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More Permanent Establishments: The Dwindling Preparatory and Auxiliary Activities Exception

More Permanent Establishments: The Dwindling Preparatory and Auxiliary Activities Exception

Nothing is certain in this world, except death and taxes – and even taxes are subject to change.  The ever-expanding definition of a permanent establishment (“P.E.”) and ever diminishing exceptions to a P.E. under the O.E.C.D.’s B.E.P.S. Project has made one thing clear – the restrictions local jurisdictions put on activities by foreign taxpayers to trigger taxation are tightening.  The dwindling preparatory and auxiliary activities exception is a prime example.  Neha Rastogi and Beate Erwin explain.

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O.E.C.D. on Digital Business – Seriously?!

O.E.C.D. on Digital Business – Seriously?!

On February 13, 2019, the O.E.C.D. issued a discussion draft addressing the tax challenges of the dig- italization of the economy and asked for feedback in a shockingly brief time- frame. Is the discussion draft – which, in many respects, mimics G.I.L.T.I.provisions and highlights the value of a market as a key determiner of profitallocation – a move away from value of functions? In a stealth way, it may be a precursor to a global B.E.A.T. Christian Shoppe of Deloitte Deutschland, Frankfurt, cautions that the ultimate destination of B.E.P.S. may be added complexity in tax laws and expanded opportunity for double taxation. Bad news for taxpayers; more work for tax advisers.

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Alta Energy Affirms Treaty Benefits: A Canadian Case Study for Applying the M.L.I.

Alta Energy Affirms Treaty Benefits: A Canadian Case Study for Applying the M.L.I.

As part of its attack on B.E.P.S., the O.E.C.D. published its Multilateral Instrument, a device that revised more than 1,200 income tax treaties. One of the provisions of the M.L.I. targets treaty shopping by the adoption of, among other things, a principal purpose test ("P.P.T."). In simple terms, the P.P.T. disallows a treaty benefit when a principal purpose of a transaction is to obtain that benefit. Transactions in accordance with the object and purpose of the provisions of a treaty are not affected by the P.P.T. Many North American tax advisers know that the P.P.T. is based on a provision of Canadian law known as the General Anti-Avoidance Rule or G.A.A.R. A recent decision of the Tax Court of Canada addresses the application of G.A.A.R. to a cross-border tax plan set up by a U.S. financial institution designed specifically to obtain enhanced Canadian tax benefits by rechanneling a U.S. investment in Canada into a U.S. investment into Luxembourg that was then invested into Canada. The Canada Revenue Agency ("C.R.A.") attacked the Luxembourg company's entitlement to treaty benefits relying heavily on G.A.A.R. Kristy J. Balkwill and Benjamin Mann of Miller Thomson L.L.P., Toronto, explain the decision and its potential impact on the P.P.T. The case has been appealed by C.R.A.

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O.E.C.D. Discussion Draft on Financial Transactions – A Listing of Sins, Little Practical Guidance

O.E.C.D. Discussion Draft on Financial Transactions – A Listing of Sins, Little Practical Guidance

In July, the O.E.C.D. Centre for Tax Policy and Administration released Public Discussion Draft on B.E.P.S. Actions 8-10: Financial transactions (the “Discussion Draft”) addressing financial transactions (e.g., loans, guarantees, cash pools, captive insurance, and hedging). Michael Peggs and Scott R. Robson review the draft guidance and express disappointment. The Discussion Draft is not a thought leader, as tax authorities have successfully litigated the issues inherent in intercompany loans. Decided cases generally reflect a “not in my back yard” approach to deductions for interest expense. The Discussion Draft makes statements regarding allocation of risks in financial transactions that are inconsistent with arm’s length evidence. It also promotes decisions based on 20-20 hindsight. All these lead to several unanswered questions: What is the ultimate meaning of the term “arm’s length” when used in a cross-border financial transaction? Is it the terms and conditions that exist in actuality among lenders and borrowers, or is it the terms and conditions that should exist in the mindset of the tax authorities?

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Joint Audits: A New Tool for Cross-Border Tax Evasion

Joint Audits: A New Tool for Cross-Border Tax Evasion

When a large corporate taxpayer receives an audit notification letter from the tax authority in its country of residence, the taxpayer typically knows what to expect: a lengthy process of documenting and defending its tax position. It also knows the process under domestic law for appealing adverse tax adjustments, and if cross-border issues are raised, it knows how to take advantage of Mutual Agreement Procedures between competent authorities under an income tax treaty. The full process can take years to resolve. Now, however, a pilot program between German and Italian tax authorities empowers a joint cross-border audit team to conduct a single joint audit of cross-border operations between the two countries. The joint audit is intended to be more effective for resolving issues of double taxation in cases involving complex facts related to (i) transfer pricing issues, (ii) residency or permanent establishment issues, and (iii) aggressive tax planning schemes. Marco Orlandi of Ludovici Piccone & Partners, Milan, examines the actual process followed in the pilot program and comments on whether the goals of the joint audit have been achieved.

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O.E.C.D. and European Commission Unveil Proposals on Taxation of the Digital Economy

O.E.C.D. and European Commission Unveil Proposals on Taxation of the Digital Economy

Following the release of the O.E.C.D.’s B.E.P.S. Action Plan and the E.U.’s approval of the Anti-Tax Avoidance Package, the taxation of the digital economy continues to be unfinished business in the international tax arena.   New O.E.C.D. and the European Commission documents mark a milestone, especially the latter, which include two different approaches.  They also highlight the difficulties in achieving a consensus, which seems desirable when implementing measures that increase the tax burden of digital activities.  José Luis Gaudier of Cuatrecasas, Barcelona, delves into the O.E.C.D. and the European Commission approaches to taxing the digital economy.

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O.E.C.D. Receives Public Comments on Proposed Changes to the Model Tax Convention

O.E.C.D. Receives Public Comments on Proposed Changes to the Model Tax Convention

In August, the O.E.C.D. released public comments on proposed changes to the Model Tax Convention.  Beate Erwin and Stanley C. Ruchelman examines the suggestions received by the O.E.C.D. and provides observations on the interplay between the O.E.C.D. proposed changes and existing U.S. approaches to these issues.  Areas covered include whether competent authority agreements can define undefined terms thereby removing the interpretation from local courts, whether a limitation on benefits (“L.O.B.”) clause or a principle purpose test (“P.P.T.”) is the better approach to limit treaty shopping, and whether a home that is leased to others can be a permanent home for purposes of applying the residence tiebreaker provision in a treaty. 

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O.E.C.D. Issues Proposed Changes to Permanent Establishment Provisions Under Model Tax Convention

O.E.C.D. Issues Proposed Changes to Permanent Establishment Provisions Under Model Tax Convention

Earlier this year, the O.E.C.D. proposed amendments to Article 5 (Permanent Establishment) of the Model Tax Convention and Commentary.  The revisions eliminate loopholes that exist for commissionaire arrangements, artificial characterization of core activities as “preparatory,” avoidance of permanent establishment status through artificial fragmentation of contracts, and the use of not-so-independent agents.  Neha Rastogi, Beate Erwin, and Stanley C. Ruchelman explain the replacement provisions.

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Insights Vol. 4 No. 1: Updates & Other Tidbits

This month, we look briefly at several timely issues, including (i) the termination of foreign acceptance agent agreements used to confirm copies of passports outside the U.S. when a non-U.S. individual obtains an I.T.I.N., (ii) a court order in Canada upholding a demand for disclosure of client names and documentation relating to participation in a discredited tax shelter, (iii) E.U. steps that identify potentially blacklisted low-tax or no-tax countries, and (iv) worsening relations between the U.S. and the E.U. stemming from widening differences in tax policies.

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Global Exchange of Information: How Does the U.S. Fit into the Puzzle? Meet the U.S. Foreign Trust

Global Exchange of Information: How Does the U.S. Fit into the Puzzle? Meet the U.S. Foreign Trust

In the context of a model 1 I.G.A. under F.A.T.C.A., the U.S. undertakes certain reciprocal information exchanges.  But reciprocal may not mean equal.  This produces interesting results when a U.S. foreign trust is formed by a foreign individual.  Galia Antebi and Nina Krauthamer compare C.R.S. reporting and F.A.T.C.A. reporting in the context of a U.S. foreign trust that invests in U.S. assets producing tax-free income for a foreign investor.

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O.E.C.D. Reaction to Research Tax Incentives – Acceptance with a Limitation Blocking Mobility

Notwithstanding the war on State Aid within the E.U., the O.E.C.D. issued a Working Paper recognizing that the encouragement of R&D is an essential part of the development, innovation, and growth of an economy and that carefully tying incentives to the performance of R&D locally is not abusive.  Philip R. Hirschfeld and Galia Antebi explain.

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O.E.C.D Targets Hybrid Mismatch Arrangements Using Branch Structures

Advisers who took comfort in the belief that the B.E.P.S. Project’s attack on hybrid mismatches did not apply to transactions between two branches of the same entity were disappointed when the O.E.C.D. released draft recommendations for domestic law that would neutralize income inclusion mismatches using branches located in different countries.  Kenneth Lobo and Beate Erwin explain that D/NI, DD, and indirect D/NI outcomes are not legitimized when branches, rather than affiliates, are used.

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Exchange of Information: Israel Inches Toward International Norms

The State of Israel depends on immigration for growth in population and capital. Favorable tax rules and confidentiality rules are key pillars of the policy to promote immigration. In a world that is obsessed with B.E.P.S., Israeli policy towards confidentiality is experiencing change. Boaz Feinberg and Ofir Paz of ZAG-S&W, Tel Aviv discuss the scope of that change.

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The Common Reporting Standard – A Global F.A.T.C.A.?

The Common Reporting Standard ("C.R.S.") for the automatic exchange of information by financial institutions is now in effect for the 56 jurisdictions that are Early Adopters. How will the C.R.S. work and who will be affected? How does it interact with F.A.T.C.A. I.G.A.’s? Richard Addlestone of Solomon Harris, Grand Cayman answers these and other questions.

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Neutralizing the Effects of Hybrid Mismatch Arrangements: The New OECD Discussion Drafts Regarding Base Erosion and Profit Shifting

Published in Journal of Taxation and Regulation of Financial Institutions, Volume 27, Number 5: May/June 2014. © Civic Research Institute. Authorized Reprint.

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BEPS Action 4: Limiting Base Erosion via Interest and Other Financial Payments

Published in Journal of Taxation and Regulation of Financial Institutions, Volume 28, Number 4: March/April 2015. © Civic Research Institute. Authorized Reprint.

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Final Stages of B.E.P.S. Implementation and its Effects

As the conclusion of the O.E.C.D.’s B.E.P.S. Project draws ever nearer, Rusudan Shervashidze examines domestic implementation efforts in a number of foreign countries and the unanticipated tax ramifications for multinational enterprises. In their attempts to meet these requirements, countries are making some of the most significant changes to international taxation policy that we have seen in decades.

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European Commission, State Aid, and Tax Transparency – More Steps in One Direction

The EDF experience in France demonstrates that State Aid in Europe comes in many forms, and it can be harshly treated when discovered. Beate Erwin looks at the case against France’s main electricity provider and other developments in the European Commission’s attack on State Aid through private tax rulings. She finds that the result in the EDF case is not an anomaly.

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Can B.E.P.S. Survive Without U.S. Support?

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On May 28, 2015, the O.E.C.D. announced the countries that will participate in a meeting to begin substantive work on drafting a multilateral instrument under B.E.P.S. Action 15. Currently, more than 83 countries have expressed interest in joining the discussion, which will take place on November 5 and 6, 2015. The United States was noticeably absent from the list. However, the O.E.C.D. hopes that support will continue to grow in the intervening months and that the meeting may ultimately include as many as 100 countries.

The U.S. Treasury chose not to participate in negotiating a multilateral instrument under B.E.P.S. Action 15. After a careful review of the agenda for the discussion on the multilateral instrument, the U.S. Teasury felt that participation did not seem like a good use of its scarce resources. This decision was prompted by the question, “What is there for U.S. to gain by participating in the discussions?”

Transfer Pricing Implications of the B.E.P.S. Action Plan

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Determined to eliminate so-called “double non-taxation,” as well as no or low taxation, associated with practices that are perceived to segregate taxable income from the activities that generate them, the Group of Twenty (“G20”) and the Organisation for Economic Co-operation and Development (“O.E.C.D.”) released their Action Plan on Base Erosion and Profit Shifting (“B.E.P.S. Action Plan”) in 2013. Included in the B.E.P.S. Action Plan are several provisions related to transfer pricing:

  • Action 4: Limit base erosion via interest deductions and other financial payments;
  • Action 8: Assure that transfer pricing outcomes are in line with value creation – Intangibles;
  • Action 9: Assure that transfer pricing outcomes are in line with value creation – Risks and capital;
  • Action 10: Assure that transfer pricing outcomes are in line with value creation – Other high-risk transactions; and
  • Action 13: Re-examine transfer pricing documentation.

The O.E.C.D. has since delivered a number of reports and recommendations related to these actions, including revisions to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (“Transfer Pricing Guidelines”), and it continues to perform additional work on deliverables scheduled for later this year.