This issue’s question

“With OECD having presented its final BEPS Action Plan in October 2015, in what ways will its implementation impact the treasury departments of multinational companies and what should treasurers be doing now to prepare?”

The Base Erosion and Profit Shifting (BEPS) project is an OECD Action Plan addressing concerns that the profits of multinationals are being allocated to locations different from those where the actual business takes place in order to reduce their overall tax liability. The main impetus behind the BEPS initiative is to align the profits of multinational companies with value producing activities and to encourage companies to increase their economic substance in jurisdictions that have typically been considered low-tax or preferential regimes.

While the BEPS initiative will have a significant effect on the tax departments of multinational companies, it will no doubt also encourage treasurers to determine what changes are required from a business standpoint and to create a plan of action to address these changes. As an example, one of the BEPS Action Items, Action 13, will require businesses to re-examine their transfer pricing documentation, causing treasurers to balance conformity with these rules against their compliance costs, which could potentially be significant depending on the amount and accuracy of information readily available. Under Action 13, large multinationals are required to annually file a country-by-country report for each tax jurisdiction in which they do business, and will need to provide the amount of revenue, profit before income tax and income tax paid and accrued and other indicators of economic activities.

In addition to increased compliance costs, treasurers will need to be involved in the day-to-day decision making as to how to increase economic substance (eg people, processes) in specific jurisdictions. Action 10 focuses on transfer pricing with respect to “other high-risk areas”, which addresses situations in which profits are diverted from the most economically important activities of the multinational group, and the use of certain types of payments between members of the group (such as management fees and head office expenses) to erode the tax base. The revised guidelines on transfer pricing address the situation where a capital-rich member of a group provides assets such as funding for use by an operating company but performs only limited activities. As such, tax departments will call on treasury to determine whether the amount of economic substance in these jurisdictions is adequate and whether it can be allocated to value-producing activities. If substance does not align with the risks and value produced by the entity in question, then treasury must determine how to functionally realign substance with value creation and work with tax to implement this into the business.

Finally, Action 4 (limit base erosion via interest deductions and other financial payments) will require treasury’s input and analysis with regard to specific cash flows, currency exposure, and existing related party and third party financial debt. The treasury and tax departments of multinationals will need to work closely together to evaluate existing financial transactions in order to determine their conformity with BEPS. Going forward, the BEPS Actions will require increased coordination within the business where each department must collaborate in order to create a workable solution that will better align the company’s profits with its economic substance.

BEPS is a global tax reset, and that means the biggest change to international tax principles in more than a generation. Business model operations, treasury operations, intercompany leverage structures and risk management structures will all be impacted. The OECD’s 15-point action plan will promote greater transparency with increased information exchange between tax authorities and enable an environment that taxes profits in the country where the value is added.

To prepare, corporate treasurers will need to review the new BEPS action plan and related articles and engage with their tax team about what the actions mean for their businesses, including departments such as finance and intercompany leverage. BEPS is a key business risk for the global C-suite and investors are increasingly interested in tax strategy. Treasurers should begin working closely with their corporate executives to assess current state and identify the actions that will impact the people, property, and functions of the organisation. Ask these questions: how do we sell to customers? How will this impact our supply chain? Do new systems need to be implemented or can existing systems be leveraged?

When that portion of the analysis is done, treasury teams can begin redesigning their own department. A treasury team will need to determine just how this impacts liquidity, where the foreign currency exposures are, and what this will do to business. The OECD has estimated that effective corporate tax rates may rise between four and 10%. Should this occur, it would impact liquidity, leverage, and possibly even the credit ratings of some companies. Evaluating the readiness to satisfy the proposed data and reporting requirements can help establish how the current state of the treasury compares to the desired future state and analysing gaps and prioritising action items are the first steps in preparing for implementation.

Multinational companies without personnel in the various jurisdictions of their financing entities and in-house banks need to also consider whether they should shift professionals into those jurisdictions. Decentralisation draws questions around the governance structures and processes and controls. This also creates the need for better technology and reporting to manage these risks. However, treasury should see this as a great opportunity to get closer to the business and become more of a value-adding partner to the organisation.

Documentation of all intercompany loans is going to be very important to prove the loans’ existence to tax authorities. Treasurers have to think about how good their documentation is and whether intercompany loan portfolios need adjusting. Foreign currency gain or loss on the repayment of an intercompany loan may create a tax liability. An organisation’s response and approach to managing the OECD’s prescription for better tax health could ultimately impact the company’s competitiveness, brand value and reputation.

The final BEPS Action Plan was delivered on time and is remarkably comprehensive. Although further work is planned during 2016 and its success will in a large part rely on domestic implementation by the participating jurisdictions, it has already had a significant impact on the international tax environment and no doubt will continue to do so.

The BEPS Action Plan has three main themes: coherence in domestic rules that affect cross-border activities, substance and improving transparency. Of the 15 action points, those likely to be of most relevance to treasury operations are the proposals on hybrid mismatch arrangements (Action 2), interest deductibility and other financial payments (Action 4), tax treaty abuse (Action 6), transfer pricing methodologies (Actions 8-10) and those on transfer pricing documentation (Action 13).

Intercompany transactions, in particular financing transactions, have been the focus of a number of the proposed actions, which is highly relevant to treasury departments who may find current structures are vulnerable. For example, cash management may include use of hybrid structures or instruments that give rise to either a tax deduction for financing costs without a corresponding taxable receipt or a tax deduction in more than one jurisdiction. Such deductions may now be denied or unexpected tax payments may arise. Structures may also rely on access to treaty benefits (such as to enable exemption from withholding tax) which will be lost if new tests are not satisfied, giving rise to increased tax costs in the group. The proposals which limit excessive interest deductions may reduce the tax benefit of existing arrangements. In light of the proposals, it may be appropriate to unwind existing arrangements and to consolidate certain group operations.

New transfer pricing documentation, including country-by-country reporting (CBCR), is aimed at enhancing transparency for tax administrations. The treasury department will need an understanding of the reporting requirements, in particular in relation to intra-group transactions which may face greater scrutiny. There are concerns as to how tax authorities will use the information provided via CBCR; for instance, it might lead to more withholding taxes being levied as previously ignored transactions are brought into tax.

Changes to the OECD transfer pricing guidelines aim to ensure that transfer pricing outcomes better align with value creation of the multinational enterprise group; returns will not accrue to an entity solely because it has contractually assumed risks or has provided capital. This is likely to impact on available deductions and the location of taxable profits. Groups that have a centralised treasury function may need to review whether their transfer pricing policies remain good for purpose post BEPS and how any required changes might impact on costs.

Treasury and tax functions of multinational groups need to work together to assess risks and issues in respect of current treasury operations, consider what changes might be made now and to put in place processes and strategies to monitor and plan for future developments and changes. This will need to be done both by reference to the BEPS agenda generally and by reviewing the changes being introduced by respective jurisdictions in which the business operates, noting that there is some disparity as to how certain actions might be addressed in a domestic context. Finally, it will also be necessary to educate the wider business about the impact of BEPS and seek to develop best practices that can be met by the business in its day-to-day activities.

Footnotes

1. This contains general information only and Deloitte is not, by means of this article, rendering financial or other professional advice or services.