Companies in low- or no-tax jurisdictions must show ‘economic substance’
In countries with low- or no tax, firms must have staff, premises, expenses and activities aligned with the company’s nature. South African companies in so-called low- or no-tax jurisdictions should take heed to the economic substance rules that have been introduced to prevent the artificial shift of taxable profits away from where value is created. Although the legislation has been around for more than a year, the reporting dates are only becoming due now. “Failure to meet the requirements can result in the exchange of information between the relevant jurisdiction and other countries’ tax authorities, financial penalties and, ultimately, striking off the companies register.” Since the 2008 economic crisis, the Organisation for Economic Cooperation and Development (OECD) started a process of ‘reforming’ international tax. The main aim was to prevent base erosion and profit-shifting from high-tax jurisdictions to low-tax jurisdictions (tax havens). The countries where the economic substance requirements were implemented include Bermuda, the British Virgin Islands, Cayman Islands, Isle of Man, Jersey, Guernsey, Mauritius, Bahamas and Seychelles. Substance The international approach is that no one can be prevented from forming companies in these countries. However, when they do, there has to be substance in the form of staff, premises, expenses and activities, which must be determined in accordance with the nature of the company. The new economic substance requirements do not apply to all companies, but are required for companies with income from “geographically mobile financial and other service activities”. This include banking; insurance; shipping; fund management (except collective investment vehicles); financing and leasing; headquarters; distribution and service centres; holding companies; and intellectual property. The legislation defines “core-income generating” activities of each of these industries. In the case of finance and leasing the activities include agreeing the funding terms, identifying and acquiring assets to be leased, setting the terms, monitoring, revising and managing risks. In addition to the above, there must be an adequate number of employees working in the affected jurisdiction, as well as adequate expenditure and physical assets. Companies need to establish their obligations on substance and reporting in terms of the rules and must ensure they meet the requirements by the due dates. Time for implementation The legislation was introduced around 18 months ago, but companies were given time to get their house in order. Some countries have indicated that temporary “leniency and pragmatism” will be allowed to cater for the effect of the Covid-19 pandemic. The economic substance rules add another layer of complexity to other rules applying to cross-border structures. These rules include determining the place of effective management, transfer pricing, source of income and withholding taxes. It is becoming increasingly important to understand all the rules when choosing a country to use as an offshore centre.
BEPS Pillar Two reflects radically changing world of corporate taxation
In 2013, the Organisation for Economic Co-operation and Development and G20 countries jointly developed an action plan to address base erosion and profit shifting by multinational enterprises. Essentially, base erosion and profit shifting, or BEPS, occurs when multinationals exploit tax legislative gaps between countries to reduce or eliminate the taxation of profits. As part of their plan, the OECD and G20 finalized 15 BEPS Actions in late 2015. The actions are intended to “equip governments with domestic and international rules and instruments to address tax avoidance, ensuring that profits are taxed where economic activities generating the profits are performed and where value is created.” Since the release of the BEPS Actions, the pace of change as regards tax rules worldwide has been dizzying. In the last five years, over 135 countries — known as the OECD/G20 Inclusive Framework — have worked together to implement BEPS recommendations. According to the OECD website: more than 250 tax regimes that facilitated base erosion and profit shifting have been changed or eliminated; more than 85 countries have signed the multilateral BEPs convention (which closes tax loopholes in thousands of tax treaties); and more than 2,000 bilateral relationships for country-by-country exchanges are now in place. The bottom line is that corporate groups with international supply chains and operations are increasingly facing myriad new and changing domestic and international tax rules. The most significant changes include recent and ongoing proposals to fundamentally reshape the taxation of the digital economy. It’s critical for multinationals to understand that these proposals will go way beyond the tech sector and affect virtually all multinational businesses. As we enter a new decade, and more and more countries implement BEPS recommendations, the global tax landscape will continue to change. In this period of uncertainty, the boards, CFOs and indeed all corporate stakeholders of multinationals must prioritize achieving tax compliance while remaining tax efficient. Some new and upcoming country-specific rules on digital taxation While the OECD’s BEPS recommendations have provided the catalyst for many countries to revisit their own tax rules, not all OECD guidelines are adopted consistently across all jurisdictions. Many countries have continued to act unilaterally to protect their tax bases and make changes to account for the evolving global, digitalised economy. Here’s a list of examples of some unique, country-specific tax rules that primarily address digital commerce: The U.S. base erosion and anti-abuse tax (BEAT). This new minimum corporate income tax was introduced under the Tax Cuts and Jobs Act (TCJA) of 2017. It looks to curtail large multinationals with a U.S. presence from shifting profits to lower tax jurisdictions. Australia’s diverted profits tax (Australia DPT). Widely referred to as the “Google tax,” Australia’s DPT has been in effect since 2017 and looks to prevent multinationals from shifting profits made in Australia to other jurisdictions to avoid paying tax. It imposes a 40 percent tax rate on diverted profits. The UK’s diverted profits tax (UK DPT). Introduced in 2015 and amended in 2018, the UK’s DPT — like Australia’s — targets large groups (typically multinational enterprises) that shift profits outside the UK. The specifics of the two DPTs, however — including rates and penalties — are distinct. France’s digital services tax (France DST). France unilaterally implemented its DST last July, retroactive to 1 January 2019. It imposes a 3 percent tax on revenue generated from digital services, and applies to companies with annual revenues of more than 750 million euros worldwide and more than 25 million euros in France. The UK’s digital services tax (UK DST). The UK’s DST will go into effect in April 2020. It will impose “a new 2 percent tax on the revenues of search engines, social media platforms and online marketplaces which derive value from UK users.” All of the above tax rules look to combat base erosion and profit shifting. It’s critical to understand, however, that they are being implemented at different times, with different levels of application, by different countries. BEPS Pillar Two: The “GloBE” proposal Many tax authorities, experts and even business leaders have recognized that our current patchwork system of country-specific tax laws that allows for base erosion and profit shifting in a global, digital economy is not sustainable. In language outlining the policy objective of its new digital services tax, UK tax authorities speak to the need for a unified approach, acknowledging that the UK’s DST is a stopgap measure: “The [UK] government still believes the most sustainable long-term solution to the tax challenges arising from digitalisation is reform of the international corporate tax rules and strongly supports G7, G20 and OECD discussions on the different proposals for reform. The government is committed to dis-applying the digital services tax once an appropriate international solution is in place.” The OECD’s ongoing BEPS work informs and reflects this widely accepted belief. As we discussed in a previous post, the OECD’s current work plan on the taxation of the digital economy is divided into two pillars: Pillar One. This examines the allocation of taxation rights and profit allocation between countries, and the associated tax nexus. Pillar Two. This is referred to as the Global Anti-Base Erosion Proposal, or “GloBE.” It proposes to provide countries with a right to “tax back” when other countries have not imposed a minimum level of tax or not exercised their taxation rights. In November 2019, the OECD issued a public consultation document on Pillar Two. As the OECD recognizes, notwithstanding its wider BEPS recommendations, the GloBE proposal “seeks to comprehensively address remaining BEPS challenges by ensuring that the profits of internationally operating businesses are subject to a minimum rate of tax.” The consultation document emphasizes that the GloBE proposal, like Pillar One, addresses challenges posed by the digital economy, but “goes even further and addresses these challenges more broadly.” The GloBE proposal consists of four rules: An income inclusion rule. This effectively taxes the income of a foreign branch or controlled entity if that income was not subject to a minimum rate of tax. An undertaxed payments rule. This denies a tax deduction (or imposition of a de facto sourced-based withholding tax) for a payment to a related party if the associated income
