International Tax: Hybrid Mismatches, CbC Reporting, Treaty Shopping

 EU Adopts Rules to Block Hybrid Mismatching

The European Commission formally adopted a directive to prevent tax avoidance through non–European Union (EU) countries. The directive is designed to neutralize the effect of hybrid mismatches, where companies try to avoid taxes by hopping from country to country to exploit differences between the tax systems of EU members and those of “third countries” — countries that aren’t part of the EU.

Working Against Common Challenges

“Our campaign for fairer taxation in Europe continues to reap results,” said Pierre Moscovici, Commissioner for Economic and Financial Affairs, Taxation and Customs. “Today’s agreement is further proof of what the EU can achieve when we work together against common challenges. It is another victory for fair taxation and another blow against those companies that try to escape paying their fair share.”

The rules will go into effect on January 1, 2020, with a longer phase-in to 2022 for the provision that targets reverse hybrid mismatches.

In addition to the ambitious Anti-Tax Avoidance Directive, agreed in 2016, a host of new tax transparency rules have been adopted to ensure fairer and more open taxation throughout Europe. These include the following rules:

  • Since January 2017, EU member states have been obliged to automatically exchange information on financial accounts, an important step against offshore tax evasion.
  • Since July 2017, similar transparency rules apply for tax rulings, while multinationals will have to provide country-by-country (CbC) reports to tax authorities by the end of the year.

Other Antiabuse Proposals in the Works

The EU Council and the European Parliament are currently negotiating other important proposals to prevent tax abuse, including public CbC reporting (see EU committees clear public CbC reporting with an exception below), stronger anti–money laundering provisions and tighter good governance rules for EU funds. A number of other substantial corporate tax reforms have also been proposed, notably the relaunch of the Common Consolidated Corporate Tax Base (CCCTB) in October 2016.

EU members are also working on a common EU list of noncooperative jurisdictions to tackle third countries that refuse to adhere to tax good governance standards. The list should be ready by the end of the year.

What’s Ahead?

In the coming weeks, the Commission will bring forward another new transparency initiative, with a proposal for intermediaries to report cross-border tax planning schemes.

Committees Clear Public CbC Reporting with an Exception

The Economics and Legal Affairs Committees of the European Parliament voted to make large multinational entities (MNEs) publicly report their activities, structures and tax payments on a country-by-country (CbC) basis. The draft report was approved 38-9, with 36 abstentions.

The result, if approved by the Parliament, would require MNEs to publicly disclose how much tax they pay, and where, including outside the European Union (EU). The measures would cover companies with an annual worldwide net turnover of €750 million ($836 million) or more. Members of the Parliament (MEPs) rejected the European Commission’s proposal to exclude non-EU jurisdictions from the legislation.

A Closer Look

The draft report reads:

The report on income tax information shall be published in a common template available in an open data format and made accessible to the public on the website of the undertaking on the date of its publication in at least one of the official languages of the Union. On the date of publication of the report on income tax information, the undertaking shall also file the report in a public registry managed by the Commission.

The tax report is to include:

  • A brief description of the nature of the corporation’s activities,
  • Number of employees,
  • Total net turnover, which includes the turnover made with related parties,
  • Profit or loss before income tax,
  • Current-year income tax accrued (the current tax expense recognized on taxable profits or losses of the financial year by undertakings and branches residing for tax purposes in the relevant tax jurisdiction),
  • Income tax paid (the amount of income tax paid during the relevant financial year by undertakings and branches residing for tax purposes in the relevant tax jurisdiction),
  • Income tax paid (the amount of income tax paid during the relevant financial year by undertakings and branches residing for tax purposes in the relevant tax jurisdiction), and
  • Accumulated earnings.

Commercially Sensitive Exception

An amendment was passed that would let EU members grant exclusions for multinationals that would allow them to avoid disclosing certain information.

In part, the amendment says:

In order to protect commercially sensitive information and to ensure fair competition, Member states may allow, that one or more specific information listed in […] this directive, be temporarily omitted as regards activities in one or more specific tax jurisdictions when its nature is such that it would be seriously prejudicial to the commercial position of the undertakings [… .] to which it relates. The omission shall not prevent a fair and balanced understanding of the tax position of the undertaking.

Next Steps

It’s understood that MEPs didn’t get the two-thirds majority required to be able to begin negotiations with EU members and the European Commission to implement the draft report. The draft report will now be sent to the European Parliament plenary for final consideration.

OECD Moves to Limit Treaty Shopping

The Organisation for Economic Co-operation and Development (OECD) released the key document that forms the basis of the peer review of the base erosion profit shifting (BEPS) minimum standard on preventing inappropriate treaty shopping.

Treaty shopping is the practice of structuring a multinational business to take advantage of more favorable tax treaties available in certain jurisdictions. A business that resides in a home country that doesn’t have a tax treaty with the source country from which it receives income establishes an operation in a second source country that has a favorable tax treaty in order to minimize its tax liability with the home country.

4 Minimum Standards

BEPS Action 6 on Preventing the Granting of Treaty Benefits in Inappropriate Circumstances. Peer Review Documents is one of four BEPS minimum standards. Each standard is subject to peer review to ensure timely and accurate implementation and to safeguard the level playing field.

The 99 members of the Inclusive Framework on BEPS have committed to participating in the peer reviews and implementing the minimum standards. (The Inclusive Framework is a group of countries that have pledged to implement BEPS measures designed by the OECD and G20 countries.)

The Action 6 minimum standard requires that countries’ tax treaties include a statement clarifying that the treaty isn’t intended to allow nontaxation or reduced taxation through avoidance or evasion. The document is aimed at providing an effective way to quickly put into effect the minimum standard on treaty shopping. It includes terms of reference setting out the criteria for assessing the implementation of the minimum standard. It also outlines the methodology, which sets out the procedural mechanism for conducting the review.

The Road Ahead

The OECD says the review of the implementation of the minimum standard on treaty shopping won’t begin until 2018 because:

  • The first signatures of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) won’t take place until the second half of 2017, and
  • It’s unlikely that many jurisdictions will ratify the MLI or bilateral treaties implementing the minimum standard before 2018.

Starting in 2019, at the January meeting of the Inclusive Framework on BEPS, an annual report on the implementation of the minimum standard on treaty shopping will be presented. The report will deal with compliance with the minimum standard by each of the 99 jurisdiction members of the Inclusive Framework. It will reflect whether and how the minimum standard has been incorporated in all the existing bilateral treaties of each jurisdiction of the Inclusive Framework.