In this Article, we discuss the recent global
developments in the sphere of international taxation which would be of
relevance and use in day to day practice. We intend to keep the readers
informed about such developments from time to time in the future.
1. OECD
(i) OECD issues report Aggressive Tax Planning based on After-Tax Hedging
On
13th March 2013, the OECD issued the report Aggressive Tax Planning
based on After-Tax Hedging, describing the features of aggressive tax
planning (ATP) schemes based on after-tax hedging as well as the
strategies used to detect and respond to those schemes. This report
follows after the 2011 OECD report Corporate Loss Utilisation through
Aggressive Tax Planning, which recommends countries to analyse the
policy and compliance implications of after-tax hedges in order to
evaluate the appropriate options available to address them.
Risk
management and hedging are key issues in corporate management. In
certain cases, taxpayers may see an opportunity or a need to factor
taxation into their hedging transactions to be fully hedged on an
after-tax basis. However, after-tax hedging, while not of itself
aggressive, may be used as a feature of schemes which are designed to
allow taxpayers to achieve higher returns, without actually bearing the
associated risk which is in effect passed on to the government through
the tax charge.
In general terms, after-tax hedging consists of taking
opposite positions for an amount which takes into account the tax
treatment of the results from those positions (gains or losses) so that,
on an after-tax basis, the risk associated with one position is
neutralised by the results from the opposite position.
ATP schemes based
on after-tax hedging pose a threat to countries’ revenue base:
empirical evidence suggests that hundreds of millions of US dollars are
at stake, with a number of multi-billion US-dollar transactions
identified by certain countries. ATP schemes based on after-tax hedging
exploit the disparate tax treatment between the results (gain or loss)
from the hedged transaction/risk on the one hand, and the results (gain
or loss) from the hedging instrument on the other. In some of these
schemes, the tax treatment of gains and losses arising from each
transaction is symmetrical, while in others the tax treatment is
asymmetrical. Other schemes rely on similar building blocks and are
often structured around asymmetric swaps or other derivatives. ATP
schemes based on after-tax hedging can exploit differences in tax
treatment within one tax system and are in that sense mostly a domestic
law issue. Any country that taxes the results of a hedging instrument
differently from the results of the hedged transaction/risk is
potentially exposed. The issue of after-tax hedging also arises in a
cross-border context with groups of companies operating across different
tax systems, which gives rise to additional challenges for tax
administrations.
The report describes the following main challenges
raised by after-tax hedging from a compliance and policy perspective,
and takes the following positions:
• The difficulty in drawing a line
between acceptable and non-acceptable after-tax hedging. The report
concludes that, in practice, the decision of where to draw the line will
depend on a number of elements, including the facts and circumstances
of each case, the commercial reasons underlying the transactions, and
the intent of the applicable domestic law.
• The difficulties in
detecting ATP schemes based on after-tax hedging, especially crossborder
schemes. These difficulties arise because often there is no explicit
link between the hedged item and the hedging instrument or because there
is no trace of them in the taxpayers’ financial statements.
• Here, the
report underlines that, in order for tax administrations to be able to
face the above challenges, it is important for them to ensure they have
sufficient resources and expertise to understand schemes of this nature
which are often very complex. A fair and transparent dialogue with the
taxpayer, as part of discussions which take place under cooperative
compliance programmes, has also proven to help tax administrations gain a
better understanding.
• Deciding how to respond to ATP schemes based on
after-tax hedging. The report shows that different response strategies
have been used, including strategies seeking to deter taxpayers from
entering into such schemes and/or promoters/advisors from promoting the
use of such schemes.
Finally, the report recommends countries concerned
with ATP schemes based on aftertax hedging to:
• Focus on detecting
these schemes and ensure that their tax administrations have access to
sufficient resources (in particular expertise in financial instruments
and hedge accounting) to detect and examine in detail after-tax hedging
schemes.
• Introduce rules to avoid or mitigate the disparate tax
treatment of hedged items and hedging instruments.
• Verify whether
their existing general or specific anti-avoidance rules are suitable to
counter ATP schemes based on after-tax hedging and, if not, to consider
amending those rules or introducing new rules.
• Adopt a balanced
approach in their response to after-tax hedging, recognising that not
all arrangements are aggressive, that hedging in and of itself is not an
issue and that ATP schemes based on after-tax hedging may necessitate a
combination of response strategies.
• Continue to exchange information
spontaneously and share relevant intelligence on ATP schemes based on
after-tax hedging, including deterrence, detection and response
strategies used, and monitor their effectiveness.
(ii) OECD releases
study on electronic sales suppression
On 19th February 2013, the OECD
released the study Electronic Sales Suppression: A Threat to Tax
Revenues, to help all countries understand and address this risk.
“Electronic sales suppression” techniques facilitate tax evasion and
result in massive tax loss globally. Point of sales systems (POS) in the
retail sector are a key component in comprehensive sales and accounting
systems and are relied on as effective business accounting tools for
managing the enterprise. Consequently, they are expected to contain the
original data which tax auditors can inspect. In reality such systems
not only permit “skimming” of cash receipts just as much as manual
systems like a cash box, but once equipped with electronic sales
suppression software, they facilitate far more elaborate frauds because
of their ability to reconstitute records to match the skimming activity.
Tax administrations are losing billions of dollars/ euros through
unreported sales and income hidden by the use of these techniques. A
Canadian restaurant association estimates sales suppression in Canadian
restaurants at some CAD 2.4 billion in one year. Since the OECD’s Task
Force on Tax Crimes and Other Crimes (TFTC) began to work on and to
spread awareness of this phenomenon a number of countries (including
France, Ireland, Norway and the United Kingdom) have tested their retail
sector and found significant problems.
The report describes the
functions of POS systems and the specific risk areas. It sets out in
detail the electronic sales suppression techniques that have been
uncovered by experts, in particular “Phantomware” and “Zappers”, and
shows how such methods can be detected by tax auditors and
investigators.
Phantomware is a software program already installed or embedded in the accounting application software of the electronic cash registers (ECR) or computerised POS system. It is concealed from the unsuspecting user and may be accessed by clicking on an invisible button on the screen or a specific command sequence or key combination. This brings up a menu of options for selectively deleting sales transactions and/or for printing sales reports with missing lines.
Zappers are external software programs for carrying out sales suppression. They are carried on some form of electronic media such as USB keys, removable CDs, or they can be accessed online through an internet link. Zappers are designed, sold, and maintained by the same people who develop industry-specific POS systems, but some independent contractors have also developed these techniques.
The report compiles and analyses the range of government responses that are being used to tackle the abuse created by electronic sales suppression and identifies some best practices. These include strengthening compliance with a focus on voluntary compliance through industry bodies, raising awareness with all stakeholders including the public, improving audit and investigation skills, developing and sharing intelligence and the use of technical solutions such as certified POS systems.
The report makes the following recommendations:
• Tax administrations should develop a strategy for tackling electronic sales suppression within their overall approach to tax compliance to ensure that it deals with the risks posed by electronic sales suppression systems and promotes voluntary compliance as well as improving detection and counter measures.
• A communications programme should be developed aimed at raising awareness among all the stakeholders of the criminal nature of the use of such techniques and the serious consequences of investigation and prosecution.
• Tax administrations should review whether their legal powers are adequate for the audit and forensic examination of POS systems.
• Tax administrations should invest in acquiring the skills and tools to audit and investigate POS systems including developing the role of specialist e-auditors and recruiting digital forensic specialists where appropriate.
• Tax administrations should consider recommending legislation criminalising the supply, possession and use of electronic sales suppression software.
2. Singapore
(i) Taxation of property developers
The Inland Revenue Authority of Singapore (IRAS) issued an e-Tax Guide on the taxation of property developers on 6th March 2013. The main details of the Guide are as follows:
• the date of commencement of a property development business is the date of ac-quisition of any land/property acquired for development for sale;
• for tax purposes, the profits of a property development project are recognised when the Temporary Occupation Permit (TOP) is issued;
• taxable profit is generally computed as sale proceeds of the property units in accordance with the sales and purchase agreement payment schedule less development costs incurred up to that date;
• income from the lands/properties accruing before and during development is, depending on the nature of the income, either taxed upfront or set-off against development costs;
• expenses that are directly attributable to the acquisition of land and property development activities are to be capitalised and accumulated in the Development Cost Account up to the TOP year of assessment;
• provisions (e.g. for diminution in value, warranty liability etc.) are generally non-deductible;
• expenditure related to development projects that are held partly for sale and partly for investment, or for mixed uses should be apportioned based on actual costs incurred;
• all gains from the sale of land or uncompleted development projects and rental income earned from the letting out of unsold properties are taxable; and
• discounts on sale of properties to employees are taxable as benefits-in-kind.
(ii) Rights-based approach for software payments – e-Tax Guide issued
Further to the Inland Revenue of Singapore’s (IRAS) Consultation on Software Payments, an e-Tax Guide (the Guide) on the same was issued on 8th February 2013. The Guide reiterates the rights-based approach proposed in the consultation paper, which draws a distinction between the transfer of a “copyright right” and the transfer of a “copyrighted article” from the owner to the payer, with effect from 28th February 2013. With this, the withholding tax exemptions u/s. 13(4) of the Income-tax Act for certain payments for soft-ware and rights to use information are abolished.
The Guide clarifies the following:
• A transaction involves a copyright right if the payer is allowed to commercially exploit (as defined in the Guide) the copyright.
• A copyrighted article is transferred if the rights are limited to those necessary to enable the payer to operate the software or use the information or digitised goods for personal consumption or for use within his business operations. Such payments are not treated as royalty and hence are not subject to withholding tax when made to non-residents. However, where the payments constitute income derived from a trade or profession of the non-resident in Singapore, or is effectively connected with a permanent establishment of that person in Singapore,
he will be required to file an income tax return to declare the income which is subject to tax in Singapore.
• Where a payer obtains multiple rights, the primary purpose of the payment will be examined in determining whether a payment is for the right to use a copyrighted article or a copyright right.
• Payment for the transfer of partial rights in a copyright is treated as a royalty, which is subject to withholding tax if made to a non-resident.
• Payment for the complete alienation of the transferor’s copyright right in the software, information or digitised goods is treated as business income or capital gains, which is not subject to withholding tax.
3. Japan: Earnings stripping provisions to take effect from 1st April 2013
As part of the 2012 Tax Reform, Japan adopted earnings stripping provisions under which a corporation’s deduction for net interest expense paid to a related party will be limited to 50% of adjusted income effective for tax years beginning on or after 1st April 2013.
Related party
A related party is defined to be any:
(i) person with whom the corporation has a 50% of more equity relationship;
(ii) person with whom the corporation has a de facto controlling or controlled relation-ship; or
(iii) third party lender which is financially guar-anteed by a person in (i) or (ii) above.
Net interest
Net interest is the difference between the interest paid to related parties and any interest income which corresponds to such interest paid. Interest paid to related parties includes interest and inter-est in the form of lease payments or guarantee payments, but excludes back-to-back repo interest and interest paid to a related party lender which is subject to Japan corporation tax.
Corresponding interest income includes a pro rata portion of interest income and interest in the form of lease payments received based on the ratio of interest from related parties to total gross interest income, but excludes interest income from resident related parties, domestic corporations, and non-residents and foreign corporations with a permanent establishment in Japan.
Adjusted income
Adjusted income is taxable income to which is added back (or subtracted) net interest expense, depreciation expense, excluded dividend income, and extraordinary loss (or income).
Net interest expense which exceeds 50% of adjusted income is not deductible, but may be carried forward for up to seven years and deducted in such future tax year up to the 50% threshold computed for that tax year. In addition, the unused carry-forward amount of a disappearing corporation in a tax qualified merger, or 100% subsidiary in liquidation, is transferred to the surviving, or parent corporation.
The limitation does not apply if net interest expense for the tax year is JPY 10 million or less, or if interest paid to related parties (after deducting back-to-back repo interest, but before deducting corresponding interest income from third parties or non-residents) is 50% or less of the total interest expense (excluding interest paid to related parties which is subject to corporation tax).
In the case of a corporation which is part of a consolidated group tax filing, the excess of the corporation’s net interest (excluding interest of other consolidated group members) over 50% of the adjusted consolidated income, is not deductible.
Where the thin capitalisation interest limitations apply (i.e. when the debt-to-equity ratio exceeds 3:1), the deductible interest expense is the lower of the limit under either the thin capitalisation or these earnings stripping rules.
If the corporation is subject to the anti-tax haven (controlled foreign corporation) rule, the non-deductible interest paid to the tax haven company (the corporation’s foreign subsidiary) is reduced to the extent that the corporation is subject to current tax on the interest income of the tax haven company.
4. South Korea: Arm’s length calculation for inter-company guaranty transactions clarified
In response to a growing number of disputes involving companies receiving guarantee fees from their foreign subsidiaries, the Ministry of Strategy and Finance (MOSF) has amended the Law for the Coordination of International Tax Affairs (LCITA) to provide new standards for Korean companies to calculate the arm’s length price for intercompany guaranty transactions.
Under the new standards, there are four methods that may be used in calculating the arm’s length price of guaranty fees for intercompany guaranty transactions. The new standards, which will be effective from January 2013, are summarised as follows:
• Benefit approach: This method is based on the benefit that a company is expected to receive from a guarantor’s guaranty. The arm’s length price is to be calculated as the difference in the company’s financing cost, with and without the intercompany guaranty.
• Cost approach: This method is based on the guarantor’s expected risks and costs. The arm’s length price is calculated as a sum of the guarantor’s expected risks from the guaranty provided and the related costs incurred.
• Cost-benefit approach: This method is based on both the guarantor’s expected risks and costs, and the company’s expected benefits. The arm’s length price is reasonably ad-justed from the arm’s length range derived from using the benefit approach and the cost approach taking into consideration the guarantor’s expected risks and costs and the company’s expected returns.
• Price deemed arm’s length: If a guaranty fee was calculated based on the difference between borrowing rates, quoted by a lending financial institution, with and without a guarantee, or calculated with a method specified by a commissioner of the National Tax Service (NTS), then it is deemed to be an arm’s length price.
5. Poland : Introduction of general anti-avoidance rules announced
The Minister of Finance (MF) announced to introduce comprehensive modifications to the Tax Code, which regulates the administration of taxes. The most significant changes that are proposed are as follows:
• General anti-avoidance rules (GAAR) are to be introduced aiming at counteracting avoidance of tax, with a particular focus on transactions and arrangements of artificial and abusive character, the only purpose of which is the obtaining of a tax advantage.
• Bank secrecy: The fiscal authorities are to be granted a larger access to the taxpayer’s personal and account information available to banks.
• GAAR Ombudsman: MF proposes to set up a council of GAAR Ombudsman, the role of which will be limited to non-binding opinions in the appealing proceedings, concerning tax abusive transactions. The GAAR Ombudsman will consist of the representatives of the Supreme Administrative Court and Supreme Court, Ombudsman, National Chamber of Tax Advisors, Attorney-General, universities and the Minister of Finance.
Note: Currently the concept of a general Tax Ombuds-man does not exist in Poland.
• Tax rulings: Taxpayers will be entitled to apply for a tax ruling exclusively by way of using electronic means. The very application for the ruling will already be subject to a fee, whereas currently, the fee is paid only upon the receipt of the tax ruling. MF proposes that the issue of a tax ruling may be denied if the facts imply the taxpayer’s intention to avoid taxation.
• Statute of limitations: MF intends to expand the catalogue of events, which lead to the suspension of the limitation period (e.g. consulting the tax institutions of other countries about the taxpayer’s “hidden” income will be included in the catalogue). Additionally, adjudication of bankruptcy or starting of the enforcement proceedings will entail the restarting of the limitations period, instead of its suspension. In practice, upon the completion of the enforcement proceedings, the new period of limitation will commence.
6. Australia : Non-residents will be ineligible for capital gains tax concession
The Assistant Treasurer released Exposure Draft Legislation that will make non-resident individuals ineligible for the Capital Gains Tax (CGT) discount in respect of gains from disposal of taxable Australian property with effect from 8th May 2012, when this measure was initially announced.
At present, individuals may be entitled to a 50% reduction, or discount, of their net capital gains in respect of assets held more than a year. Capital gains of non-residents are subject to tax only to the extent the gains are from Australian taxable property, such as Australian real estate.
The proposed changes will retain the discount for the gains to the extent the increase in value that contributed to the gain occurred before 9th May 2012, but any increase in value after that date that contributed to a capital gain made by non-resident individuals will be ineligible for the concessional treatment.
Temporary residents and relevant individual beneficiaries of trust estates will also be ineligible for the capital gain discount.
The Draft Exposure legislation was released on 8th March 2013.
7. Switzerland : Revised lump-sum taxation regime enters into force in 2016
On 20th February 2013, the Swiss Federal Council decided that the revised lump-sum taxation regime will enter into force as per 1st January 2016. The Swiss cantons are given two 2 years’ time to adapt their cantonal tax legislation.
The lump-sum taxation regime is granted to individual taxpayers at the federal level and (with the exception of the cantons of Basel-Landschaft, Basel-Stadt, Zurich, Schaffhausen and Appenzell-Ausserrhoden) in all cantons of Switzerland. The privilege is granted only to a resident individual with foreign nationality who does not derive in-come from employment in Switzerland.
The worldwide annual living expenses form the lump-sum tax base, but with a minimum pre-determined threshold:
• for federal and cantonal tax purposes, the lump-sum tax base will be at least:
- seven times the rental value of the individual’s own property; or
- seven times the rent paid to the landlord in Switzerland; or
- three times the costs for board and lodging;
• for federal tax purposes, the minimum tax base will be CHF 400,000;
• for cantonal tax purposes, the minimum tax base will be freely determined by the canton concerned; and
• the cantons will levy a wealth tax.
Individuals who at the time of the entry into force of the revised tax legislation benefit from a lump-sum taxation agreement with the tax authorities which is more relaxed compared to the new tax legislation benefit from a transition period of five years.
8. United Kingdom
(i) Non-standard treaty tie-breaker rules for company residence – guidelines published
On 14th January 2013, HM Revenue & Customs (HMRC) published new section INTM120085 of the International Manual on company residence, providing clarification on non-standard treaty tie-breaker rules.
According to certain double taxation agreements, e.g. Canada – United Kingdom Income Tax Treaty (1978), Netherlands – United Kingdom Income Tax Treaty (2008) and United Kingdom – United States Income Tax Treaty (2001), when a person, other than an individual, is a resident of both States, the competent authorities of the two States determine by mutual agreement the State of which the person shall be deemed to be a resident (see also section INTM120080). The person is not able to attend or directly take part in the discussions, but can make representations regarding the State in which it considers itself to be actually resident.
Different criteria may be used by the competent authorities when discussing the question of residence and, according to HMRC, the relevant fac-tors that are likely to be considered are as follows:
• place of incorporation;
• place of central management and control;
• place of effective management;
• where company’s business activities are;
• economic linkages to each State;
• if there is actually double taxation; and
• the simplest administrative route for the company.
In addition, the section provides for several example scenarios.
(ii) Settlement opportunity for participant in tax avoidance schemes
On 8th January 2013, HM Revenue & Customs (HMRC) announced that it will offer to individuals, companies and partnerships that have entered into specific tax avoidance schemes, the opportunity to finalise their tax position and settle their tax liabilities by agreement without recourse to litigation.
The schemes covered include UK Generally Accepted Accounting Practice (GAAP) Partnership and schemes seeking to access the film relief leg-islation for production expenditure or create losses in partnerships through specific reliefs.
However, the settlement opportunity will not be available to participants in film partnership sale and lease-back schemes, interest relief schemes and schemes falling within HMRC’s criminal investigation policy or civil investigation of fraud procedures.
HM Revenue and Customs published the terms of the settlement opportunity open to individuals taking part in UK GAAP Partnerships and will publish the details of the opportunity available for other eligible schemes as they become available.
9. New Zealand
(i) Issues paper on review of the thin capitalisation rules
An officials’ issues paper, “Review of the thin capitalisation rules”, released on 14th January 2013, invites public submissions on proposed changes to the thin capitalisation rules as part of a continuing improvement to the international tax rules.
The proposed changes include:
• extension of the thin capitalisation rules to apply not only to investments controlled by single non-residents, but also to groups of non-residents, provided that those investors are acting together either specifically by agreement or by co-ordination by a party, e.g. a private equity manager;
• extension of the current rules applying to a resident trustee where more than 50% of settlements on the trust are made by a non-resident, to include settlements made by a group of non-residents acting together, or another entity which is subject to the rules;
• exclusion of related-party debt from the debt-to-asset ratio of a multinational’s worldwide group for the purposes of the thin capitalisation calculations. Debt from third parties would not be affected;
• exclusion of capitalised interest from assets when a tax deduction has been taken in New Zealand for the interest;
• exclusion of increased asset values as a result of internal sales of assets, with the exception of internal sales that are part of the sale of an entire worldwide group; and
• consolidation of individual owners’ interests with those of an outbound group.
(ii) Officials’ report on taxation of large multi-national companies
On 19th December 2012, the Minister of Revenue released an officials’ report on issues relating to the taxation of large multi-national companies.
The report considers the global issue of large multi-national companies paying little or no taxation in any country. The broad options put forward to tackle the problem are:
• to identify and amend the deficiencies in New Zealand’s base protection rules that apply to non-resident investment in New Zealand;
• promote best practice for residence taxation by all countries under their domestic law;
• participate in work to update and improve the international tax framework, in particular in the OECD tax base erosion and profit shifting (BEPS) project; and
• work closely with Australia at an official level to develop measures to address the problem.
Officials will report back to government on the issues in March 2013.
[Acknowledgment: We have compiled the above information from the Tax News Service of the IBFD for the period 18-12-2012 to 18-03-2013.]
