BEPS reforms will hit financial institutions
The OECD and G20 plan to reform the international tax system is targeted principally at global e-commerce companies but as the details of its program roll out issues of concern for large financial institutions are emerging, according to new research.
KPMG has published a BEPS (base erosion and profit shifting) update, highlighting areas that could affect banks and other international financial institutions. These include proposals for new reporting rules, transfer pricing and "permanent establishment" status.
In 2013 The Organisation for Economic Co-operation and Development published a major report on BEPS - a term referring to a range of practices that artificially segregate taxable income from the activities that generate it and, in so doing, exploit different tax rules in various jurisdictions to reduce tax liability.
"As the world economy has globalised, international tax planning by both individuals and companies has increased significantly. The current rules have not kept pace with the way business operates in the twenty-first century," the OECD said.
Since then the OECD, working with the G20, has been co-ordinating a program aimed at fixing the deficiencies in the international tax system, with a strong focus on "developing instruments to facilitate better co-ordination among tax jurisdictions."
OECD member country finance ministers met in Paris in May last year to review the program and since then the organisation has issued several briefs on aspects of its 15-point plan for reform.
KPMG has identified three issues that will have a significant impact for financial institutions.
* Reporting transparency. The proposed rules include a requirement that enterprises provide all relevant governments with needed information on their global allocation of income, economic activity and taxes paid, according to a common template.
KPMG said the idea was that, regardless of the corporate structure, tax authorities in all jurisdictions where a company has a presence should be able to review extensive transfer pricing documentation and country-by-country reports on economic activity, resources, employees, costs and profits.
"The issue for financial institutions could be that tax authorities may not fully consider the contribution of capital and the need for it to be rewarded in the jurisdiction where it is provided," KPMG said.
* Transfer pricing. The OECD proposes new restrictions on transfer pricing rules to ensure that "inappropriate" returns and tax benefits are not captured by a group company simply as a consequence of its intra-group risk bearing or its capital position.
The new rules are aimed at weeding out transactions that would not normally occur between unrelated parties and which do not exhibit an underlying economic rationale. The objective is to align the location of taxable income returns with perceived economic value creation.
KPMG said: "The application of these principles to the financial services sector can be problematic. The core business of financial services often involves a risk transfer and, despite being intangible, capital is a key economic factor.
"An underlying assumption of the OECD's work is that capital is fungible and thus easily moved. However, financial institutions are regulated in such a way that they must hold capital in particular locations.
The determination of where risk resides in financial institutions needs to reflect a sophisticated understanding of the regulatory frameworks that they operate under."
* Permanent establishment status. Profits recorded by a non-resident company are taxable in a jurisdiction if the economic activity giving rise to the profits are undertaken by a local "permanent establishment". One of the concerns of the OECD is that global companies avoid PE status by supplying goods and services from remote locations.
The threshold of activity or presence for determining the existence of the permanent establishment has historically been high. However the BEPS Action Plan (Action 7) would limit the scope for arguing that a permanent establishment does not exist.
"The OECD has its eye on global e-commerce businesses but financial institutions also offer services without establishing a permanent physical presence in a country. They need to review their current business arrangements and some reorganisation may be necessary," KPMG said.