International tax law can feel overwhelming to companies new to the global operating space or with a large number of transactions that cross foreign jurisdictional borders. Analyzing the term company presence—most commonly defined as having a fixed place of business in a country—delivers a starting point for delving into a wide array of the subsets and common practices of international tax law.
Most foreign presence concerns and decisions that multinational companies face, regardless of size, come from potential exposure to US and foreign taxation on export activities. Understanding how to effectively and efficiently enter into and operate in markets—as well as how to properly use available tax laws and treaties in each jurisdiction—can make international tax planning less burdensome, often resulting in a lower worldwide effective tax rate and a more efficient tax structure.
Let’s examine how different types of international operations and presence can influence domestic and foreign tax outcomes.
Base Erosion and Profit Shifting (BEPS) Initiative
In recent years, the Organisation for Economic Cooperation and Development (OECD) has led the charge to change how the international tax system operates. In 2013, the OECD published an action plan to mitigate the perceived tax evasion of large multinational enterprises (MNEs) shifting profit to low tax jurisdictions solely for the purpose of minimizing taxes. In October 2015, the OECD released final reports on 15 key BEPS issues to address how MNEs need to update their business and tax models to conform to the changes. These reports are collectively known as the BEPS package.
In addition to recommending countries modify tax laws and increase enforcement, the ultimate goal of the BEPS package is for every country to agree to the proposed changes. This would allow for the creation of one global, coordinated set of rules for governing the international tax system.
This global set of rules likely won’t happen because it requires every country to unilaterally agree to every proposal made by the OECD. Not all countries are interested in completely overhauling their tax policies, as some would undoubtedly lose investments from MNEs doing business in their jurisdictions. This lack of commitment could potentially lead to less transparency between countries and result in a greater risk of double taxation and challenges from local authorities on amounts of taxes paid. These outcomes could in turn result in higher effective tax rates and increased costs to defend certain tax positions.
Essential to managing a company’s effective tax rate and minimizing potential adjustments upon audit is a solid understanding of these topics:
- The intended result of the BEPS package
- Applicable changes to local country tax law
- Jurisdictional differences
Under the new guidelines described in the BEPS package, MNEs must concurrently document their transfer pricing policies and procedures and file a Form 8975, Country-by-Country Report, with their annual income tax return. This form requires a schedule of profit an MNE earned in each country in which it operates. You can read more about required documentation in this article published by Moss Adams in August 2015.
Only MNEs with more than $850 million in worldwide gross revenue are required to file this form, but it may behoove companies to begin tracking this data now in case unexpected growth causes the threshold to be met. This information will likely be expected to be produced under an IRS audit or examination as well.
Permanent Establishment (PE)
The OECD and the IRS typically decide an MNE is required to pay taxes in a country when the creation of a permanent establishment (PE)—also known as a company or business presence—occurs, giving rise to income.
Countries have different definitions of PE and use tax treaties to regulate what constitutes one. The most common way to create a PE in a jurisdiction is to have a fixed place of business in that country—for example, a place of management, local branch or office, factory, or workshop—but there are exceptions to that standard as well as a variety of ways PE can be created that are unique to specific treaties.
The guidelines outlined in the BEPS package make it increasingly difficult for companies to avoid PE status if a physical office exists or an employee resides in a given jurisdiction, unless an applicable treaty applies. Understanding these requirements is crucial to operating globally without triggering a PE and the consequent income taxation for any earnings generated in that country.
While various tax authorities have increased efforts to find MNEs with fixed places of business in various countries, most tax treaties haven’t been updated since the BEPS package was released. Typically, tax treaties take precedence over local country tax law, but in practice, many countries have blended local enforcement practices with the benefits afforded via treaties. It’s therefore essential to understand local country law and the overlay of any applicable tax treaties.
Who's Affected by the BEPS Initiative?
As a result of countries adopting the recommendations in the BEPS package, MNEs may see an increased global tax burden in coming years. The local countries in which a company operates will likely dictate a portion of its global profit be shifted to higher tax jurisdictions, as many MNEs don’t have the appropriate documentation in place to justify allocating certain profit to countries that don’t impose income taxes or have very low tax rates.
Any multinational company that operates in a jurisdiction implementing the changes suggested by the OECD will be impacted. This includes businesses with customers, employees, or property in a country, or that domicile a place of business in that jurisdiction. While there’s an $850 million threshold to file Form 8975, this doesn’t recuse companies from the requirement of accurately documenting their transfer pricing policies and adhering to new local requirements. Having a robust understanding of which countries are implementing the BEPS package is crucial to avoiding problems with future audits.
How to Prepare for BEPS-Driven Rule Changes
Having an understanding of the BEPS package and the changes that may be coming or have already been implemented is a key element of building an effective tax structure. However, being aware of the rule changes isn’t enough. Action should be taken by all MNEs, regardless of whether the Country-by-Country Report applies to them directly via the revenue threshold or indirectly via local country adoption of the BEPS action items.
Now is the time for businesses to be proactive with their global tax footprint. Understanding the organizational chart, operational activities, and added value each location provides the organization is essential to managing a company’s global tax expense and minimizing risk in the countries it operates in. There should be knowledge surrounding the operations and activities of each subsidiary in a company’s structure.
Companies should ask themselves:
- Why is this entity in one country over another country? Is that still appropriate?
- What does this entity do operationally?
- How many employees are registered with a specific subsidiary, and what do they do?
- Are there financial statements for this entity?
- Is there transfer pricing documentation in place for this entity?
- What are the effective current and projected tax rates for this entity?
Conducting this kind of analysis—and implementing adjustments and changes as needed—will greatly reduce future headaches if and when local tax authorities enforce the new BEPS rules. Additionally, having proper documentation in place as a result of this type of assessment will reduce the probability that authorities will require changes to a company’s global structure.
How We Can Help
Reach out to your local Moss Adams professional to get started on this important project. For more information on the Moss Adams international tax team, please see our Web page or email email@example.com.