BEPS: FATCA on Steroids or Much Ado About Nothing?

By now, most CPAs have heard of FATCA (Foreign Account Tax Compliance Act), which requires foreign financial entities to report information on their U.S. account holders to the IRS. In return, the U.S. (in some cases) is sharing information on accounts held in this country by foreign nationals with the individual’s home country. The goal of this information sharing is to ensure that individuals are reporting all their income properly and paying the appropriate amount of tax.

Now the focus is shifting to tax avoidance by multi-national businesses. In early October, the Organization for Economic Co-operation and Development (OECD) released the final reports from their two-year project targeting Base Erosion and Profit Shifting (BEPS) activities. BEPS occurs when businesses take advantage of differences in countries’ tax laws, tax treaty provisions and (occasionally) special arrangements with a local tax authority to minimize their total worldwide tax liability. Some of the ways businesses do this include:

Hybrid or reverse hybrid entities to take advantage of differences between various country laws to subject certain types of income to no taxation;
Patent or innovation boxes – applying reduced tax rates to income earned from intangibles; and
Earnings stripping – allocating expenses to a high tax jurisdiction and income to a low-tax jurisdiction.

The OECD brought together over 80 countries to develop reports on 15 action items intended to address these and other issues to hopefully level the playing field in international taxation of business. In some areas, the final reports proposed either new or updated minimum standards. For other action items, the OECD report only suggested a set of best practices. In the remaining cases, further study or negotiations will be required. While U.S. businesses will be impacted by all 15 action items, the ones with the greatest potential impact, as explained below, are included in those facing further negotiations.

Privacy Concerns Mount

The highlight for large multi-national businesses is known as “country-by-country” reporting. Required for fiscal years beginning on or after Jan. 1, 2016, these reports will contain information on a company’s revenues, profits, taxes, capital, employees, assets and other data for each country in which they operate. Companies will file these reports with their home countries’ tax agency and the tax agency will share them with all the other countries in which the company operates.

Many companies have already expressed concerns about whether this information will be kept confidential or even shared with state-owned foreign competitors. Late in November, the European Parliament passed a resolution requiring country-by-country tax information be made public. The European Commission and most European counties’ tax agencies oppose the public disclosure of such sensitive information. It remains unclear how this dispute gets resolved.

In the U.S., the Department of the Treasury has promised to release regulations implementing this reporting requirement for U.S. multi-nationals by the end of 2015. The first reports, covering 2016 operations, are expected to be due Dec. 31, 2017.

Of greater significance to small businesses who are operating overseas (or considering doing so) are:

Tougher standards on transfer pricing rules;
Limitations on using treaty benefits to avoid taxation in any country for certain income (known as “double non-taxation”); and
Recommendations designed to make it more difficult to operate in a country without being subject to their tax laws (the “permanent establishment” rules).

Largest Impact on US Business? Dispute Resolution

In the long run, other BEPS action items that will also likely have a material impact on all U.S. businesses are Action 14 on dispute resolution and Action 15 on a Multilateral Instrument. The negotiations on the multilateral document are intended to allow for easy and mass incorporation of the various tax treaty-related BEPS provisions into existing tax treaties. Rather than requiring each set of countries to modify their bilateral document, the goal is to have a significant group of countries all agree to this master treaty. The target date for completion of a draft is the end of 2016, an aggressive timetable for such a complicated document. Whether the final product will take an “all or nothing” approach or allow countries to pick and choose different modules is an open question.

The U.S. is participating in the negotiations for the multilateral document, although it is a virtual certainty that they will not be an eventual signatory. This is largely because many of the new OECD provisions already exist in most of the U.S’s bilateral treaties. The principal reason that the U.S. is participating is to advocate for inclusion of a strong dispute resolution provision and binding arbitration (Action 14).

The U.S. is one of 20 countries that have committed to require binding arbitration, but many key parties (such as India) strongly oppose it. Many feel that the new standards on transfer pricing and permanent establishment status will result in a significant uptick in disputes between countries on where income should properly be taxed. Without mandatory arbitration, nations and companies fear that disputes will stretch out for years and/or result in unfair double taxation to businesses.

The AICPA’s Tax Advocacy Team will be closely monitoring regulations issued by the IRS or Treasury implementing any portions of the BEPS action items. It will also keep watch on any possible congressional action. Many members of Congress believe the IRS and Treasury lack the authority to require U.S. multinationals to follow some of the BEPS requirements. As a result, there is the potential for legislative action that either provides the needed authorization or prohibits U.S. tax authorities from taking certain steps.

However, regardless of any action or inaction by the U.S., as other countries implement BEPS action item recommendations, the cost and complexity of international tax compliance for U.S. businesses is guaranteed to increase.

To learn more about BEPS, access the Joint Committee on Taxation report, which provides background information and a summary of the implications for the United States.

Jonathan Horn, CPA, CGMA, Lead Technical Manager-Taxation, American Institute of CPAs.

Arbitration courtesy of Shutterstock.

Gavel courtesy of Shutterstock.