This issue’s question

“How should corporate treasurers in Asia be responding to BEPS?”

The complexities associated with BEPS implementation call for deployment of an effective risk management strategy by global organisations. There are many unknowns around BEPS implementation which give way to potential inconsistencies in application of OECD recommendations, despite timelines assigned to actions such as country-by-country reporting. Even if businesses are currently compliant with guidelines, the rapidly changing tax landscape poses risks which treasury departments need to be cognisant of.

Many corporations have historically focused on booking profits in lower tax jurisdictions, which BEPS now makes transparent. In order to tell a reasonable story to explain where profits are booked, treasurers should gain a stronger understanding of customers and supply chain. BEPS may also affect the acquisition or investment plans of an organisation given the changing tax treatment of cash flows. Treasurers may, therefore, need to change their operational structures to better align with the initiative.

Asian organisations often operate in a decentralised way which further heightens the risk given the large amounts of data required to comply with BEPS, being with overseas operations. Relying on consolidated data formats may hide underlying challenges and to mitigate this risk, new tools and technology are required to enable organisations to operate effectively within existing frameworks.

Given this, treasurers must develop a better understanding of funding transactions and the intricacies of the BEPS recommendations pertaining to financing activities, which means working cross-functionally with different teams within the company.

Treasurers must also gain better control of data, as information-gathering and production will need to be done more quickly as requests for homogenous information move towards an on-demand model. This is where tax technology can help align stakeholders and information providers and enable businesses to effectively cope with the regulatory changes. Treasury departments must start partnering with relevant technology providers that can help, with the right tools, to ensure compliance and increase efficiency.

Without proactive management, the increased level of scrutiny on funding transactions posed by BEPS could impact a group’s effective tax rate. At the same time, having ready data visibility could provide significant insight for not just the treasury department, but also the company’s strategic decision-makers. Corporate treasurers should not underestimate the amount of work to be done and should start planning now in order to successfully mitigate financial risks, reduce administrative burdens and take pre-emptive actions as required.

The BEPS Project brings unprecedented change to international and domestic tax landscapes globally. This will have an impact across a number of 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. 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. 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 a 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. 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. With BEPS, we have seen some Asian countries now considering a more general interest limitation rule.

In the past, using 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.

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. 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.

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.

Michael Velten

Asia Pacific Financial Services Industry Tax leader

Deloitte

Benny Koh

Southeast Asia Treasury Advisory Leader

Deloitte

What does BEPS seek to achieve?

The OECD BEPS recommendations are now being implemented by domestic tax authorities; including in Asia. There are 15 BEPS Action items. With respect to treasury and treasury centres, BEPS seeks to eliminate base erosion through what tax authorities consider unwarranted deductions in the case of hybrids and excess deductions associated with the use of excess intercompany debt and intercompany pricing distortions reflected in the improper application of the transfer pricing principles. Additionally, BEPS seeks to ensure that tax authorities have the necessary taxpayer information to identify and address the types of arrangements noted above.

BEPS and transfer pricing

An immediate focus of BEPS has been transfer pricing and ensuring an appropriate return to relevant entities in a group. This is at a time when tax authorities in Asia had started to focus on transfer pricing via new regulation, guidelines and disclosure requirements. The overarching expectation is that profits will be reported where the economic activities that generate them are carried out and where value is created. This includes the need for substance in an entity, undertaking commercially rational transactions and demonstrating control in the entity taking on risk.

What substance does BEPS require?

A treasury centre will need to have people with adequate qualifications, experience and knowledge who will form part of the decision-making process for the transactions undertaken by the treasury centre. The impact of not having this substance may be a challenge if a tax authority takes the view that the treasury centre, absent of the important people, only warrants a risk-free return.

Increased tax authority scrutiny

Reviews of an entity’s transfer pricing will be facilitated by enhanced transfer pricing documentation requirements and, in the case of large multinational enterprises there is an obligation to file a Country by Country (CbC) Report for each jurisdiction in which they do business (including capital, number of employees and profit). The CbC report will be used as a risk assessment tool by tax authorities.

What are some of the operational aspects of BEPS for treasurers?

Operationally, the location, administration and ultimately, the value of the treasury function has to be re-examined. The operating model has to shift from head office “executing” transactions via treasury centres to head office “providing guidance” on transactions at treasury centres. The impact of BEPS on treasury operations is that there will be a need for greater visibility on risk and who bears it in respect of working capital management, timing and manner of cash repatriation, payments/receipts on behalf of, FX risk management, and the overall enterprise liquidity model – financing entities, cash pooling, factoring and increasing local funding vs intercompany loans for some. This is where treasury technology will play a big part. In this regard, BEPS is not just a tax matter but an overall finance strategic imperative.

What next?

The expected increase in tax audit scrutiny will require a systematic approach to ensure that tax and treasury have a shared understanding of the tax and BEPS impacts on treasury operations and financial objectives.