Board oversight of tax risk

Understanding the global focus on base erosion and profit shifting
As part of their role in the oversight of risk and tax strategy, boards and audit committees need to be well informed about tax policy developments and trends worldwide — both in the markets their company currently serves and those it may be considering.

Governments around the world are scrutinizing the global tax profiles of multinational companies (MNCs) that do business in their countries, questioning MNCs’ local tax positions and seeking greater transparency into their entire tax footprint.

In this regard, a key initiative to monitor is the Organisation for Economic Co-operation and Development (OECD) project to address base erosion and profit shifting (BEPS).

That project, which is driven by the G20, is based on a 15-point action plan issued in July 2013 and is designed to address government concerns about the potential for MNCs to source profits to jurisdictions where they are subject to more favorable tax treatment. The OECD is expected to issue final reports in all 15 focus areas this autumn, with consensus recommendations for changes in international tax laws and treaties that governments can implement to reduce the potential for base erosion and profit shifting activity.

In addition to the active participation of the OECD and G20 governments, officials from several developing countries also have provided input into the BEPS project. With this global focus on BEPS, the tax landscape for MNCs is already changing.

And the pace of change is expected to intensify with the finalization of the OECD’s recommendations.

Broadly, these recommendations are expected to include changes that would:

Limit interest deductions
Eliminate the benefits of hybrid financing arrangements
Lower the permanent establishment standards for taxable presence in a country
Place new restrictions on access to benefits of tax treaties
Create new transfer pricing rules for intangible property
Recharacterize taxpayers’ transactions through new approaches to transfer pricing
Require more robust transfer pricing documentation
Require new country-by-country reporting
These areas have been the focus of unilateral action by countries around the world even in advance of the final OECD output. EY has catalogued BEPS-driven changes in laws and administrative practices in more than 50 countries since the beginning of 2014.

For example, legislation in Mexico and France has included several BEPS-related changes, including new restrictions on the deduction of financing costs. The United Kingdom has introduced a “diverted profits tax” aimed at addressing base erosion, and Australia announced proposals that would expand its general anti-avoidance rule to address avoidance of a taxable presence.

The EU recently presented a package of tax transparency measures aimed at increasing information exchange between member states. China has issued transfer pricing rules on outbound related-party fee payments.

Countries including Australia, Poland, Spain and the UK have taken steps to implement documentation standards in line with the OECD’s recommendations on country-by-country reporting.

Long-term, as a result of the global focus on BEPS, MNCs can expect to face:

Increased reporting obligations
More scrutiny of intangible property ownership and financing structures
A greater focus on the substance of a transaction and its alignment with the business
Increased complexity in transfer pricing
Further limitations on access to treaty benefits
More (and more complex) controversy with tax authorities
A need for more proactive engagement with tax authorities to gain certainty and avoid or resolve disputes

With the OECD recommendations imminent and countries already implementing BEPS-related tax legislative and administrative changes, the timing is right for companies to review their business models and structures against the BEPS focus areas to identify possible pressure points.

Boards should encourage companies to consider taking the following steps to prepare for the new global tax environment:

Build consideration of potential BEPS impacts into current tax planning
Re-examine supply chains and evaluate current and future financing arrangements
Assess the company’s readiness for increased reporting requirements, including new requirements for reporting key financial and operating metrics on a country-by-country basis
Consider advance pricing agreements (APAs) and other early engagement with tax authorities to gain greater certainty
Communicate with stakeholders regarding the implications of the changing global tax environment for the company

Board oversight of tax risk