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OpinionJan 5 2024


MNCS SHOULD PAY TAXES IN EACH COUNTRY WHERE THEY OPERATE

Mark Taylor, Kreston Global


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The first part of Pillar 1 aims to ensure MNCs pay more tax where their
customers are located, rather than where their companies are tax resident
(Mehaniq41/Envato)
0

The OECD last year published guidance in relation to a consensus-based
“Multilateral convention to implement amount A of Pillar 1”.





Pillar 1 is part of Action 1 of the OECD’s base erosion and profit
shifting project “Addressing the tax challenges arising from the digitalisation
of the economy”.

Amount A introduces a new taxing right over a portion of the profits of the
largest and most profitable companies in the world. 

The move demonstrates that the OECD and the international governmental community
continue to move forwards with their desire to implement the first part of
Pillar 1, which is aimed at ensuring multinational companies pay more tax where
their customers are located or goods and services are supplied, rather than
where their companies are tax resident.

The guidance issued by the OECD does not mean the MLC can be signed at this
point, as certain matters remain outstanding. The MLC will not come into force
until sufficient countries have signed it and so the implementation of the MLC
remains outstanding. Based on this however, it is worth considering the
implications now as companies and their advisers plan their 2024 tax strategy.




THE NEW BEPS REGIME – WHAT, WHY, WHO?

The OECD estimates that the practice of BEPS, where MNCs exploit gaps in global
tax rules to avoid paying tax by moving profits to lower-tax jurisdictions,
costs countries up to $240bn every year in lost tax revenue. 

There are two fundamental pillars to this action of the BEPS project: Pillar 1
applies to the biggest and most profitable MNCs, and potentially changes where
they pay taxes, by reallocating a portion of profits to the countries where they
have sold products or provided services (that is, where their customers are
based); Pillar 2 applies to a much broader range of MNCs and imposes a global
minimum corporate tax rate of 15 per cent.

The OECD estimates that the practice of BEPS, where MNCs exploit gaps in global
tax rules to avoid paying tax by moving profits to lower-tax jurisdictions,
costs countries up to $240bn every year in lost tax revenue

Moreover, the overall BEPS project includes a series of 15 Actions that target
the key tactics that businesses may use to shift profits. 



This is part of an increasingly sophisticated international programme to limit
profit-shifting exercises by businesses, including through the creation of
offshore trusts, shell companies, and other complex financial intermediary
structures. While Pillar 1 is aimed only at the very largest MNCs, the overall
regulatory focus means that any business that operates across multiple
jurisdictions needs to be aware of its obligations and best practice. 




ASSESSING THE COMMERCIAL IMPACT

Many MNCs and digital businesses will continue to come under the scope of the
BEPS project. Even where digital enterprises have no physical presence at all in
countries where they do business, they will still be required to comply with the
tax laws in multiple jurisdictions. 

Businesses must be aware of the new rules and ensure they are compliant — or
could risk costly tax penalties. Now is the time to assess operations, ownership
and organisational structures to determine whether the current structure and
operations are compliant with developing international regulations.

The evolution of the BEPS project may increase MNCs’ tax liabilities in certain
jurisdictions. Compliance is likely to raise costs, as groups are required to
keep abreast of potentially changing tax rules in each country where they
operate.

Small and medium-sized enterprises that may be indirectly impacted will have to
ensure compliance on much more limited budgets than the bigger multinationals
that have the benefit of economies of scale.




AVOIDANCE ACTIVITIES IN THE SPOTLIGHT

Companies and their tax advisers also need to take note of the various specific
actions that the BEPS package of measures contains, to ensure that they stay on
the right side of the rules. These 15 Actions currently standardise compliance
requirements and give governments the tools they require to tackle tax-avoidance
activities.

Some of the most important developments to note are those that:


 * Put boundaries around the digital economy. It is commonly agreed that a tax
   system designed for a “bricks-and-mortar” world is no longer sufficient for a
   digital economy where physical presence is not necessary to trade and where
   geographical borders are transcended, so the “nexus” rules require an
   overhaul. Action 1 is designed to ensure that MNCs with a significant digital
   presence in a country pay taxes in that country, even if they do not have
   physical premises there.

 * Eliminate the tax benefits of hybrid mismatch arrangements, where structures
   may exploit differences between tax regimes in multiple jurisdictions. To
   counteract such moves, Action 2 aims to create model treaty provisions and
   contains recommendations as to how domestic rules should be designed.

 * Prevent the shifting of income into a controlled foreign company. Action 3
   calls for the design of more effective CFC rules to discourage companies from
   moving profits into offshore structures. This includes defining what a CFC is
   and how CFC income should be calculated and attributed. This aims to ensure
   that CFCs are subject to a minimum level of taxation in the country where
   their parent company is located.

 * Target preferential tax regimes, which are seen as ways for companies without
   any real economic substance in a country to reduce tax bills, to the
   detriment of the tax base in other countries (Action 5). To ensure economic
   substance is sufficient, companies must have adequate presence and/or
   carry-on economic activities in the jurisdiction in which they are claiming
   tax residency.

 * Close loopholes in tax treaties, which can lead to ‘treaty-shopping’ and
   other treaty abuse strategies to minimise tax liabilities (Action 6).

 * Strengthen standards on transfer pricing, to ensure that tax outcomes are
   more aligned with an MNC’s true value creation profile. As intra-group trade
   has grown, this has become a critical issue. Actions 9 and 13 include
   guidance on how to determine the transfer prices for goods and services
   between related entities, and how the transfer of valuable intangible assets
   such as patents, trademarks and copyrights will be taxed.


GETTING BEPS-READY 

While continual development of the BEPS project should ultimately give MNCs
greater clarity and certainty in the long run, the changes the project ushers in
are significant and ever evolving. Navigating them, in the short term at least,
is likely to be a complex task, especially for SMEs that may not have in-house
tax expertise. 

International tax advisers will have a critical role to play in guiding
businesses through this continually evolving regulatory landscape, acting as a
valuable resource in helping to plan ahead to achieve tax efficiency and meet
regulatory requirements. 



By reviewing how the business is structured, advisers can assess a group’s
global tax affairs and tax risk and help plan for any areas that need to be
addressed. 

International tax advisers will have a critical role to play in guiding
businesses through this continually evolving regulatory landscape

Businesses may also need support with the development of a transfer pricing
policy that aligns with OECD guidelines. This will require a review of the
functions of a group and its intra-group activities, followed by benchmarking
analysis. Transfer pricing documentation is a requirement of many jurisdictions
and penalties for non-compliance can be severe. 

Understanding what your company needs to record and disclose, and when, is
likely to require professional expertise. However, the data collated from all
this activity will prove extremely valuable in terms of the visibility and
oversight it should deliver into a company’s global operations and effective
global tax rate. 

With all this in mind, it has never been more important for MNCs to take
international tax advice.




THE FUTURE OF INTERNATIONAL TAXATION

While the exact shape some of these rules will finally take is yet to become
fully clear, what is certain is that major changes are ongoing. Policymakers are
pushing forward on addressing what they see as an urgent need to create an
international tax framework that is fit for purpose in today’s
globalised digital world, to ensure profits are taxed where economic activity
and value creation actually take place.

They do not just have the biggest MNCs in their sights — any business with
cross-border sales needs to take note. With professional help, those companies
can get ahead of the curve.

Mark Taylor is global tax chair at Kreston Global






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