Base erosion and profit shifting why it matters to utilities

ey.powerutility

60148PjaE

Base erosion

and profit

shifting: why

it matters to

utilities


2 | Base erosion and profit shifting and why it matters to utilities

Significant overhauls

to the basic principles

of taxation have been

agreed upon globally.

Base erosion and

profit shifting (BEPS)

is now firmly on the

boardroom agenda

at power and utility

(P&U) companies that

do business across

borders.

Report by

Stefan Waldens and

Ronald van den Brekel


In October 2015, after lengthy

negotiations, the Organisation

for Economic Co-operation

and Development (OECD) and

20 countries published revisions

to tax principles, which are

based on a 15-point action

plan on BEPS. Over the past

12 months, some of these

measures have already

taken effect.

This is one of the most fundamental

overhauls of taxation for a generation.

The overriding principles are:

The 15 action items can be categorized into

three groups:

1

2

3

Minimum standards: participating

countries to implement minimum

standards in national laws, tax treaties

and other local requirements

Reinforced standards: tightening

of existing OECD Transfer Pricing

Guidelines and the OECD Model Tax

Convention

Common approaches and leading

practices: optional building blocks to

help countries implement revisions

to national law, tax treaties and other

local requirements

1

2

3

Transparency between taxpayers and

the public, between taxpayers and

tax and governmental authorities, as

well as between the governmental

authorities of different countries. This

includes the automatic exchange of

certain information.

Substance, so that tax follows the

source of profits. Taxpayers will have

to pay more attention to matching

economic substance to tax.

Coherence between individual

countries’ tax systems.

Action items enter into effect on different

dates, depending on the method of

implementation. While action items in the

minimum standards grouping may be in

effect already, even retroactively, others

must be implemented first into national law

or via tax treaties.

In any case, P&U companies should act now

to prepare for and address relevant

action items.

Base erosion and profit shifting and why it matters to utilities |

3


Action items most

relevant to P&U

companies

Irrespective of whether P&U companies

have entered into complex tax planning

arrangements, they will have areas to

review and risk assessments to perform in

advance of reporting to tax authorities in

financial year 2016. Although all 15 action

items may be relevant to P&U companies,

the following are among the most

important.

4 Action

Limitations on interest

deductions

Interest expense limitation rules vary

greatly across countries. Under the

new OECD principles, restrictions on

deductibility of interest expenses will

become standard. This, in effect, drives up

a company’s effective tax rate and could

impact price setting to customers.

This action sets out changes to the

definition of permanent establishments

(PEs). Before BEPS, P&U companies

could use commissionaire structures or

exemptions, without triggering PEs in

different countries. Under the proposed

rules of Action 7, PEs may be recognized in

other countries, which will trigger changes

to operating models, financial and tax

reporting, and compliance.

The final OECD report also proposes

the principal purpose test (PPT) rule.

This is included in proposed changes to

the OECD Model Tax Convention, under

Action 6, to prevent treaty abuse. It deals

with strategies to split contracts across

different companies to avoid establishing a

PE. Under the PPT provision, treaty benefits

will be denied where it is reasonable to

conclude that the main purpose of the

arrangement is to secure a benefit under

the tax treaty. For those states unable to

address the issue through the PPT rule,

an automatic rule will be included in the

commentaries on the Articles of the Model

Tax Convention.

Against this background, P&U companies

need to be alert to the risks of creating

unwanted PEs in, say, sales activities

that use a commissionaire structure or in

trading, origination or facilitation activities.

Equally, P&U companies risk triggering

PEs when building power plants or

machinery for generation and exploration,

or constructing and installing pipelines and

transmission apparatus, in which the total

project exceeds 12 months — even when

broken into subprojects.

The critical takeaway for P&U companies

is the need to review existing operating

models and to monitor cross-border sales

and construction activities closely.

7 Action

Preventing the artificial Actions

avoidance of permanent

8,9 and 10

establishment status

Aligning transfer pricing

outcomes with value

creation

Technical transfer pricing issues stem from

the alignment of profit allocation with value

creation. The OECD developed a six-step

approach to determine risk allocation,

using functional analysis. A similar

stepped approach has been developed

for the allocation of profits relating to

intangible assets.

Many P&U companies outsource services

and activities, but who bears the risk and

has the financial capacity to bear that

risk if it materializes? Where activities

are outsourced, profits will be reallocated

according to who performs controls

over risk and DEMPE (development,

enhancement, maintenance, protection

and exploitation) functions in relation to

intangible assets. So, for a P&U company

focused on generation, asset optimization

may be a valuable activity.

However, in wind parks, for example,

asset management/optimization is

often outsourced because generation

activities can be controlled remotely and

local maintenance is often low-value.

Nonetheless, even when there is remote

exploitation and control of infrastructure by

a nonresident principal due to outsourcing,

the risks of creating a PE in the local

jurisdiction are higher than in the past.

In general, the new BEPS guidelines

shift the allocation of risks and profits

from a legal to an economic stance.

Given the increased focus on functions,

risk, risk capital and intangibles in

Actions 8, 9 and 10, relevant substance

is now critical for the tax treatment of

P&U business models. There is also a

requirement for increased transparency

over value drivers within the P&U value

chain. Moreover, new guidance in relation

to material business restructuring requires

taxpayers to meet a higher threshold of

commercial rationale in transfer pricing.

4 | Base erosion and profit shifting and why it matters to utilities


13

Transfer pricing

documentation

and CbCR

Existing documentation requirements for

multinationals vary greatly by country and

trigger a significant compliance burden

for taxpayers. Yet they do not provide full

insight into multinationals’ activities for

local tax authorities. Action 13 introduces

a master file, which gives tax authorities

information about countries in which a

multinational is active, where intellectual

property is owned, where revenue is

reported, where taxes are paid and the

intercompany transactions a multinational

enters into.

BEPS implications for

P&U companies

For most countries, the BEPS train is in full

motion. Some OECD recommendations

apply to tax year 2016. Others will enter

into force only once adopted into local

law by the individual countries and/or

implemented in tax treaties.

For tax functions, BEPS is creating

significant new tax reporting obligations.

The finance function may feel the

effects too. It comes on top of increased

government-to-government information

sharing and collaboration. BEPS also

introduces substantive changes to internal

tax rules. P&U companies need to prepare,

do test runs, perform risk assessments and

check their readiness for BEPS.

Key implications are:

Action Base erosion and profit shifting and why it matters to utilities | 5

Also new is country-by-country reporting

(CbCR). Companies with annual

consolidated group revenue of €750 million

or more must provide certain financial

information from fiscal year 2016 onward,

on a country-by-country basis. The CbCR

must be prepared at a consolidated level

and provided (either filed directly or

through exchange by tax authorities) to all

relevant local tax authorities. The CbCR

includes figures on the activities carried out

in each country, revenue by country, taxes

paid/accrued, number of employees and so

on. The master file and CbCR should give

tax authorities a comprehensive overview

of the overall allocation of revenue and

profit across all relevant countries, focusing

on the complete value chain.

P&U companies should be proactive. A test

run will reveal whether the required data

can be retrieved from existing systems

or if a more reliable and efficient data

extraction solution needs to be developed.

Once resolved, data should be reviewed

to identify potential risks or problem

areas. Tax administrations will use data

analytics tools to analyze the information

provided through the CbCR. In advance,

P&U companies can carry out their own

internal analysis and test their ability to

respond to tax authority questions.

• Increased government inquiries and

enforcement actions due to greater

transparency of information

• Data extraction difficulties and

increased compliance requirements:

P&U companies need to be able to extract

data from existing databases and IT

systems, make significant modifications

to systems or allow manual intervention

• A more coordinated and strategic

approach to global risk management

• A potential long-term cash tax impact

due to changes to existing legal and

operational structures, which may go

beyond earnings before interest and

tax (EBIT) and could lead to higher tax

payments

• Heightened value-added tax (VAT) risks,

particularly regarding PE status

• Potential public disclosure of additional

reporting, which will require substantial

management of stakeholders and may

lead to reputational risk


How EY can help

International tax changes,

stemming from the OECD

BEPS project, will transform

the global tax environment in

which cross-border businesses

operate. P&U companies that

do not prepare may struggle to

adapt and fail to comply with the

new rules. Now is the time to

evaluate potential BEPS pressure

points within your business. EY

can help take the pressure off

you. We offer:

• Access to professionals within

our globally integrated P&U

and BEPS networks

• Detailed insights into global

and local BEPS-related

country developments

(see, for example,

http://www.ey.com/GL/en/

Services/Tax/ey-bepsdevelopments-tracker)

• Innovative tools and

technologies to perform

BEPS readiness and risk

assessments, Action

13 transfer pricing

documentation, CbCR

compliance and Action 7 PE

risk assessment

Working with you, we can help

you successfully align your

business model and structure to

the new global tax mindset.

ey.com/powerandutilities

EY Global Tax Power & Utilities

(P&U) contacts

Rocio Reyero Folgado

Partner — Tax

+34 915 727 383

rocio.reyerorolgado@es.ey.com

Suzanne Alcock

Director — Capital Allowances

+44 207 951 0036

salcock@uk.ey.com

Duncan Coneybeare

Sector Analyst — Power & Utilities

+44 207 951 5628

dconeybeare@uk.ey.com

Stefan Waldens

Partner — Tax

+49 2119 3521 2085

stefan.waldens@de.ey.com

Ronald van den Brenkel

Partner — Tax

+31 88 40 79016

ronald.van.den.brekel@nl.ey.com

6 | Base erosion and profit shifting and why it matters to utilities


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About EY’s Global Power & Utilities Sector

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