Published: May 01, 2014
The tax landscape for business is changing, and the pace of that change is faster now than at any time in the last 20 years. The changes being discussed are wide-ranging and will have a major impact on the way multinational organisations carry out their business activities. The treasury function is not immune. This article highlights the types of change that treasurers can expect to see, and what they might mean for the treasurer’s activity.
There are various environmental factors driving changes. Firstly, developments in business practices and increased globalisation in recent years have not been matched by corresponding updates to global tax policies. Governments have recognised that major changes are required to ensure that global tax policies reflect new business models.
Secondly, the economic crisis of 2008, and resulting budget deficits in a number of territories, have led to increased focus on the ability of tax authorities to raise money.
Readers will also be aware of the increased attention the media has given to large companies’ corporate tax contributions.
Three types of change are likely to affect the corporate treasurer.
1. Changes are being made to direct tax legislation. In particular, an initiative led by the Organisation for Economic Co-operation and Development (OECD) is proposing various changes to the international tax regime. This would change the basis on which many multinationals are taxed, with the aim of preventing perceived abuses.
2. Additional compliance will be required in some areas. For example, the US FATCA regulations impose compliance burdens and/or withholding obligations on Financial Institutions and their counterparties.
3. New taxes are being devised. Some countries have already introduced a Financial Transactions Tax. Other countries, including a core group of EU Member States, may follow suit.
Changes such as these are likely to have a material impact on the treasury function of most large companies. It is therefore vital that the treasury team is prepared to deal with the impact of these changes.
In response to a request by the G20, the OECD launched an ‘Action Plan on Base Erosion and Profit Shifting (BEPS)’ in 2013. The objective was to address concerns that the behaviours of large companies may result in mismatches between profits and tax. The Action Plan identified a number of actions that it considered necessary to enable a co-ordinated global approach to address the identified risks.
The overall aim of the BEPS initiative is to ensure that a group’s profits are taxable where the group has economic substance and business activity. The project has various strands. The parts most relevant to corporate treasury are those that aim to eliminate financial arrangements that mitigate taxable profits, either through complex structures (‘hybrids’) or by mitigating withholding taxes (‘treaty abuse’). The OECD published papers on these topics earlier this year. Although they are not binding, they give a strong steer as to the likely development of legislation.
Some territories have already enacted unilateral rules based on the OECD proposals, and others may follow. The final form of the rules is still unclear.
The proposals on ‘treaty abuse’ seek to prevent groups from accessing the benefits of tax treaties of states where they have no real activity. The principal proposals involve restricting the right of a company to benefit from a reduction in withholding tax unless the receiving company has its main listing in the territory concerned, or an ‘active business’ there. For example, a US-headed group with a Netherlands treasury centre might not pass either of these tests (unless it had other Dutch operations), and so the treasury company would not benefit from the Dutch treaty network.
The paper acknowledges that making such changes in international treaties is slow and cumbersome. It suggests that the proposals could be brought into effect by a single multilateral treaty.[[[PAGE]]]
Where a treasury function is involved in group financing arrangements, it may also be affected by changes proposed in relation to hybrids. These proposals target a range of common arrangements that create a low effective tax rate, by using either entities or financial instruments that are treated inconsistently in the tax systems of different territories.
The OECD paper proposes that the rules should apply ‘mechanically’; and it specifically recommends that the criteria for applying the rule should not include a test of whether there is a tax avoidance purpose. Consequently, there is a risk that entirely commercial transactions are caught. For example, a structured borrowing from a third party could become non-deductible for the borrower, if the lender obtains a tax exemption for the income. The paper recognises this as an issue, but the risk remains unresolved.
Rules of this type are being gradually introduced in various territories. For example, France recently introduced a rule blocking interest deductions where the corresponding receipt is not taxed at a sufficient rate. Other territories are likely to take similar steps.
Further discussion papers are due to be released in 2015. For treasurers, a paper in relation to limiting the tax deductibility of interest and other financing costs is likely to be particularly important.
FATCA legislation was announced by the US in 2010, to combat cross-border tax evasion by US residents using foreign accounts. Under this legislation, financial institutions (wherever they are tax resident) have certain reporting requirements for US tax compliance purposes. Failure to fulfil these requirements will result in withholding taxes being applied to US sourced payments.
While the rule is primarily aimed at the financial services industry, group treasury entities in other industries may in some circumstances be drawn into the rules. Treasurers need to confirm their group’s position carefully and be prepared to certify their status to counterparties.
Domestic financial transactions taxes have already been introduced in France and Italy. The FTTs apply to transactions in relation to shares and certain other equity instruments.
In 2013 it was announced that 11 EU Member States (including Germany, France, Italy and Spain) would introduce an FTT. It is likely that a phased approach will be required, with a tax on equities and equity derivatives as a possible first step and potential implementation in 2016. This is likely to affect many treasury transactions where either party is in one of the 11 states. While exemptions for intragroup transactions and hedging transactions have been discussed, it is not yet clear what form these might take.
The impact of the above measures remains to be seen. In particular, much co-ordination is required in respect of the BEPS proposals and the European FTT. However, it is certain that changes are coming that will have a substantial impact on businesses’ commercial operations, and that will include treasury functions. Although the implementation of changes will take time, it will be important to monitor these changes and the implications for treasury activity.
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