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Future of treaty formed holding companies and preferential tax regimes and unwinding
existing structures impacted by BEPS or GAAR in PSD
GCM Parker Conferences, 7th International Taxation in CEEPrague, 13 & 14 October 2016
Harm J. Oortwijn MBA
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How comfortable would you feel if your company’s “inappropriate” tax structure were challenged ?
What is the right time and speed to make “appropriate” changes to your company’s tax structure?
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Agenda
A. My First Tax Plan – Tax Planning Pre-BEPS
B. Treaty based Holding structures: past-present-future- Current Country’s GAAR approach to Holding structures- Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances- GAAR in EU Parent Subsidiary Directive - GAAR in ATAD Anti Tax Avoidance Directive
C. Preferential Tax regimes: past – present-future - Action 5: Countering Harmful Tax practices More Effectively, Taking into
Account Transparency and Substance- EU State aid investigations
D. Business Restructuring initiatives transforming to BEPS / GAAR proof TP/PE structures
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A. Mid 90s, My First Tax Plan …
USA opco
CANparent
NL HoldingConduitOther
International Subs
Interest / Dividend
Loan/Capital
NIB Loan
CapitalRepayment
LoanInterest - Zero CAN Notional Income- Dutch InfoCap ruling – notional interest deduction & statutory capital- Dutch Interest BtB spread ruling
PURPOSE: Avoid 10% WHT between US&CAN
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… and how we changed in response to the
1996 LOB clause in the NL/US Treaty!
USA opcoCAN
parent
NL Holding
International Subs
BELGUMBCC
FactoringFinance
Capital
Dividend
Capital
Dividend
Capital
Dividend
Receivable
Cash
Loan
Interest
PURPOSE: Avoid 10% WHT between US&CAN
Belgian Coordination Centre ruling
Dutch Board Meetings & BooksRecords in one of the Dutch subsfor substance
IC Factoring fee, not subject to FAPI (CAN equivalent of US subpart F)
Would we have taken the same approach to change in post BEPS?5
2016 Base Erosion Profit Shifting (BEPS)
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B. Treaty Based Holding Structures
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Treaty based Holding structures
EU investor
BVNL
PolandCzechRepublique
Non EU investor
EU investor
Non EU investor
BVNL
BVNL
PolandCzechRepublique
PolandCzechRepublique
BVNL
(C) Non EU Investor- EU Hub(s)- (Re) Investment pooling- EU PS Directive- Investor’s Treaty rules- Local EU GAAR vs EU Freedom?
(B) Joint Venture- Neutral jurisdiction- (Re) Investment pooling- EU PS Directive- Investor’s Treaty rules- Local EU GAAR vs EU Freedom?
(A) EU Investor- EU Hub(s)- (Re) Investment pooling- EU PS Directive- Investor’s Treaty rules- Local EU GAAR vs EU Freedom? 8
Country’s GAAR approach re Holding structures
Germany: An active management holding as understood by the German tax authorities is a holding that does more than just resolving on dividend distributions and approving financial statements. It requires that strategic decisions are being taken at the level of the holding.
Brazil: A foreign Holding company regime is considered as a privileged tax regime the one that presents one or more of the following characteristics:• It does not tax income or taxes it at a maximum rate lower than 20%;• It grants tax benefits to a non-resident individual or legal entity: (a) without
requiring substantial economic activity to be carried in the country or dependency; or (b) contingent upon no substantial economic activity being carried out in the country or dependency;
• It does not tax, or taxes at a maximum rate lower than 20% , income earned outside its territory;
• It does not provide access to information related to shareholding composition, ownership of goods or rights, or the economic transactions carried out.
So what about the Participation exemption regime in any of the EU countries? 9
Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances
• Purpose: To include a common minimum standard in tax treaties to raise the bar for tax treaty application to tackle abuse
• “Inappropriate” meaning as in circumventing limitations within the treaty (treaty shopping) or in domestic law using treaty benefits (thin cap rules, transfer mispricing)
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Minimum Standard
• OECD proposed common minimum standard in tax treaties – 3 options:
(i) combination of limitation-on-benefits rule (“LOB Rule”) and principal purpose test (“PPT”), or
(ii) PPT, or
(iii) LOB ‘Light’ supplemented by anti-conduit arrangements rule
• Applies to all forms of income
– I.e., incl. dividends, interest and capital gains
• LOB Rule consists of mechanical and complicated LOB tests – hard for a company with foreign shareholders to meet tests, unless listed and head quarters in the Netherlands
• LOB Light assumes that all activities are in the same entity: does not work that way in the ‘real world’
• US – more restricted LOB clause in 2016 new model treaty, no PPT included (treaties with Hungary and Poland to include LOB clause awaiting consent from Senate since 2011…)
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Principal Purpose Test (“PPT”)
OECD: access to tax treaty benefits denied:
“Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention.”
• Not mechanical, but subjective
• Business Rationale
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GAAR in EU Parent Subsidiary Directive (“PSD”)
• Purpose: to prevent taxpayers from gaining PSD benefits through the use of artificial arrangements which do not reflect economic reality
• Limited impact where strict local anti avoidance measures are already in place
• EU GAAR - 2 elements:- (i) Main purpose test
- (ii) Lack of economic reality test
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GAAR in EU PSD -Main Purpose Test
2. “Member States shall not grant the benefits of this Directive to an arrangement or a series of arrangements that, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage which defeats the object or purpose of this Directive, are not genuine having regard to all relevant facts and circumstances.
An arrangement may comprise more than one step or part.
3. For the purposes of paragraph 2, an arrangement or a series of arrangements shall be regarded as not genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality.”
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GAAR in EU PSD –Lack of economic reality test
• GAAR adopted for EU PS Directive: – Subjective and objective elements– No clear guidance on the terms used in the GAAR– To be implemented by EU jurisdictions on 31 December 2015 at the latest
• Similar amendments expected for EU Interest & Royalty Directive
• Problem is that tax is always one of the principal purposes in deciding where to locatea company, especially if you look as non-EU investor to Europe as a single market
• The question is therefore whether the structure is:(i) genuine, i.e. has been put in place for valid commercial reasons, which reflect
economic reality(ii) and(/or?) defeats the object or purpose of the Directive
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GAAR in Anti Tax Avoidance Directive (“ATAD”) (July 2016)
• All taxpayers that are subject to corporate tax in member states, incl subs of companies based in 3rd countries.
• 5 anti tax avoidance rules- Interest limitation (BEPS Action 4) - Exit taxation *- GAAR *- cover gaps in country’s specific anti abuse rules in line with wording GAAR PSD- CFC (BEPS Action 3)- Hybrid mismatch (BEPS Action 2)
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C. Preferential Tax Regimes
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BEPS Action 5 Preferential Tax regimes
• 1998 OECD report: “Harmful Tax Competition. An emerging global issue”
• “Preferential” as in comparison with the general principles of taxation in the relevant country, NOT in comparison with principles applied in other countries
• Four key & other 8 determinants that constitute a preferential regime considered “potentially harmful”. Gateway criterium: “no or low effective tax rates imposed”.
• Those preferential regimes which can be used for artificial profit shifting and about a lack of transparency in connection with certain rulings
• The ‘nexus approach’ or ‘substantial activity requirement’ to be applied (same as with IP patent boxes), so that such regimes are found to require substantial activity where the taxpayer undertook the core income generating activities.
• IP related: Link between expenditures, IP assets and IP income.
• Non-IP related: Type of preferential regime and core activities. Headquarter-, Distribution & Service Centre -, Financing or Leasing -, Fund Management-, Banking and Insurance -, Shipping – and Holding company regimes.
• Holding company regime: (i) mixed income and (ii) dividends and capital gains only
- Mixed income (interest, royalty) – substantial activity requirement
- Dividends and capital gains only – transparency and beneficial ownership & treaty benefits
• Compulsory spontaneous exchange of information on rulings that could give rise to BEPS concerns in the absence of such exchange. Past rulings issued from 1 January 2010 and still in place on 1 January 2014 and future rulings.
• Example non IP: Swiss Holding and Mixed Company regimes (in the process of being eliminated).
• Example IP: Hungary super royalty deduction18
EU Code of Conduct - Adopted 1 Jan 1997 (1999 report) Harmful Tax
Practices
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EU State Aid Mechanism
State Aid Art. 61(1) Case closed
Exceptions applicable?- De minimis aid- Block
Exemptions- Guidelines- Art 59.2
No ExistingAid?
No Recovery
Yes
No
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EU State aid - EEA Art 61(1)
1. The measure involves an economic advantage
2. Granted by State resources: public funds
3. To «undertakings» - (not individuals or households) engaged in economic activity, irrespective of its legal status and the way in which it is financed
4. Aid is selective – it favours only certain undertakings or production of certain goods
5. The aid affects competition and trade within the EEA
• Cumulative criteria
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EU State aid - Exemptions
• Art. 61 (2) Shall be compatible with EEA Agreement: • Aid to individuals• Natural disasters; exceptional occurrences
• Art 61 (3). May be compatible with the EEA agreement:• Underdevelopment• European projects, serious disturbance • Certain economic activities or areas• Culture & heritage• other
• Regulation regarding «De Minimis aid» (200 000 Euro over 3 years) may be granted without notification
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EU State Aid Existing or new aid -recovery
• Illegal state aid must be recovered with interest (up to 10 years!)
• Existing Aid = aid existing before the entry in force of the EEA agreement – must not be recovered – only aid granted after the decision regarding illegal aid is made by ESA
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EU State Aid & Preferential Regimes
• Addressing Preferential Tax Regimes is pretty muchsuccesful – being abolished or modified to match BEPS principles
• Preferential Tax Regimes may be subject to EU State AidInvestigation – even after the Preferential Tax Regime has been terminated
• State Aid regime does not care about creating a level playing field – in conflict with OECD principles
• IRS Notice 2016-52: Limits the ability of US multinationals to claim credit against US taxes for significant (>USD 10mln) foreign tax assesments (incl State Aid) to encourage US multinationals to contest major foreign tax adjustments ; what if Apple / Amazon will lose in ECJ court?
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D. Business Restructuring
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Making tax structures BEPS proof
• Holding company structures – not much choice, think outside the box: examine if a tax treaty is required, holding in a non OECD country
• Preferential tax regimes – decide to retain (until abolition date) or unwind as appropriate
• ‘ Google taxes’ – decide to retain (until Court case decision) or unwind as appropriate
BUT THEN THERE ARE LOCAL GAAR measures….like:
• Diverted Profit Tax (UK) / MAAL (AU) - change if adverse impact is significant
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Exit charges and business restructuring
• Payment to compensate for the removal of an asset belonging to an entity whose activity in the business is being simplified or reduced.
• Not justified solely by reason of a reduction in profit earned by an enterprise. There must be evidence that there is an asset, that it is transferred and that between unrelated parties payment would have been made for that asset.
• Asset definition: valuable tangible and intangible assets, valuable contracts
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Exit charges and business restructuring – analysis
Functional analysis: a. Comparing actual “assets” before & afterb. For each asset, analyze whether:1. Asset has been lost, not transferred. 2. Within the entity’s power to retain the asset, but it chose to allow the transfer3. Commercial law stipulates that compensation must always be paid in these
circumstances4. Contract under which the entity operates provides for compensation on termination
of the arrangement.Under 1, exit charge unlikely to arise. Under 2-4, exit charge may be applicable
c. Special relationship within a MNE: Additional analysis re (3) and (4): Re 3: Absence of claim to compensation is not accepted, it is deemed to have been made and paidRe 4; Whether the terms of contract are at arm’s length in nature
*Anti Tax Avoidance Directive (July 2016): exit tax for certain predefined situations, which includes both transfers to other Member States and third countries.
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Exit charges and business restructuring - categories
Categories of changes (3)
A. Change of risk profile by contractual arrangement
- Conversion of distributor in a commission agent
B. Change in functional profile and allocation of intangibles
- Substitution of a specific product during its life cycle
C. Transfer of assets, impacting change risk and/or functional profile
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Exit charges and business restructuring - conclusion
Exit charge in an arm’s length situation:
- Change in profitability may be informative in determining value of the exit charge-if applicable.
- Change in profitability does not justify exit charge
- Amount of exit charge is not equal to the full amount of fall in profits e.g. license terminated by licensor in accordance with arm’s length terms, does not deprive licensee of any asset, but it does result in licensee fall of profits
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Tax motivated transactions
• ‘Under Article 9 of the OECD Model Tax Convention, the fact that a business restructuring arrangement is motivated by a purpose of obtaining tax benefits does not of itself warrant a conclusion that it is a non-arm’s length arrangement. The presence of a tax motive or purpose does not of itself justify non-recognition of the parties’ characterisation or structuring of the arrangement’
• What may be commercially rational at group level, including restructuring to save tax, may not be so at the entity level (HMRC).
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Change is the process of all existence … but change before you have to!
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