With BEPS looming on the horizon, James Badenach, International Tax Services Leader, Asia Pacific Financial Services, EY, explains what impact it will have on corporate treasury.
The OECD Base Erosion Profit Shifting (BEPS) Project brings unprecedented change to international and domestic tax landscapes globally. This will have an impact across many departments within multinational corporations, particularly the treasury and tax functions.
In an Asian context, responses to BEPS vary significantly across the region, so corporate treasurers will need to be prepared and stay on top of all the changes.
Uncertainty and inconsistency
BEPS will have a significant impact on treasury activities, particularly in terms of the structuring of cross-border intragroup funding arrangements, the mix in capital structure, the types of financial instruments used and the location of treasury entity.
“Intragroup lending through intermediate entities in treaty jurisdictions with limited substance is not uncommon for Asian investments,” says James Badenach, International Tax Services Leader, Asia Pacific Financial Services, EY. “For example, we have seen the use of Mauritius structure to fund Singapore investment. Going forward, with principal purpose test (PPT) in Action 6 being included in tax treaties, treaty benefits may be denied if the intermediate entity does not have substance to actually manage the risk booked in the entity and an appropriate amount of capital.”
A fundamental issue in Asia is the plethora of domestic anti-abuse approaches leading to uncertainty and inconsistency in the application of tax treaties. The hope is that PPT will eventually bring consistency to the application of treaties, creating greater certainty. “However, as we look to domestic law and practice for guidance on how a PPT may be interpreted by a country, we see significant divergence in interpretation,” says Badenach. “Corporate treasurers should be conscious of this divergence and map out their current financing footprint.”
The interest limitation rules under Action 4 aim at limiting excessive tax deductions on interest and other financial payments, which will inevitably have an impact on internal gearing/capital structure and reduce the tax benefits of existing financing arrangements. “Historically, Asian countries commonly used thin capitalisation rules to limit excessive interest deduction on related party debts,” explains Badenach. “With BEPS, we have seen some Asian countries now considering a more general interest limitation rule.”
Badenach adds that in the past the use of hybrid financial instruments may have resulted in a deduction/non-taxation outcome due to inconsistent tax treatment across jurisdictions. “Action 2 aims to counteract such tax arbitrage, so corporate treasurers will need to re-examine the tax consequences of using hybrid instruments for financing purposes.”
Substance and treasury
Many Asian jurisdictions, including Singapore, Hong Kong, Malaysia and China, provide tax incentive regimes for corporate treasury activities. Tax preferential regimes for economic mobile activities such as treasury are currently under review by the OECD to ensure they are not harmful tax practices. “The elevation in importance of the substantial activity requirement in assessing whether a preferential regime is potentially harmful is expected to increase the substance requirement that a country requires for the eligibility of the regime ,” says Badenach. “Corporations currently benefitting from these types of regimes, or considering centralising the treasury function in countries offering them, should keep an eye on the outcome of the review.”
From a transfer pricing (TP) perspective, the use of zero-interest loans for related party financing may no longer be sustainable in the post-BEPS environment. There will also be increased compliance costs due to the more comprehensive TP documentation requirements under Action 13. This is particularly relevant given the differing approaches to local implementation of Action 13 across Asian countries.
Plan to respond
Corporate treasurers in Asia will need to consider a comprehensive plan to respond to and comply with BEPS standards and related local tax law changes.