Recent Developments in International Direct Tax
Nora Cosgrove, Deloitte
The international tax landscape has changed considerably in recent times and more significant change is on the horizon. The purpose of this session is to discuss some recent, significant international direct tax developments that have come into effect and some significant international direct tax developments that are coming down the line. As you will appreciate, the pace of change in an international tax context is unprecedented and for that reason, this paper is likely to become dated within a short period of time. This should be borne in mind when referring to it at a later date.
There have been many changes in international direct tax over the past number of years and there are further proposals and consultations in the pipeline. Wider political and economic challenges such as Brexit and the potential for escalation in international trade wars are also making for a very dynamic international tax landscape.
Today, we will focus on some key areas of change over the past few months, as follow:
- The implementation of BEPS measures and EU Directives into national Irish legislation,
- US Tax Reform,
- Impending changes in Transfer Pricing rules,
- Tax controversy and dispute resolution,
- Taxing innovation,
- Digital taxation, and
- IFRS 15 and 16 tax matters.
Historical context to international developments in direct tax
Most of the rules governing taxation of multinational businesses date back to the 1920s, a time when a relatively small number of companies operated across international borders. In today’s information age, the landscape is very different and advances in transportation and digital technology make it far easier for, even small companies, to trade across country borders. As the number of companies operating internationally grew throughout the 20th century, the tax systems that governed their operation also began to develop in both complexity and inconsistency. International taxation became a complex web of individual country tax laws and bi and multilateral trade agreements between nations. Unsurprisingly, elements within the framework became outdated and no longer suited to the realities of the modern global business economy.
Therefore, in 2013 the G20, which is comprised of the most powerful world economies, engaged the Organisation for Economic Co-operation and Development (OECD) to address perceived inequities and inconsistencies in the global tax landscape. This became the Base Erosion and Profit Shifting (BEPS) project.
Since then, the G20 has endorsed the OECD’s BEPS 15-point action plan to modernise the principles underlying today’s international tax landscape and to develop a consistent framework for countries to base their tax legislation upon.
At the core of the G20/OECD’s project is:
- Eliminating tax mismatches such that all income is taxed,
- Aligning profits with value creation,
- Increasing consistent levels of transparency with tax authorities, and
- Implementing change in a coordinated fashion
The confluence of the G20/OECD’s efforts, combined with the changing perspective of taxation, increased sharing of information between tax authorities in different countries, and the pressure on governments to collect additional tax revenues, are culminating in sweeping changes to tax laws and treaties. This is triggering a complete Global Tax Reset for businesses with worldwide operations. While some of the proposals will be seen as increasing tax risk and bringing greater complexity, ultimately having a consistent tax platform is important to global businesses. The alternative is individual country measures, such as the UK Diverted Profits Tax, which creates inconsistency and potentially uncertainty.
At the OECD level over the past number of years, we have had the BEPS project and consultations on the taxation of the digital economy. The EU have brought forward their Anti-Tax Avoidance Directives and digital tax proposals, as well as reigniting discussions on moving towards a common consolidated corporate tax base. The US (and many other countries) have brought forward tax reform measures of their own. Recently, we have also seen substantial changes in historically low/no tax jurisdictions such as Cayman, Barbados and Bermuda, with respect to the introduction of potentially impactful substance requirements.
We will look at some of these changes in more detail during the course of the session.
The implementation of BEPS and EU Directives into national Irish legislation
In 2015, the OECD published 13 final reports and an explanatory statement outlining consensus actions under the BEPS project. In the time since, Ireland has taken a number of measures to implement the BEPS initiatives into our national legislation including:
- Signing up to the Multi-lateral Instrument (‘MLI’) – Action 2, 6, 7 and 14
- Introducing Controlled Foreign Company (‘CFC’) rules – Action 3
- Introducing OECD-compliant Knowledge Development Box rules – Action 5, and
- Introducing Country by Country reporting rules – Action 13.
Ireland also took steps to end the ‘Double Irish’ structure in response to the BEPS project.
The EU presented an Anti-Tax Avoidance Directive (‘ATAD’) in January 2016. The ATAD was formally adopted by the EU Economic and Financial Affairs Council on 12 July 2016. The aim of the ATAD was to provide a minimum level of protection for the internal market and ensure a harmonised and coordinated approach in the EU to the implementation of some of the recommendations of the OECD BEPS project.
The ATAD provides for the minimum harmonisation of rules in the areas of CFCs, hybrid mismatches and interest deductions, and requires the introduction of a corporate general anti-abuse rule (GAAR) and an exit tax (the latter two measures were not part of the BEPS project). The EU Economic and Financial Affairs Council subsequently finalised amendments to the ATAD and published a subsequent Directive (ATAD 2) which was primarily concerned with an expansion of the scope of hybrid mismatches rules.
To date, Ireland has implemented aspects of the EU Directive (i.e. CFC rules and an Exit Tax) and future changes to our domestic legislation are likely over the coming months and years to incorporate:
- Anti-Hybrid rules – ATAD 2 and BEPS Action 2, and
- Interest restriction rules – ATAD and BEPS Action 4.
We will explore the above in further detail as we go through today’s session.
Multilateral Instrument (‘MLI’)
One of the key international tax developments in the past number of years has been the introduction of the MLI. On 7 June 2017, representatives from 68 countries and jurisdictions (including Ireland) signed the OECD’s MLI, encompassing a network of around 1,100 bilateral tax treaties to implement the treaty based recommendations of the BEPS process. Subsequent to 7 June 2017, a number of other jurisdictions have also signed up to the MLI. The MLI operates to modify tax treaties between two or more parties. It applies alongside existing tax treaties, modifying their application in order to implement the BEPS measures. The intention of the MLI is to enable all countries to meet the treaty related minimum standards that were agreed as part of the final BEPS package. These include measures to prevent treaty abuse, changes to the definition of permanent establishment (PE), changes to the residence tiebreaker for companies, mutual agreement procedures and mandatory binding arbitration.
Going forward, it will be necessary to review and consider the MLI provisions as well as the relevant tax treaty to fully understand the tax position of each country.
For a specific tax treaty to be covered by the MLI, both treaty partners need to meet a number of conditions;
- Both treaty partners must have signed the MLI and must have listed the relevant treaty as being covered by the MLI,
- Both treaty partners must have ratified the MLI, and
- Both treaty partners must have deposited an instrument of ratification, followed by the entry of the MLI into force in their domestic legislation.
As there is wide diversity in the choices and reservations made by treaty countries in respect of the provisions of the MLI and the mechanisms for the implementation of those provisions can vary from country to country, the OECD has a comprehensive website, which lists details of up to date signatories and ratification and entry into force details. The OECD also has a very useful matching database available which summarises the rules adopted by the treaty countries and which can be filtered to show the interaction of the various rules between countries. When you are looking at how the tax treaties apply to various countries, this database should be your first port of call for determining the impact that the MLI will have on those tax treaties. The database is updated on a continuous basis for any changes in the rules/provisions in the different jurisdictions.
The MLI addresses a number of the BEPS action points including dual resident entities (Action 2), prevention of treaty abuse (Action 6), permanent establishment status (Action 7) and dispute resolution (Action 14). We will look at Ireland’s position on some of the key MLI articles, which deal with these in further detail below.
Ireland deposited its instrument of ratification for the MLI with the OECD on 29 January 2019. The rules provide that the MLI enters into force on the first day of the month following the expiration of a period of three calendar months beginning on the date that the MLI ratification instrument was deposited with the OECD. Therefore, the MLI entered into force in Ireland on 1 May 2019.
The provisions of the MLI that Ireland have chosen to adopt will become live and take effect to a specific tax treaty only when the treaty partner has enacted the same provision. Currently, the earliest date that the provisions relating to withholding tax can take effect is 1 January 2020. It is likely that 1 January 2020 is the date when all other provisions will take effect also (although an earlier date is possible if both treaty partners decide to apply a shorter period).
The United States of America is not a signatory to the MLI. Therefore, Ireland’s tax treaty with the United States is unaffected by MLI provisions. Ireland is currently negotiating a new tax treaty with the Netherlands, so Ireland and the Netherlands have agreed to exclude the existing tax treaty from the scope of the MLI. Ireland has also agreed bilaterally with Germany and Switzerland to exclude the current tax treaties in place with these countries from the scope of the MLI. The BEPS recommendations will be implemented by Protocols to these tax treaties instead of through the MLI due to domestic law restrictions in those countries. The remainder of Ireland’s tax treaties are in scope of the MLI provisions.
Dual Resident Entities
In terms of addressing Dual Resident Entities (BEPS Action 2), Article 4 of the MLI contains provisions to address how tax residency is to be determined in the case of entities which are considered to be dual tax resident.
Under the existing OECD model tax treaty, the tiebreaker for dual resident entities is generally considered to be the place of effective management. The place of effective management is generally considered to be the place where decisions are taken and where the actual decision making powers of the company are located. Ireland has chosen to adopt the new rule in Article 4 of the MLI. Article 4 of the MLI now provides that in a tiebreaker situation, tax residence is to be determined by mutual agreement between the respective tax authorities. For example, in a dual residence situation between Ireland and the UK, tax residence would be determined by mutual agreement between Irish Revenue and the HMRC.
The MLI does not provide clarity on how the tax authorities will agree on the tax residency of the applicant taxpayers. Article 4 states that regard will be given to the place of effective management, the place of incorporation and any other relevant factors but it does not specify what weight will be given to the various factors. There is also no indication of the capability and capacity of taxing authorities to handle requests for mutual agreement decisions on residency. The practicalities of how Article 4 will be applied remain to be confirmed.
Prevention of Treaty Abuse
Article 7 of the MLI introduces measures aimed at preventing treaty abuse (BEPS Action 6). Whilst Article 7 is mandatory for all signatories to introduce, there are three options available to signatories;
- Principal purpose test (PPT)
- Simplified limitation on benefits test and principal purpose test, and
- Detailed limitation on benefits text (similar to that contained in tax treaties with the US).
Ireland has chosen to adopt option (a), a principal purpose test. This introduces a general anti-avoidance provision into tax treaties where the treaty partner has also chosen to adopt the PPT option. The PPT operates to deny treaty benefits if a tax authority considers that obtaining the treaty benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit. For example, a pure conduit
company with no commercial substance which has been interposed into a transaction to benefit purely from the favourable terms of a double tax treaty between two jurisdictions would likely not qualify for tax treaty benefits once the MLI is ratified into treaties.
There are a number of jurisdictions, which have, in addition to the PPT, included a simplified limitation on benefits provision. What happens when one party has signed up to the PPT and the counterparty to the double-tax treaty has included a simplified limitation on benefits clause? There are a multitude of outcomes that are relevant depending on the reservations and options chosen by each party; however, broadly, and in most scenarios,
where one party has included the PPT and the counterparty jurisdiction has included the PPT and simplified limitation on benefits clause, only the PPT will apply.
Permanent Establishment Status
Article 12 introduces a new test for when an agent can constitute a Permanent Establishment (“PE”). Ireland has chosen not to adopt the MLI provision, which would create a PE for a company where a person is acting on behalf of an enterprise and in doing so
habitually concludes contracts, or habitually plays the principal role in leading to the conclusion of contracts that are routinely concluded without material modification, in the country in which the person undertakes these activities.
Article 12 of the MLI widens the existing provisions under many tax treaties, which provide
that where a person, other than an agent of independent status, is acting on behalf of an enterprise and has, and habitually exercises, in a contracting state, the authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment.
Ireland has chosen to adopt the minimum standard Article 16 of the MLI, which sets out standard time limits and procedural rules for how disputes under tax treaties should be dealt with.
Ireland has chosen (in order to ensure an efficient mechanism for resolving certain disputes is available) to adopt Article 17 (but only for agreements that do not contain a similar provision) which provides an ability for countries to unilaterally adjust the amount of tax paid by a taxpayer in certain circumstances.
Articles 18 – 26 deal with mandatory binding arbitration. Countries must first decide whether to opt into this at all and where they do so, whether they adopt or reserve on a number of articles detailing how the arbitration would work. Ireland has opted into this arbitration procedure.
The provisions of the MLI regarding arbitration and increased cooperation between global tax authorities will be a welcome change to the way in which tax authorities have dealt with each other in the past. However, this increased communication between tax authorities will require global tax teams to work more closely together to ensure consistency and communication across borders in the new tax environment.
Controlled Foreign Company (‘CFC’) Rules
One of the most significant changes in Ireland’s tax law arising out of the BEPS/ATAD processes has been the introduction of CFC rules. CFC rules are an anti-abuse measure, designed to limit the diversion of profits through the use of offshore entities in low or no tax jurisdictions.
Prior to 1 January 2019, Ireland had no CFC rules in domestic legislation. Documentation published as part of Budget 2019 states that the Government expect the CFC rules to be tax neutral (i.e. no actual tax revenue is expected to derive from the new legislation). However, the rules still require consideration by taxpayers and documentation is likely to be needed to support the position taken by companies within the scope of the legislation.
The Anti-Tax Avoidance Directive (ATAD), under Article 7, provided two options when determining how to implement the new CFC rules required:
- Option A - applies a CFC charge on undistributed income of the entity or PE which is derived from certain types of passive income such as interest, royalties, dividends or financial leasing income, or
- Option B - applies a CFC charge on undistributed income of the entity or PE arising from non-genuine arrangements, which have been put in place for the purposes of achieving a tax advantage.
After consultation, Ireland adopted Option B and these rules, which were introduced as part of Budget 2019, are effective from 1 January 2019.
There are a number of questions that need to be answered in order to determine whether a CFC charge will apply.
What is a CFC?
A CFC is defined in the legislation as a company, which is non-resident in Ireland and is controlled by a company or companies’ resident in Ireland. For the purposes of the legislation, control is defined as having the right to acquire or control the greater part of the share capital or issued share capital of the company or voting power. It also includes rights to income/assets on distribution on winding up or control over the composition of the board of directors. Essentially the concept of control is based on the existing close company provisions we have under Section 432 TCA 1997 with some additional measures such as the ability to control the composition of the board of directors.
Is there undistributed income?
The second step to consider is whether there is any undistributed income in the subsidiary held by Ireland. If a CFC has no undistributed income, then there is nothing to apply the CFC charge to in the first instance. That term is defined in s835Q TCA 1997 as being the distributable income of the CFC per the accounts less any relevant distributions.
One point on s835Q TCA 1997 is that it looks to accounting profits of a company “notwithstanding any prohibition on the making of a distribution under the laws of the territory in which the controlled foreign company is resident or otherwise”. This is interesting as close company provisions contain an ‘out’ for instances in which the making of a distribution is prohibited under law.
For the purposes of the definition, relevant distributions are those made:
- To a resident of a relevant member state;
- Within 9 months of the end of the accounting period; and
- Subject to tax in the relevant member state and does not fall to be repaid.
These conditions are, therefore, key and the time limits for payment of distributions will likely need to be factored into standardised compliance review processes. In due course, we would expect that this will become part of the compliance calendar for many taxpayers.
Are there significant people functions (SPFs) being performed by the Irish company?
Section 835R(2) TCA 1997 applies the CFC charge to undistributed income attributable to relevant Irish activities (i.e. functions performed in Ireland on behalf of the CFC). This effectively means you look to the significant people functions (SPFs) or key entrepreneurial risk taking (KERT) functions exercised by Ireland.
The SPFs and KERTs that will be relevant will vary from one business sector to the next so whether or not the Irish company exercises any SPF/KERTs will very much be based on the facts at hand.
Are there arm’s length arrangements in place already?
Once you know that there is a CFC, undistributed income and SPFs/KERTs, you must then consider whether there are arm’s length arrangements in place already. The legislation provides that the CFC charge will not apply where is it reasonable to consider that such arrangements would be entered into by persons dealing at arm’s length.
Is it reasonable to consider that tax was the essential purpose of the arrangement for the controlling entity?
Section 835R TCA 1997 states that a CFC charge will not apply where it is reasonable to consider that securing a tax advantage was not the essential purpose of the arrangement for the controlling entity.
Are the arrangements subject to Irish Transfer Pricing rules?
Section 835R(5)(a)(ii) TCA 1997 provides that where an Irish entity has received an arm’s length remuneration for the SPF/ KERT function, then the CFC charging provision will not apply in respect of that undistributed income (i.e. the Irish entity is being remunerated for the services provided and taxed on same). It would be important to ensure that robust benchmarking and Transfer Pricing reports are prepared and available to support reliance on this exemption in the event of a challenge from Revenue.
Is the undistributed income negligible or is the low margin exemption available?
If it is not possible to get out of the CFC charge under any of the foregoing provisions, consideration should be given to whether the low profit margin exemption is available to remove the CFC charge. This applies where the accounting profits of the CFC are less than 10% of the operating costs of the CFC.
A low accounting profits exemption is also available which provides exemption where:
- The accounting profits of the CFC are less than €750,000 AND the non-trading element of those profits is less than €75,000, or
- The accounting profits are less than €75,000.
In addition, there is a negligible income exemption, which applies where there is a negligible increase in the undistributed income of a CFC post assumption of the risks or assets from the controlling entity. ‘Negligible’ is not defined but we can take some guidance from the provisions of Section 538 TCA 1997, which refers to ‘negligible’ from a Capital Gains Tax perspective. Revenue’s manual on the section (Part 19-01-09) states, “As stated in Tax Briefing 52 the word ‘negligible’ is not defined for the purpose of the Capital Gains Tax Acts and therefore takes its normal meaning, i.e. not worth considering; insignificant. The concept of negligible value is not comparative in nature.” It should be noted that this manual is currently being updated by Revenue and is currently unavailable on their website.
Are there any non-genuine arrangements in place?
Section 835R(10) TCA 1997 provides that a CFC charge shall not apply in an accounting period where the CFC did not have any non-genuine arrangements in place. A non-genuine arrangement is defined as one where:
- The CFC would not own the asset; or
- Would not have borne the risks which generate the income, but for the relevant Irish SPFs, and
- It would be reasonable to consider that the relevant Irish activities were instrumental in generating that income.
Was tax the essential purpose for the CFC?
There is a second tax essential purpose test, contained in Section 835R TCA 1997 which is written from the viewpoint of the CFC (as opposed to the earlier test which is written from the viewpoint of the controlling entity). It is necessary to consider whether securing a tax advantage was the essential purpose of the arrangement for the CFC.
What is the effective tax rate of the CFC?
The final question to consider is what is the effective tax rate of the CFC? A CFC charge will not apply if the CFCs foreign effective tax rate is more than 50% of the tax that would
have been suffered had the income been taxed in Ireland on the relevant income under Irish tax rules.
Anti-Hybrid and Interest Restriction Rules Consultations
A hybrid mismatch can arise due to the difference in how entities are treated for tax purposes in two different jurisdictions. In some cases, due to hybrid mismatches the same expenditure item can be deductible in more than one country or where expenditure is deductible, the corresponding income may not be taxable in the other country. The ATAD contained anti-hybrid rules to close out these anomalies. Ireland has confirmed its intention (in the Corporate Tax Roadmap released by the Irish Government) to introduce anti-hybrid rules in Finance Bill 2019. Reverse hybrids (i.e. where one country classifies an entity/partnership as transparent whilst another country classifies an entity/partnership as opaque for tax purpose) will be legislated for in subsequent Finance Bills.
Article 4 of the ATAD requires the introduction of fixed ratio interest limitation rules which will operate to deny a deduction in respect of net interest expense (being gross interest less interest income) that exceeds 30% of the taxpayer’s EBITDA. The limitations can be applied on an entity-by-entity basis or at group level. The deduction is restricted to 30% of EBITDA or €3million, whichever is higher. The interest limitation rules must be transposed into law by 1 January 2019 unless there is a derogation (where it can be shown that the country has an equally effective rule already in domestic legislation) to 1 January 2024. We understand that Ireland is in discussions with the EU with respect to obtaining a derogation.
In November 2018, the Minister for Finance launched a public consultation process in respect of adopting the ATAD provisions dealing with hybrid and interest limitation rules (for Finance Bill 2019 purposes). A response by the Minister to the submissions received in respect to the public consultation is expected in the coming months.
EU Mandatory Disclosure Regime
The EU Tax Intermediaries’ Directive, which requires mandatory reporting by tax intermediaries and the automatic exchange of information by the tax authorities of member states for certain cross-border arrangements in relation to individuals, companies and other entities took effect earlier this year.
The Directive broadly reflects the elements of Action 12 of the BEPS project on the mandatory disclosure of potentially aggressive tax planning arrangements.
The Directive will provide EU tax authorities with information about such schemes by requiring intermediaries, such as tax advisers, accountants, banks and lawyers, who design and promote tax planning schemes for their clients, to report to the tax authorities in the country in which they are resident any cross-border tax planning arrangement they design or promote that contains specific broadly defined criteria (“hallmarks”). That EU Member State then will share the information with all other Member States on a quarterly basis. Penalties will be imposed on intermediaries that do not comply with these transparency measures. If the taxpayer develops the arrangement in-house, or is advised by a non-EU adviser, or if legal professional privilege applies, the taxpayer must notify the tax authorities directly.
The Directive will apply from 1 July 2020, and Member States have until 31 December 2019 to transpose it into their national laws and regulations. It should be noted that arrangements, the first step of which is implemented between the date the directive entered into force (June 25, 2018) and its effective date (1 July 2020), would have to be reported by 31 August 2020. However, it is likely that we will not see the legislation implementing the directive until Finance Act 2019 so taxpayers need to be aware that transactions being entered into currently may have to be reported.
Other EU developments
Common Consolidated Corporate Tax Base (CCCTB)
The European Commission originally proposed the CCCTB in 2011 but that proposal was not agreed upon by the Member States. As a recap, the proposed Common Consolidated Corporate Tax Base (CCCTB) is a single set of rules to calculate companies' taxable profits in the EU. With the CCCTB, cross-border companies would only have to comply with one, single EU system for computing their taxable income, rather than many different domestic systems. Companies could file one tax return for all of their EU activities and offset losses in one Member State against profits in another Member State. The consolidated taxable profits would be shared between the Member States in which the group is active using an apportionment formula. Each Member State would then tax its share of the profits at its own domestic tax rate.
In October 2016, the Commission re-launched the CCTB. The CCCTB proposals of October 2016 are made up of two elements:
- Common Corporate Tax Base (CCTB), and
- Common Consolidated Corporate Tax Base (CCCTB).
Under the October 2016 proposals, Member States would first agree on rules for a Common Corporate Tax Base (CCTB) and then agreement would be sought on consolidating those rules. The focus of the attention in the October 2016 proposals is more on countering tax avoidance as opposed to simplifying compliance. It is also worth noting that the proposals (2011 or 2016) do not propose any changes to domestic tax rates.
In June 2018, France and Germany issued a common position paper on the European Commission’s proposals of October 2016. This position paper proposed a number of modifications to the Commission’s proposals. Member States have been discussing these proposals and other modifications in recent months. However, no major progress towards agreement on the proposals has been made to date.
Qualified Majority Voting (QMV)
On 15 January 2019, the European Commission issued a proposal on how to move away from unanimous voting to qualified majority voting (‘QMV’) for tax matters, human rights issues and civilian missions on a phased basis.
QMV is used for more than 80% of legislative decision making in the EU and it gives the European Parliament and the European Council an equal say in adopting new laws. When QMV is in operation, a qualified majority is reached when the following two conditions are met:
- 55% of Member States vote in favour (i.e. 16 Member States out of 28), and
- Member States representing at least 65% of the EU population support the proposal.
A decision, that has received a qualified majority vote, can be blocked by a ‘blocking majority’. A ‘blocking majority’ is formed by at least four Member States representing more than 35% of the EU population.
Minister for Finance, Paschal Donohoe, has stated that Ireland will not support any changes in how tax matters are agreed at EU level and it is expected that a number of other Member States have similar views (including Luxembourg, the Netherlands and Malta).
There is an option open to the Commission under Article 116 of the Treaty on the Functioning of the European Union to effectively force through the QMV proposal but to date, there has been no majority within the EU Commission to exercise this provision. It will be interesting to see how these proposals progress once the new European Commission takes office on 1 November 2019.
EU Council – Blacklist
On 12 March 2019, the European Council added a further ten countries/jurisdictions to its list of non-cooperative jurisdictions for tax purposes. These jurisdictions were added to the list as a result of a failure to implement the commitments they had made to the EU within the agreed timeline.
The list was originally published in December 2017 following a review of 92 jurisdictions and is intended to “prevent tax avoidance and promote tax good governance worldwide”. The list of non-cooperative jurisdictions now includes American Samoa, Aruba, Barbados, Belize, Bermuda, Dominica, Fiji, Guam, Marshall Islands, Oman, Samoa, Trinidad and Tobago, United Arab Emirates, US Virgin Islands and Vanuatu.
In addition to the jurisdictions listed on the non-cooperative list, there are also 34 countries on the “grey list” (i.e. these countries have committed to making required changes by an agreed future date).
Under the EU Mandatory Disclosure Requirements where there are arrangements that involve deductible cross-border payments made between two or more associated enterprises and the recipient is resident for tax purposes in a jurisdiction that is included in the non-cooperative jurisdictions list, then this transaction will need to be disclosed.
US Tax Reform
US tax reform has had a significant impact on global business since the reforms were announced at the end of 2017. The aim of the tax reforms was to move the US towards a territorial system of taxation. However, the mechanism by which this is being achieved is having the potential to tax foreign source income also.
I don’t propose to go into a lot of detail on the US reforms. However, I will touch on some of the key reforms at a very high level.
A Global Intangible Low Taxed Income (GILTI) charge was introduced to treat all income in excess of a specified return on tangible property (e.g. property, plant and equipment) as flowing from intangible property, and taxing that income on a current basis in the hands of the US parent company (even where the income may actually be accounted for in a foreign subsidiary). Generally, GILTI income is subject to tax at a rate of 10.5%. As there is a credit for 80% of the foreign taxes incurred in relation to the GILTI income (subject to some complexities), the Irish rate of 12.5% is well placed.
The Foreign Derived Intangible Income (FDII) rules provide for a deduction for US domestic entities to incentivise them to locate IP in the US. Under this regime, a US entity is generally entitled to a deduction of 37.5% of its foreign derived intangible income, which means that such income is taxed at an effective rate of 13.125%. This appears to be an attractive incentive for companies to return IP to the US (albeit dependent on the headline rate of US tax, which could rise in the future, and possible challenges by the World Trade Organisation).
The Base Erosion Anti-Abuse Tax (BEAT) rules seek to prevent US multinationals from eroding their tax base through making tax deductible payments to foreign companies. The rules impose a minimum tax by denying a deduction for such base eroding payments through a specific formula. The BEAT rules do not appear to take into account the fact that there may be genuine commercial reasons for making such payments to the foreign affiliates or that they are supported by Transfer Pricing documentation.
Ireland’s 12.5% rate of corporation tax remains attractive when compared with the US
combined federal income tax and state rate tax (circa 25% in total) but the US is now a bigger competitor on the world stage than it was before US tax reform.
Impending changes in Transfer Pricing rules
Finance Act 2018 did not contain any specific transfer pricing related measures, but the Minister in his Budget speech further reinforced the significance of Ireland’s Corporation Tax Roadmap that was published on 5 September 2018. The roadmap discussed possible changes that could be made to Irish transfer pricing rules to ensure Ireland is in line with new international best practice but did not commit Ireland to any definite transfer pricing changes.
The roadmap confirms that Ireland will update domestic transfer pricing rules in Finance Bill 2019 with effect from 1 January 2020. The updated transfer pricing rules are likely to be incorporated into Irish law in Finance Act 2019. The enactment of some or all of the recommendations of the roadmap with respect to transfer pricing will increase the compliance burden and costs for companies.
A public consultation launched on 18 February 2019 allowed stakeholders to input on some of the complex transfer pricing issues recommended in the Coffey Review, ahead of the implementation of the new rules.
The updated Irish transfer pricing rules will look to validate Ireland’s commitment to seek greater alignment of taxable profits with the location of economic substance and value creation. While certain aspects of BEPS Action 13 were enacted in 2015 (Country by Country reporting), the remaining transfer pricing recommendations were not formally legislated for in Ireland. The roadmap concludes that it is important for changes to the Irish rules to be made in a careful and considered manner as one coherent package, rather than in a piecemeal approach over a number of years.
The transfer pricing changes as discussed in the roadmap and contained in the Coffey Review include:
- With reference to adoption of the OECD’s 2017 Transfer Pricing Guidelines, Ireland is looking to introduce legislation in Finance Act 2019 to update Ireland’s transfer pricing rules with effect from 1 January 2020.
- The changes that could be introduced include:
- extending Ireland’s transfer pricing regime to non-trading and capital transactions;
- applying transfer pricing rules to small and medium enterprises (removal of current SME exemption); and
- applying transfer pricing legislation to pre 1 July 2010 grandfathered arrangements and bringing them within the scope of transfer pricing law.
- applying transfer pricing legislation to branches in Ireland
- extending documentation requirements
The next few years are likely to see fundamental changes to Irish transfer pricing and companies should review their current transfer pricing arrangements, both financial and non-financial transactions, and business models, to assess their readiness to deal with the changes in a timely manner. With more aggressive positions taken recently by tax authorities on transfer pricing audits, companies need to be well informed of the various tax reforms and be aligned with globally agreed transfer pricing standards.
Tax controversy and dispute resolution
Internationally, there has been a significant increase in the number of tax audits (domestic and cross-jurisdictional) and enquiries across all tax heads as Revenue authorities become more sophisticated and dedicate more resources towards the area of tax controversy. This is creating a very challenging environment for companies operating across borders as they are required to dedicate time and resources to dealing with these audits on what can be an ongoing basis.
Some of the reasons for the international rise in tax controversy include;
- Increasing levels of information available to tax authorities as a result of country-by-country reporting (CbCR),
- Changes introduced as part of the OECD BEPS initiative,
- Increases in the exchange of information between tax authorities,
- An increase in the number of joint tax audits by tax authorities across jurisdictions,
- Substantial increases in resources dedicated to tax controversy by tax authorities globally, and
- Increased media and public interest in international tax structuring which results in tax mismatches across jurisdictions.
Multinationals are responding to the increased scrutiny by setting up dedicated internal tax audit functions that take a clear and consistent approach to dealing with international tax audits and which work across the globe to ensure that tax positions are articulated consistently in all tax audits and that the group’s international worldwide view is put forward (instead of having local adhoc responses to specific domestic tax audits).
The OECD encourages taxpayers to resolve disputes through mutual agreement procedures (‘MAP’) and to prevent disputes through advance pricing agreements (‘APA’).
The MAP process is a means through which tax authorities consult with each other to resolve disputes, which involve the application of double taxation treaty provisions. These disputes usually involve situations where the same profits have been taxed in two jurisdictions. The aim of the MAP process is to negotiate a solution that is agreeable to both tax authorities and which resolves the issue of double taxation for the taxpayer.
An APA is a binding agreement between two tax authorities and the taxpayer concerned, which sets out the tax treatment of future transactions between associated taxpayers for double tax treaty purposes. An APA is generally fixed for a period of three to five years.
Revenue, in their recently published Annual Report for 2018 confirmed that they completed 12 MAPs (28 were initiated in 2018) and granted three APAs (nine applications for APAs were received) to Competent Authorities of other jurisdictions to eliminate double taxation in 2018. They have confirmed that there has been a significant increase in applications for MAPs and APAs in recent years.
Section 291A TCA 1997
Technical amendments to Section 291A TCA 1997 were introduced in Finance Act 2018 relating to the 80% cap re-introduced by Finance Act 2017.
The original wording in Section 291A(6) TCA 1997 (as introduced by Finance Act 2017) provided that any allowances made for specified intangible assets will not exceed 80% of the amount of trading income from the relevant trade (i.e. from the exploitation or management of the assets or from the sale of goods or services deriving their value from the assets in question). Originally, the legislation indicated that the relevant activities and other trading activities would be streamed on a just and reasonable basis but it was not specific in terms of how this streaming was to be done with respect to income derived from intangible assets purchased pre and post the re-introduction of the 80% cap (i.e. pre and post 11 October 2017).
The technical amendment introduced by Finance Act 2018 requires that income generated from qualifying intangible assets acquired pre and post 11 October 2017 should be separated into two distinct income streams. The wording of the Finance Act states that the amendment will apply retrospectively to corporation tax returns already filed by the company. This could cause difficulties for companies that filed their returns on another basis before this clarification was provided.
R&D Tax Credit
On 6 March 2019, Revenue released its latest version of the R&D Tax Credit Guidelines, which are an aid to interpretation of the legislation. It is almost four years since the last update. This update contains a number of clarifications and additional examples, together with a suggested file layout for retaining documentation to evidence the Science and Accounting Tests.
I have set out, below, a very high level outline of the changes made by the new guidelines.
Subcontracted R&D Activities
The guidelines previously restricted the ability of a company to claim for any subcontracted R&D other than activities that were qualifying R&D activities in their own right. The guidelines now state that “the outsourced activity must constitute qualifying R&D activity of the company which appointed the sub-contractor, and not necessarily R&D of the subcontractor.” This is a very constructive development as it considers entitlement to tax credit from the standpoint of the claimant and reflects the reality of subcontracting, in that the claimant company does not have the expertise in-house and therefore requires outside assistance it to support its in-house R&D. The impact of the change will be the confidence that it gives claimants to include subcontracted activities that may previously have been omitted from claims.
Revenue also confirmed that it is no longer necessary for notification letters to be issued to subcontractors who cannot claim the R&D tax credit in their own right. This should make the system more efficient and less burdensome for claimant companies.
Employee Remuneration and Secondments
The guidelines state “All expenses borne by the company in relation to the employment contract of the staff member which are operated through the PAYE/PREM payroll system should be considered to be emoluments, and apportioned.” The limitation on health insurance that previously excluded contributions for dependents of R&D personnel has been removed.
The guidelines provide that the costs of employment of individuals seconded to a company, borne by the company carrying on R&D activities, can now be treated as direct employee costs (i.e. not subject to the “subcontracted R&D” rules) if the individual(s) carries on the R&D activities in Ireland and contributes specialist knowledge to a specific R&D project.
Two main changes were introduced with respect to documentation.
Firstly, a small but important addition has been inserted with respect to the retention of “contemporaneous and relevant” documentation in support of the claim. The additional wording is that “in circumstances where a particular project within the claim fails to meet the requirement to have sufficient appropriate documentation available, but there are no concerns about the quality or lack of documentation for the rest of the claim, Revenue will only disallow that portion of the claim with insufficient documentation”. This indicates a pragmatic approach to audits.
Secondly, Revenue has set out a suggested file structure and the key points that the documents in each section of this structure should address. Many of the sections are familiar as they match the layout and questions set out in Revenue’s self-review questions (also known as the R&D Aspect Query) sent by Revenue inspectors. Other sections are new, however, and their underlying relevance is not always clear. In addition, certain sections do not apply to all industries, so it is hoped that claimants would not be disadvantaged if these sections are missing from their documentation stores. The impact of this addition, in that it is a suggested but not obligatory file structure for organising contemporaneous supporting documentation, is largely positive. It should be of benefit to existing claimants who don’t have appropriate documentation and who are considering upgrading their systems and processes to be audit ready, but also to potential new claimants who are assessing what needs to be done to prepare a robust claim and, in time, defend it. It can be used as a benchmark against which claimants can evaluate current record keeping. It is worth remembering that in defending the claim, the burden of proof is on the claimant to evidence entitlement to tax credits, and there is no guarantee that Revenue will not request further information from a claimant regarding either the financial or technical details of a claim.
While this is a file structure for organising contemporaneous supporting documentation, it is not clear if this will modify Revenue’s approach to Aspect Queries. Having clarification on whether inspectors will request information in this format, the current Aspect Query format or another alternative would be beneficial to assist claimants. In addition, with the Guidelines having prospective effect, claimants should expect that they will only apply to claims that are filed after their publication date.
Apportionment of Costs
The guidelines include new wording concerning the bona fides of apportionment methods. This indicates that Revenue is likely to place more emphasis on ensuring that companies apply the most appropriate cost driver and allocation basis to costs being apportioned. This will be particularly relevant to companies with diverse operations on sites used for both R&D and production, where for example manufacturing operations might consume more electricity per head than purely office-based R&D activities. Of note, an allocation percentage is acceptable provided it has been chosen by the company’s management accountant, financial director or an appropriate director, if that choice is bona fide, reasonable and based on the facts of the individual claim. One would hope that where an R&D technical director or project manager has assessed the apportionment, this would also be acceptable to Revenue.
Payable Tax Credits
The guidelines now include an example (Example No.9) that sets out the correct cash instalment treatment in the event that the R&D tax credit exceeds payroll liabilities. The correct treatment is that the cash refund instalments should be based on the excess tax credit, not the limit applied to the overall allowable repayments derived from the payroll figure, with the result that there may be fewer than the expected three instalments. This improves the cash flow for claimants affected by the cash repayment limits.
Concession for SMEs in receipt of a grant
The guidance now incorporates a Tax and Duty Manual (Part 29-02-07) issued by Revenue in 2017, acknowledging that while there are differences in the definitions of R&D used for RD&I grants and the R&D tax credit, Revenue considers that the two definitions are very close. As a result, Revenue decided that it would not, as a rule, seek to challenge the Science Test in relation to funded projects for small claims (€50,000 or less of tax credit) from micro, small and medium-sized enterprises. This is welcomed in that it reduces the claimant’s burden in defending the Science Test, and it encompasses RD&I grants administered by Enterprise Ireland, EU’s Horizon 2020 fund, and IDA Ireland.
Mergers or Transfers of the trade
The guidance clarifies that, whether the transfer is effected by way of a transfer of a trade or a merger, the successor company may claim any R&D tax credit amounts not used by the predecessor company, but may not claim a payable tax credit in respect of any such unused amounts.
For a number of years, the concept of a digital services tax and how such tax could be administered has been a topic of discussion at EU and OECD level. In recent months, these discussions have garnered attention in the media at a national and international level.
In March 2018, the OECD issued an interim report on the taxation of the digital economy as part of its BEPS project. One of the important conclusions of this report is that members agreed to review the impact of digitalisation on nexus and profit allocation rules and committed to continue working together towards issuing a final report in 2020 aimed at providing a long-term solution. A consultation process took place in March 2019 and it is expected that further information will be available after the G20 meeting in June 2019.
On 21 March 2018, the European Commission issued two draft Directives on the taxation of the digital economy. Under the proposed solutions in those draft Directives, companies would have to pay corporate income tax in each Member State where they have a significant digital presence. In the interim, the Commission proposed a 3% revenue-based Digital Services Tax on specific digital services where the main value is created through user participation. Included within the scope of the digital services tax would have been the online placement of advertising, the sale of collected user data and the provision of digital platforms that facilitate interaction between users. The proposed tax would have had a threshold such that it would not apply where total worldwide revenues are below €750m and total annual revenue from digital activities in the EU are below €50m.
However, as of 12 March 2019, these interim digital tax proposals have effectively been shelved by the EU in favour of working towards greater unanimity in how such measures are to be applied on a global level given the OECD work in this area.
In recent days, the OECD announced that the international community has agreed on a road map for resolving the tax challenges arising from the digitalisation of the economy and committed to continue working toward a consensus-based long-term solution by the end of 2020.
The 129 members of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) adopted a Programme of Work laying out a process for reaching a new global agreement for taxing multinational enterprises. The document, which calls for intensifying international discussions around two main pillars, was approved during the May 28-29 plenary meeting of the Inclusive Framework, which brought together 289 delegates from 99 member countries and jurisdictions and ten observer Organisations.
The Programme of Work will be presented for endorsement at the G20 meeting in June 2019. The Programme of Work will explore the technical issues to be resolved through the two main pillars. The first pillar will explore potential solutions for determining where tax should be paid and on what basis ("nexus"), as well as what portion of profits could or should be taxed in the jurisdictions where clients or users are located ("profit allocation").
The second pillar will explore the design of a system to ensure that multinational enterprises – in the digital economy and beyond – pay a minimum level of tax. This pillar would provide countries with a new tool to protect their tax base from profit shifting to low/no-tax jurisdictions, and is intended to address remaining issues identified by the OECD/G20 BEPS initiative.
Specific jurisdictions (the UK, France and Spain) have already proposed domestic digital tax measures. For example, the UK proposed introducing a Digital Services tax from April 2020. The UK proposed applying a 2% tax on revenues of specific digital business models where revenue is linked to the participation of UK users. The tax suffered by a UK entity will be an allowable deduction for corporate tax purposes, but importantly will not be allowable as a credit against corporate tax. The scope of the UK tax will include search engines, social media platforms and online marketplaces but will exclude financial and payment services, the provision of online content and television or broadcasting services.
IFRS 15 and 16 tax matters.
IFRS 15 is applicable for entities reporting in accordance with IFRS for periods beginning on or after January 1, 2018. The standard provides guidance on how and when revenue should be recognised. IFRS 15 applies to all contracts, except for those that are within the scope of other IFRS standards (e.g. IFRS 16 Leases, IFRS 17 Insurance contracts and IFRS 9 Financial instruments).
The core principle is that an entity should recognise revenue in a manner that depicts the patterns of transfer of goods and services to customers. The amount recognised should reflect the amount to which the entity expects to be entitled in exchange for those goods and services.
The actual accounting application of IFRS 15 principles is not within the scope of this session. What should be noted is that the application of IFRS 15 principles lead to a large increase in reported revenues for companies/groups applying IFRS 15 principles for the first time. Companies in certain sectors such as telecommunications and software were affected most as long term contracts and complex arrangements are more prevalent in these sectors.
In consideration of the impact of IFRS 15, Finance Act 2017 introduced ‘spreading’ provisions to allow companies to spread the revenue effect over five years from 2018 onwards. This has mitigated the tax impacts of the adoption of IFRS 15 for most companies.
The implementation of IFRS 15 will have an impact on financial ratios and common performance measures, for example EBITDA and EBIT, ultimately affecting the application of certain interest limitation rules in future (since these rules are applied with reference to EBITDA and/or EBIT).
IFRS 16 was issued in January 2016 and applies to taxpayers that prepare financial statements under IFRS for accounting periods beginning on or after 1 January 2019. IFRS 16 replaces IAS 17. Under IFRS 16, the treatment of leases differs for the lessee and the lessor.
Under IFRS 16, the lessor is required to classify its leases as operating leases or finance
leases and to account for those two types of leases differently.
Under IFRS 16, a lessee is required to recognise assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value. A lessee is
required to recognise a right-of-use asset representing its right to use the underlying leased asset and a lease liability representing its obligations to make lease payments. Revenue consider most leases to be ‘finance leases’ from the perspective of the lessee and consequently, advises that companies preparing accounts under IFRS are entitled to a deduction on a paid basis for finance lease payments.
The tax treatment of accounting transition adjustments arising upon adoption of the revised accounting standard for the first time are set out in Section 76A(4)(c) TCA 1997.
Transitional arrangements are provided for existing operating leases to be treated as either new leases from 1 January 2019 or for an adjustment to be made to opening reserves in relation to the leases.
It should be noted that under IFRS 16, the financing element of the lease will be recognised in the income statement over the life of the lease using a discount rate that would typically result in recognising the expense upfront (instead of the straight-line discounting that would usually apply to an operating lease with a straight-line payment profile).
The timing impact arising because of Revenue’s approach to deducting lease rentals on a paid basis should also be considered when looking at the deferred tax impact of IFRS 16.