Author: Dominik Stuiber
Intellectual Property management and licensing arrangements are often at the centre of multinational corporations to optimize global taxation. Some of the structures and vehicles deployed were heavily criticized by the media and public after the revelation of the LuxLeaks and ParadisePapers. In Europe, governments and tax authorities of member states that provided favourable tax rulings to some multinational corporations were forced to revisit their practices. These events also brought the OECD’s Base Erosion and Profit Shifting (BEPS) Action Plan to greater attention. Although the BEPS project started already before the media debate on fair taxation that followed the leaked documents, it addresses gaps in international taxation rules and different tax treatments among jurisdictions. A major issue BEPS aims to tackle is taxation based on the economic activity rather than mere legal structure by harmonizing transfer pricing rules. BEPS itself does not have the effect of law, however, it sets the standard that every OECD member state is expected to implement into national law and thus, by similar treatment across jurisdictions, closes taxation gaps and eliminates mismatched arrangements that allowed the exploitation by multinationals. Another key aspect is greater transparency by mandating the exchange of information across jurisdictions where multinationals operate. (Continue reading BEPS Implementation in Hong Kong)
How is Intellectual Property affected by BEPS?
Intellectual Property (IP), such as a brand name or trademark, can account for a considerable amount of corporate value. Often
owned by companies established in low tax jurisdictions with high corporate
protection laws, high value IP can generate very profitable revenue streams
through licensing arrangement from other operating entities within a group. As
a result, profits are being diverted to low tax jurisdictions, reducing the
global effective tax rate for multinationals. IP owning companies and current IP
licensing arrangements registered in low tax jurisdictions, or offshore
financial centres, where little or no other economic activity takes place,
could be adversely affected by the proposed changes in transfer pricing
regulation under BEPS actions 8 to 10. The revised transfer pricing rules
advocate a delineation of legal and commercial ownership and a substantive
evaluation including the functions performed, assets used and risks assumed to
determine how profits attributable to IP should be allocated for taxation
purpose. The 2017 discussion draft on the BEPS Implementation Guidance on
Hard-To-Value Intangibles further includes protective measures for tax
administrations from the negative effects of information asymmetry by ensuring
that tax administrations can consider ex-post outcomes as presumptive evidence
about the appropriateness of the ex-ante pricing arrangements, including
adjustments to the application of pricing structures. Effectively reversing the
burden of proof onto corporations and allowing tax administrations to revise
earlier assessments.
Do I need to care about BEPS if my business is not a
multi-national corporation?
Although BEPS is designed with multi-national
corporations in mind and its reporting requirements would not extend to SMEs,
the BEPS standards are nonetheless being transcribed into national law and its
principles, transfer pricing rules among others, apply to SMEs just the same.
Thus, SMEs operating within a group of companies should pay attention to the
BEPS Action Plan and its implementation.
What should I do now?
Business should critically review their existing
intra-group structures and arrangements and consider if any adjustments,
whether to the arrangements or the reporting and valuation, need to be made
ahead of the BEPS standards coming into effect. The legal ownership of
intangibles, including IP, alone does, for transfer pricing, no longer mean
that it can solely benefit from the returns of exploiting the intangibles it
owns. For compensation, other than for simply holding the legal title, a rights
owner is required to perform and control the functions related to the
development, enhancement, maintenance, protection and exploitation of the IP.
For trademarks and licensing arrangements, this should include a review of the
risk assumptions, management and oversight of the trademarks and their use.
Management and oversight may further extend to include the design and control
of marketing programs and budgets for licensees.
In order to protect the revenue returns in IP holding
structures, more substantive capabilities than often currently deployed will be
necessary. If other members of the group control any of the above functions,
they may, under the transfer pricing guidelines, be entitled to a share in the
IP revenues. In the contemporary political climate regarding government
revenues, it would seem reasonable to believe that the tax authorities of most
of the G20 members may challenge the profit allocation for IP and other
hard-to-value intangibles if given a chance.
Are there other BEPS initiatives to observe?
In an
earlier article, we highlighted the development of Controlled Foreign
Corporation (CFC) rules and the BEPS Action Plan to harmonize national rules to
an international set of standards. The
development of CFC rules is particularly relevant for developing countries. In
a recent case in Mainland China, tax authorities attributed undistributed
profits of a Hong Kong company to its Chinese parent company based on CFC rules
and collected about CNY 7.79 million in taxes. (Continue reading the case
details here)
CFC Rules generally aim, as anti-avoidance rules, to include the income of overseas corporations with no economic substance under domestic taxation, often including certain deeming provisions that regards attributable income as distributed. This also follows the general principles of ‘substance over form’.