With the European Parliament showcasing its commitment to combat tax havens as well as tax avoidance and the European Commission pursuing state aid infringement procedures against Luxembourg and other member states, we have witnessed various harbingers of tougher regulations and increased tax harmonization in Europe throughout 2015 . Judging from the European Commission’s ‘Anti- Tax Avoidance Directive’ from the Jan. 28, 2016 , which is focused on ensuring uniformity in implementing the OECD BEPS outputs across the EU, the new year promises to be no less exciting.
The Anti-Tax Avoidance Directive – implementing anti-BEPS measures
The Anti-Tax Avoidance Directive (ATA Directive) proposed by the Commission comprises six anti-avoidance measures. Three of these measures are specifically designed to ensure uniform implementation of the OECD BEPS measures, namely:
- interest limitation rule (BEPS Action 4 – Article 4 of ATA Directive)
- controlled foreign company (CFC) legislation (BEPS Action 3 – Article 8 of ATA Directive)
- framework to tackle hybrid mismatches (BEPS Action 2 – Article 10 of ATA Directive)
The measures are targeted at counter-acting “some of the most pervasive aggressive tax planning schemes” and reflect the Leitmotiv of the OECD BEPS project, namely combating artificial tax structures by aligning the creation of economic value added with the allocation of profits and taxation. Combined with the reforms of the transfer pricing regulations (BEPS Actions 8-10) the measures are likely to significantly enhance the feasibility of applying the arm’s length principle as the main paradigm of international taxation. The measures have been discussed at length within the OECD BEPS project and can arguably be regarded as a more or less adequate response to aggressive tax planning. While the benefits of the individual measures are subject to debate, the necessity of reforming the arm’s length principle for coping with 21st century business structures enjoys a comparatively broad international consensus . In view of the comprehensive nature of the reforms it seems more likely than not that the extent of BEPS generating aggressive tax planning will be substantially curbed within three to five years.
Considering that the BEPS project was concluded at breakneck pace, it would have appeared sensible for the EU to adopt a kind of wait-and-see attitude and leave it up to the member states to follow through with the implementation of anti-BEPS measures. A directive, however, is legally binding on all member states and leaves comparatively little leeway to the member states. According to the Commission “the possibility of proposing soft law was also considered as an option but was discarded as inappropriate for securing a coordinated approach” . It is somewhat difficult to understand why exactly soft law was considered to be inappropriate. Appropriate institutions for implementing soft law do exist in the EU. For instance the EUJTPF, which assists and advises the European Commission on transfer pricing tax matters, could have issued general guidance for facilitating a sufficient degree of uniformity in implementing anti-BEPS measures . The main argument advanced by the Commission, namely that leaving implementation to the member states would “only replicate and possibly worsen the existing fragmentation in the internal market and perpetuate the present inefficiencies and distortions in the international patchwork of distinct measures,” is unconvincing. Following this line of reasoning would imply that the Commission seriously believes that member states individually implementing the three Anti-BEPS measures would likely lead to an increase in tax avoidance rather than decrease.
The eagerness of the European Commissions to move beyond BEPS
The approach adopted by the Commission could also be interpreted to imply a general lack of faith in the effectiveness of the OECD anti-BEPS measures. It would appear somewhat premature, however, to judge the effectiveness of the anti-BEPS measures at this point and thus this (benign) interpretation cannot be entirely accurate. The set-up of the ATA Directive makes it rather clear that the ultimate motivation of the Commission is to utilize the BEPS project as a convenient stepping stone towards greater tax harmonization within the EU.
In this context, the following two aspects should be considered:
1. The Commission intends to implement anti-avoidance measures that go beyond the OECD anti-BEPS measures. The three additional measures contained in the ATA Directive are:
- Exit taxation (Article 5 of the ATA Directive)
- Switch-over clause (Article 6 of the ATA Directive)
- General anti-abuse rule – GAAR (Article 6 of the ATA Directive)
The provision of exit taxation would require all member states to levy an exit tax on realized gains in the event of an MNE transferring assets (or residence) to another (presumably low tax) jurisdiction. Some member states (such as Germany) already have exit tax provisions in place. While most restructurings involving the transfer of assets have valid commercial reasons, the Commission holds the opinion that “such practices distort the market because they erode the tax base of the state of departure and shift future profits to be subject to tax in the low-tax jurisdiction of destination.” Irrespective of whether one would subscribe to the somewhat paranoid opinion of the Commission, it is difficult to see the harm in member states decide on their own whether or not to implement exit taxation in a protectionist effort to secure their tax base. The introduction of an excessively broad GAAR which is intended to close any gaps that could possibly exist in the current anti-abuse rules of member states is also rather intriguing. In effect the GAAR proposed by the Commission would give national tax authorities a blank check to ignore any legal arrangement of taxpayers that are deemed to have been put into place for no valid commercial reasons – a clear definition of these “non-genuine arrangements” or of the procedure to evaluate suspicious arrangement is not provided. Again, irrespective of one’s comfort level in view of legal provisions granting vast discretionary powers to tax authorities, it is unclear why the Commission feels compelled to force the member states to adopt such a provision.
2. The Commission will relaunch its proposal for a Common Consolidated Corporate Tax Base (CCCTB), which it considers to constitute a holistic solution to creating a fairer and more efficient taxation in Europe. In its press release accompanying the publication of the proposal for the ATA Directive (MEMO-16/160) the Commission made it quite clear that it ultimate regards the CCCTB as the only comprehensive solution for base erosion and profit shifting. It felt, however, that “we should not wait for the CCCTB to be proposed, agreed and implemented before taking action against major areas of tax avoidance.” The ATA Directive is perceived as offering immediate and effective solutions to tax avoidance while work on the CCCTB is underway.
As pointed out before in the Cayman Financial Review, the implications of adopting the CCCTB are rather worrisome . Not only is the CCCTB, and formulary apportionment in general, technically ill-suited to provide a panacea against BEPS, but an implementation of the CCCTB would have even more fundamental ramifications – most notably weakening the position of the arm’s length principle as the leading paradigm of international taxation. It is not feasible and possibly beside the point to argue whether one paradigm would be superior to the other on theoretical grounds. At the end of the day, the question which paradigm is to be applied remains an ideological question. The arm’s length principle simulates a market process in order to identify the economic value of a specific transaction and allocates the tax base accordingly, while formulary apportionment is based on a political value judgment regarding a fair or more equitable distribution of income. The ATA Directive clearly shows that the ideological preference of the Commission in respect to transfer pricing is fundamentally at odds with that of the OECD.
While the arm’s length principle is merely a tool or mechanism that should by no means be regarded as a sort of pseudo-religion, the benefits of having an established international consensus that is based on market processes and somewhat limits the discretionary powers of tax authorities and governmental value judgment about an equitable division of income should be to carefully considered. Business representative tend to profess that they are indifferent in regards to the paradigm of international taxation as long as it is uniformly applied on a global level. While this point of view is somewhat understandable, it is questionable whether it reflects a deliberate evaluation of the practical implications of adopting formulary apportionment – e.g. the water’s edge effect of introducing formulary apportionment on a local/regional level. There is no need to be uncritical of the work performed by the OECD, but it would be prudent to keep things in perspective. Insofar as the reforms proposed by the OECD relate to ‘modernizing’ the arm’s length principle, European transfer pricing professionals should consider adopting a more supportive stance – especially in case they regard the alternative of adopting the CCCTB as rather unappealing.
Issues to keep in mind
While taxpayers may perceive the arm’s length principle vs. formulary apportionment discussion as rather boring, they would be well advised to monitor the further developments closely. A paradigm change would leave no business model unaffected. Think about financial holding structures and any value chain centered on creating and utilizing intellectual property – applying formulary apportionment would have dramatic effect on the allocation of income. Government officials from countries that are hosting a lot of high value added activities based on intangibles as well as a small but highly qualified workforce should also be on the alert – formulary apportionment generally does not recognize or reward the impact of intangibles and a highly qualified workforce.
Coming back to the EU and making some predictions for 2016: In order to get a feeling for the intentions and political commitment of the legislators it is worthwhile to pay close attention to the wording adopted by the Commission. One idiosyncratic phrase utilized by the Commission in justifying the increased harmonization in implementing uniform anti-avoidance measures throughout Europe was the necessity to preserve the “common competitiveness” of the EU. A governmental body resorting to phrases like common competitiveness and introducing blank check GAAR provisions documents its willingness to do pretty much “whatever it takes” to reach its ultimate objective. A forceful push towards further tax harmonization in the EU and the implementation of various additional anti-avoidance measures, such as the External Strategy including a uniform European listing procedure for third countries not complying with the EU taxation code of conduct, are a foregone conclusion. The most intriguing question is arguably whether the re-launch of the CCCTB will generate sufficient political momentum to eventually achieve approval and implementation . Luckily this is not a forgone conclusion and it will all the more intriguing be exciting to watch – so, do not blink.