US disappointed with BEPS plan guidance, Treasury officials say

by Julie Martin

The US is disappointed with much of the OECD/G20 base erosion profit shifting (BEPS) plan output, particularly work on permanent establishments (PEs), though it supports efforts on country-by-county reporting, dispute resolution, hybrids, and interest stripping, US Treasury officials said June 10–11 in Washington at the 2015 OECD International Tax Conference, sponsored by the OECD, BIAC, and USCIB,

“Rather than fundamental reform, we got a lot of tinkering around the edges of old rules, and vague and subjective rules, which will empower tax administrators to make out-sized assessments against foreign investors when they think it is in their interest to do so,” said Robert Stack, Treasury deputy assistant secretary (international tax affairs) and lead US delegate to the OECD Committee on Fiscal Affairs.

Stack said he was disappointed that US proposals for fundamental change through a minimum tax did not gain much traction, and said the OECD “should not be proud” of its work on PEs and developing principal purpose tests.

Dependent Agent PEs

Henry Louie, US deputy to the international tax counsel, said the US will seriously consider entering a reservation if changes proposed in a May 15 OECD BEPS draft concerning dependent agent PEs are added to the OECD Model Tax Convention.

The proposal would modify paragraph 5 of Article 5 of the model by extending the dependent agent definition to a person that “concludes contracts, or negotiates the material elements of contracts.”

Louie said the proposal has strayed from the original purpose of BEPS action item 7, which was to address situations where, to avoid a dependent agent PE, a sales force locally negotiates a contract but then sends the contract to another jurisdiction for a “rubber stamp” signing.

He said that although the existing commentary to the OECD model treaty is sufficient to deal with the rubber stamp situation, his counterparts at working party 1 of the OECD Committee on Fiscal Affairs (WP1) were not satisfied with that language, instead settling on a proposal based on option B of the October 31, 2014, BEPS draft on PEs.

Option B, he said, departs “from the spirit of the existing commentary [and goes] beyond it in an unclear way.”

Louie said that stakeholder comments on the draft, particularly examples of situations where the proposed rules go too far, would be “very welcome and useful.”

Danielle E. Rolfes, international tax counsel with US Treasury, also criticized the provision, stating that it replaces an objective standard with an amorphous one. Rolfes said the proposal tilts in favor source country tax administrations because the lack of clarity allows administrations to interpret the provision however they wish.

Rolfes said that WP1 attempts to provide further clarification to the PE rule in commentary have so far proved fruitless because countries have different view of what it means to negotiate the material elements of contracts.

The US believes that clear objective rules can protect source jurisdictions, though drafting such rules is more difficult, she said.

Jesse Eggert, a senior advisor to the OECD BEPS project, acknowledged that countries have different opinions about “exactly what situations need to be captured” by the dependent agent PE rules. Eggert agreed that there is room to provide more clarity to the terms, so all are comfortable with the standards.

Rob Heferen, a deputy secretary at Australian Treasury said that Australia uses language in a number of treaties that refers to negotiation of material elements. Heferen said that Australia has never had any issues with the language.

Bright-line tests do not suit Australia, Heferen said, because while one might craft a bright-line rule that works today, as the world evolves that same rule may no longer work. He also said that bright-line rules often need to be extremely complex.

Preparatory and auxiliary

Huyen Huynh, US Treasury associate international tax counsel, said that the US is “very uncomfortable” with recommended changes to the PE standards which would apply a preparatory and auxiliary facts and circumstances standard to activities that were formerly per se exceptions to PE rules.

“We may not adopt these provisions, or at least reserve if they are incorporated into the model,” Huynh said.

Huynh said the US is concerned about the lack of clarity regarding how to apply a preparatory and auxiliary standard, noting that even the WP1 government officials did not seem to have a good understanding of how to apply it.

The US also questions the policy of burdening business with the requirement to track activity conducted in a jurisdiction and then, if they cross the PE line, imposing more burdensome requirements, such as filing tax returns and registering for VAT, Huynh said.

These are costs which may not be justified given that there is likely to be very little profit attributed to the activities, she said.

Huynh also said that it would be better to obtain consensus on rules for profit attribution to PEs before considering the changes, particularity since the BEPS project includes non-OECD members that may have different ideas about profit attribution to PEs.

Eggert added that further guidance on attribution of profits to PEs will “clearly not happen by September,” when the rest of the BEPS package will be completed, but will be developed as the OECD prepares the multilateral instrument to implement BEPS, due December 2016.

Country-by-country reporting

In contrast to its view of the PE changes, US Treasury is very pleased with the outcome of BEPS work on country-by-country (CbC) reporting, said Stack.

The work on CbC reporting was “an extraordinarily successful effort to use the consensus process at the OECD,” Stack said.

According to Stack, these successes include thwarting attempts to make CbC data public and rules that require multinationals to provide less data than originally proposed, yet enough for countries to do risk assessment; that provide for reporting through use of one uniform template for all countries; and that impose confidentiality requirements on governments that obtain the data.

Stack predicted that CbC reporting will change behavior because companies will not want to show tax administrations out-sized profits in no and low tax jurisdictions.

Rolfes added the US had no option but to pursue agreement on CbC reporting because too many countries were planning to add unilateral CbC reporting rules to their domestic laws.

She also called the OECD CbC work a success, asserted that Treasury has regulatory authority to collect the information needed to implement CbC under existing statutory provisions, and said that it is in best interest of US companies to have CbC information run through the US government.

Though not mentioning it, Rolfes and Stack appeared to be responding to criticism leveled by Senate Finance Committee Chairman Orrin Hatch (R-UT) and House Ways and Means Chairman Paul Ryan (R-WI) in a June 9 letter to Treasury Secretary Jack Lew.

Hatch and Ryan said Treasury should have consulted Congress before it agreed to share CbC reports with foreign countries and before it agreed that foreign governments could collect master file information from US multinationals. The lawmakers also questioned Treasury’s regulatory authority to collect CbC information and asked for written follow up on this issue.

Interest deductibility

Stack also said the US approves of the BEPS work on interest deductibility, calling it “a potential bright spot” in the project. He said he is not swayed by arguments that the interest deduction limits run counter to the arm’s length standard.

Stack confirmed statements made by OECD officials on June 8 that the current favored approach for preventing excessive interest deductions is to allow a resident company to take deductions up to a fixed percentage of EBITDA, but in the event the multinational group’s third party debt leverage ratio is higher than that fixed amount, to allow the company to use the higher percentage and deduct the greater amount of interest.

Stack said that the goal is to set the percentage for the fixed ratio high enough so that most domestic companies can use it.

Doug Poms, Treasury acting deputy international tax counsel, said that country officials working on the interest deductibility guidance have been studying data in an attempt to determine a range of acceptable percentages for the fixed ratio.

Poms said review of a comprehensive study commissioned by BIAC shows that from 2004–2013, if the fixed ratio was set at 10 percent, about one-third of large cap companies would fail the test and need to rely on a group ratio test. “The US thinks is a good place to hit as a mark,” he said.

“We are not saying that the fixed ratio is going to be 10 percent, we are just saying that the data was supportive of coming to that conclusion,” Poms said.

Poms also said that the countries working on the interest deduction project are trying to establish more unified rules, such as reaching agreement on whether the basis for the group ratio test should be earnings or assets.

Multilateral instrument & dispute resolution

Rolfes said that while the US is not one of the countries involved in drafting the multilateral instrument, that does not mean the US would not sign the agreement.

That said, there is not much in the multilateral instrument that the US is interested in right now.

Rolfes said that the US already has provisions in its treaties dealing with treaty abuse, and has no intention of changing them.  Also, as mentioned, the US does not approve of the approach being taken to modify the PE rules.

The US is “passionately engaged” in the work on mandatory binding arbitration, though, Rolfes said, and fully intends to participate in that work.

Rolfes said that if the final product on mandatory binding arbitration appears to be something the US Senate Foreign Relations Committee will accept, the US may be willing to agree to it.

Grace Perez-Navarro, deputy director of the OECD Centre for Tax Policy & Administration noted that there has been little uptake of the arbitration provision in Article 25 of the model tax treaty.

“So, the discussion has been around how we can have an effective mandatory binding arbitration provision that is a bit less than [the provision in the model treaty] but still provides meaningful dispute resolution,” she said.

Perez-Navarro also said WP1 is in the process of developing guidelines on minimum standards for countries’ dispute resolution practices and as well as objective standards to monitor the implementation of those standards. She said that WP1 is considering a system whereby an assessment of countries’ progress on implementation of the standards would be reported to the G20.

– Julie Martin is a US tax attorney and a member of MNE Tax’s editorial staff.

Related MNE Tax articles:

• US lawmakers say Treasury must consult Congress on BEPS plan, transfer pricing documentation

• OECD BEPS project to provide for binding arbitration of tax disputes, limits on interest deductibility

• OECD releases revised BEPS discussion draft on avoidance of PE status

• Countries agree on BEPS measures for country-by-country reporting, IP regimes, multilateral instrument