Will Retail & Consumer businesses need to overhaul their international group structures in light of change to the international tax landscape?
An issue facing retail and consumer companies is that international tax principles have been based upon a way of doing business that has its background in the early 20th century. Modern internet-based businesses have no need for a formal presence in a location in order to do business there, and derive a significant part of their value from IP which is highly mobile. The net effect of this is that it has been relatively easy for large retail and consumer companies to trade remotely without establishing taxable presences in higher tax countries; or, where there is a presence, to reduce taxable profits through, for example, having IP or other businesses which can be centrally managed (e.g. central procurement functions) in low tax jurisdictions and obtain tax deductions for royalties and service payments, whilst avoiding withholding taxes and/or to reduce taxable profits through high gearing and deductible interest payments.
Negative publicity in a number of high profile cases has led to the OECD and G20 countries undertaking the BEPS programme, which has sought to modernise international tax rules by, for example, changing transfer pricing rules on intangible assets to treat profits accruing where relevant people activities are based, seeking to expand the definition of permanent establishment, reduce the amount of interest deductions companies can take etc.. One particular area where the BEPS programme focussed was on the tax challenges of the digital economy.
Significant work had already been performed in the area of VAT and in particular the International VAT/GST guidelines, which focuses on changing indirect tax/VAT rules in the digital economy to be based where consumers are (which is already generally the case in the EU). The EU has also been looking at VAT under its single digital market initiative and is moving to a more general "destination based" principle, which seeks to apply VAT in the jurisdiction of the customer.
Additionally, the BEPS programme considered the direct tax aspects of digital businesses. In its final report on BEPS there were no specific tax recommendations on digital business tax treatment outside those in other areas – such as refining the concept of "permanent establishment" to catch certain warehouses and commissionaires, strengthening controlled foreign company rules (which stop profits accruing in low tax subsidiaries), and refining the transfer pricing rules relating to intangible fixed assets.
Specifically, in 2015 the OECD did not recommend any of the following:
- a new approach to tax nexus based upon "significant economic presence"
- a specific withholding tax on digital transactions
- an equalisation levy (i.e. a tax aimed at levelling the playing field between digital and other providers – an example of which is the 6% levy introduced in India in July 2016)
Following the publication of the final report on BEPS Action 1 however, the OECD reconvened its digital economy task force with an interim report to be delivered in mid-2018.
The EU, not waiting for the final outcome of BEPS Action 1, have their own agenda, shown in both the plan for a common consolidated corporate tax base under which taxes will be shared between EU countries based upon a formulaic approach, and recent proposals to seek to tax internet-based businesses through other means, such as a virtual permanent establishment with profit apportionment based upon the intangible value of customer data.
Furthermore, countries are taking unilateral decisions to change their tax rules to reduce base erosion for tax purposes. Examples include the implementation of diverted profits taxes in the UK, and a new rule in the UK under which internet-based businesses paying royalties to low tax jurisdictions will have to pay withholding tax in the UK on those royalties, even if they do not have a presence in the UK, simply because the income is derived from UK customers.
While the US has been sceptical of BEPS, it too has made radical changes to its tax system under the recent tax changes implemented by President Trump.
All of these changes mean that existing international structures may no longer be fit for purpose, and that the old way of structuring international groups and their supply chains may need a radical overhaul.
