Combating Base Erosion and Profit Shifting by Multinational Corporations
About five or six years ago, the international media reported more and more tax news. However, the news was not directly related to Hong Kong. At that time, the news mainly focused on a number of large U.S. companies such as Google, Facebook, Apple, Starbucks etc, which were exposed by the media in Europe for alleged malpractice in taxation or were brought to the courts by the Tax Departments.
The main reason for these happening is that the governments were short of revenue after the financial crisis, so tax audits were conducted focusing on large foreign Multinational Corporations (“MNCs”).
As a result, leaders of the Group of Twenty (G20) commissioned the Organization for Economic Co-operation and Development (OECD) to study how to combat the use of international corporate structures and transactions by MNCs in 2013 for tax avoidance. This is known as the “Base Erosion and Profit Shifting” (“BEPS”). OECD released 15 BEPS Action Plans in October 2015.
What is BEPS? Let us first talk about what is meant by “Base Erosion”: “Base” refers to “tax base”, which is the basis of which tax is calculated on. Using Profits Tax as an example, the assessable profit is the tax base. “Erosion” naturally means “to reduce”.
How can taxable profit be eroded? MNCs take advantage of differences in tax rules of countries to create tax benefits over the same transaction (often involving complex planning).
For example, in a transaction a person making payment could get a tax deduction, and the recipient in another country does not have to pay tax on the income according to the local tax regulations (typical example: Company A in Country A lends an interest-bearing loan to Company B in Country B. Company B is allowed to deduct interest expense, while Company A is not subject to tax on the income, which is characterised under Country A’s rules to be a tax-exempt return on investment [see diagram]).
“Profit Shifting” is the use of intra-group transactions to legally transfer profits from a company located in a high-tax area to another company located in a low-tax area, as long as the relevant payment is supported by the transfer pricing report (there will be more discussion on transfer pricing in future articles), to reduce the Group’s overall tax burden.
In summary, BEPS refers to the tax planning strategy of MNCs making use of differences and mismatches of tax rules across different countries and artificially transferring profits to low or no-tax jurisdictions with little or no economic activity.
One of the killers of the BEPS program of action is to require the headquarters of large MNCs to complete “Country-by-Country Reports” (to be further discussed in Tax Tips 3 and Tax Tips 20) to provide detailed global operational information to the tax office-in-charge of the Ultimate Parent of the MNC, which will then be automatically exchanged with tax offices in jurisdictions where the MNC operates. Readers who are familiar with company’s structure and international tax planning should be able to foresee what would be the consequences.
Tax Tips: Do not think that the BEPS program of action is just a matter for large MNCs. The Hong Kong Government gazetted the Inland Revenue (Amendment) (No. 6) Bill 2017 (“the Bill”) on 29 December 2017.
The main purpose of the Bill is to include transfer pricing principles in the Inland Revenue Ordinance and to implement the minimum standards proposed by the OECD for fighting the BEPS. The Bill, which is 162 pages long, is very complex and has a profound impact on Hong Kong’s tax system.
The most important point is that Hong Kong taxpayers may need to prepare transfer pricing reports even if they do not have cross-border related party transactions. In the future, the compliance costs of taxpayers will be greatly increased.
(This is an English translation of the Chinese article published in the Hong Kong Economic Journal Forum on 8 January 2018: https://manageyourtax.com/HKEJ Forum 1).
About the Author:
This article is contributed by Edwin Bin. Edwin is a seasoned Hong Kong tax consultant with more than 20 years of professional experience. He is a Council Member (2018/19) of the TIHK, a member of the Tax Policy Committee, China Tax Committee and International Tax Committee of TIHK and a member of the Tax-Subcommittee of ACCA.