Getting to grips with

BEPS

Action 1

Actions 8-10: Aligning transfer pricing

outcomes with value creation The OECD has recognised the importance of intangibles in

the digital economy. The OECD has emphasised that

entities will earn economic returns based on the value they

create through functions performed, assets used and risks

borne in the development, enhancement, maintenance,

protection and exploitation of intangibles; legal ownership

alone will not determine entitlement to reward.

The framework for analysing intangibles transactions

involves:

• identifying the intangibles used or transferred and the

economically significant risks

• identifying the full contractual arrangements with the

emphasis on legal ownership as a starting point

• identifying the parties performing functions, using assets

or managing risks

• reviewing the legal contracts against the actual conduct of

the group entities

• delineating the actual transaction and determining arm’s

length prices consistent with each parties’ contribution.

Where the actual conduct of the entities differs from the

contractual arrangements, conduct will prevail and the actual

transaction will be deduced from the facts.

Comparability adjustments or adoption of a transactional

profit split method are only required when the intangibles

used are unique and valuable in nature. Where reliable

comparables exist, it is often possible to determine arm’s

length prices on the basis of one sided methods.

Addressing the tax challenges of the digital economy

The OECD recognised that while certain features of the

digital economy exacerbate BEPS risks, it "would be difficult, if

not impossible, to ring-fence the digital economy from the rest of the

economy for tax purposes". As a result, it is not surprising that the

recommendations in relation to the digital economy really just

draw on wider themes and recommendations from other

actions. These include:

Action 7: Preventing the artificial avoidance

of permanent establishment status Action 7 recommends changes to the definition of a

permanent establishment (PE) to prevent the artificial

avoidance of PE status. The recommendations significantly

increase the likelihood that the activities of groups with

international operations (both large and small) will now

constitute a PE in another country where previously they did

not. This applies to both outbound and inbound groups in a

UK context.

Where sales activities meet the new definition of "habitually

concludes contracts, or habitually plays the principal role leading to the

conclusion of contracts that are routinely concluded without material

modification by the enterprise" then a PE will now exist. This is not

intended to apply to limited risk distributors.

The specific exemptions from PE status are now all subject to

the ‘preparatory or auxiliary’ test. An activity that has a

preparatory character is one that is carried on in

contemplation of an enterprise’s activity. An activity that has

an auxiliary character is one that supports an enterprise’s

activity, without being a main part of it.

The OECD provided an example of what it sees as artificial

arrangements within the digital economy. The example was of

an online seller of tangible products or an online provider of

advertising services using the sales force of a local subsidiary

to negotiate and effectively conclude sales with prospective

clients.

.

No new taxes or recommendations unique to the digital economy were suggested by

the Organisation for Economic Co-operation and Development (OECD) but the

door is still open for unilateral safeguard actions.

Action 1: Addressing the tax challenges of the digital economy

Action 3: Designing effective controlled

foreign company rules The OECD recognises that in designing CFC rules,

consideration should be given to rules that target income

typically earned in the digital economy which are at present

typically not subject to taxation, such as income from the

remote sale of digital goods and services.

The final recommendations focus on six key 'building blocks'

that the OECD considers are necessary for domestic CFC

legislation to be effective:

• Definition of a CFC

• CFC exemptions and threshold requirements

• Definition of CFC income

• Rules for computing income

• Rules for attributing income

• Rules to prevent or eliminate double taxation

VAT/GST The OECD commented on the importance of levying

VAT/GST on cross-border transactions and recommends

applying the principles of the previously issued international

VAT/GST guidelines on levying indirect tax on the

destination principle. The OECD recognises that there is a

need for countries to consider the introduction of collection

mechanisms, including the reverse charge, to ensure that

there is a level playing field and that paying VAT/GST

cannot be avoided by exempt businesses who procure

services from overseas.

Door open for a unilateral approach? The report also considers some of the broader tax challenges

of the digital economy including nexus, data and

characterisation of revenue streams. Worryingly, while the

OECD has veered away from recommending economic

nexus (ie having nexus simply as a result of a threshold of

revenue generated from a territory) or withholding tax, it has

stated that countries could still introduce these unilaterally in

domestic legislation as additional safeguards against BEPS,

provided that they still respect existing treaty obligations, or

in their bilateral tax treaties.

Key dates See individual actions for detail on the timetable of implementing key recommendations. It is expected that the development of a multilateral instrument will be concluded by the end of 2016. The OECD has said that it will review new granular tax data from country-by-country reporting and VAT returns to ascertain if additional multilateral action is needed in relation to the digital economy (although this is unlikely to be before 2020).

What next? We recommend a comprehensive review of your systems to ensure they are aligned with all the relevant BEPS actions and they provide sufficient visibility and transparency over your tax and transactional data.

We can provide advice on the growing trend of specific VAT/GST legislation designed to force non-resident suppliers of digital services to register and charge local VAT/GST on sales. We can help you implement scalable solutions to meet the challenges around tax determination and reporting.

Contact Alex Baulf

Indirect Tax Associate Director

+44 (0)20 7728 2863

alex.baulf@uk.gt.com

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