forward if they do not agree,” he said.
The developing countries participating in the BEPS process are Albania, Bangladesh, Jamaica, Kenya, Morocco, Nigeria, Peru, The Philippines, Senegal, and Tunisia.
Saint-Amans also said that two people have been hired to ensure that developing countries’ views are represented in the CFA and working parties.
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