Direct Tax

Mauritius, Singapore Investments now fully taxable for Capital Gains

[Excerpts from MNE Tax, 19 February 2019]

FY 2019-20 will be the first year after a two-year transition period since India amended its double tax avoidance agreements (DTAA) with Mauritius and Singapore. From 1 April 2019, the capital gains on investments made in India through companies in Mauritius and Singapore will become fully taxable.

India in talks with the Netherlands to amend Bilateral Tax Treaty

The Indian government wants to widen its tax base by ensuring that share transactions involving Indian entities do not escape taxation in India. After successfully plugging the loopholes in tax treaties with Mauritius and Singapore, India is now negotiating with the Netherlands to amend the bilateral tax treaty to tax sale of shares of Indian companies by the Dutch taxpayers.

The move comes after a surge in investment in Indian companies by Dutch corporates. In the first nine months of 2018-19, India had received $2.95 billion foreign direct investment from the Netherlands, topping the $2.8 billion investment in 2017-18.

OECD Crackdown on Corporate Tax Gaming Hits Roadblock (Corrected)

Most countries are opting out of adopting the new OECD standards aimed at shutting down a favorite tax planning maneuver of the multinationals. The reason for the rejection seems to be the likelihood of more disputes that would arise between tax authorities in light of the new standards. These standards aim to discourage companies from using “commissionaire arrangements” to avoid creating a permanent establishment (PE), which is subject to tax in that jurisdiction.

Companies use these structures to sell locally without creating a PE. Under the new standards, commissionaire arrangements would create a taxable presence. Countries like the Netherlands are choosing not to adopt some of the OECD’s new permanent establishment standards in their bilateral tax treaties via the multilateral instrument.

Transfer Pricing

Canada | Canadian Federal Court of Appeal (FCA) ruled that the Canada Revenue Agency (CRA) cannot compel oral interviews of taxpayers during audit.

The CRA has increasingly requested oral interviews during audits, particularly those related to transfer pricing. In a landmark tax ruling, between the Minister of National Revenue v. Cameco Corporation, the CRA sought an order compelling employees to attend oral interviews. The FCA dismissed the CRA’s appeal and held that the general power to inspect, audit or examine the books and records of a taxpayer does not extend to compelling a taxpayer to submit to oral interviews. While, the FCA distinguished between a taxpayer’s knowledge of location and maintenance of the documents and probing the taxpayer to understand potential tax liability, they also stated that if the requirement to answer the questions was implied, then the obligation and express powers to compel answers would be unnecessary.

The decision can be viewed as a positive development for the taxpayers as it sets the limit on CRA’s power to seek information and provide a reasonable framework on conduct of audits.

Australia | Australian Tax Office (ATO) issued guidelines on the Arm’s Length Debt Test (ALDT)

On 5 April 2019, the ATO released a draft ruling (TR 2019/ D2) which provided an updated guidance on the ALDT for thin capitalization rules. When finalized, this ruling will apply both retrospectively and prospectively and would replace the existing ruling (TR 2003/1). This ruling applies to entities that seek to apply the arm’s length debt test for outward investing and inward investing entities. This draft ruling has provided certain clarification which is as follows:

In determining a notional debt capital, the lower of the two amounts is to be considered:

  • Borrower Test: The notional debt capital the entity would reasonably be expected to have throughout the income year.
  • Lender Test: Arrangements that unrelated commercial lending institutions would reasonably be expected to have lent

The draft ruling clarifies that the ALDT is required to satisfy both the borrower and lender tests. While the notional lender test may determine the maximum amount a notional lender would lend, it does not mean that the notional borrower would necessarily borrow this maximum amount.

  • Although the financial statements would generally be expected to form the starting point of an ALDT analysis, a taxpayer is not prohibited from relying on alternate asset values for application of relevant factors to the notional Australian business.
  • A subjective capital structure and leverage preferences of the shareholders are not relevant in applying the ALDT as it requires an objective assessment.
  • The debt amount should be assessed “throughout the income year” and should exclude the credit support (both explicit and implicit). However while applying the ALDT, there is no single approach or method that will result in an amount that would reasonably be expected to exist throughout the year, accordingly the appropriate approach will depend on the specific facts and circumstances of the taxpayer for the relevant year.
  • Where a taxpayer is within their prescribed amendment period in relation to a prior income year, they are not prohibited from amending the income tax return for that income year to rely on the debt amount as their maximum allowable debt amount.
  • An entity must keep records that contain particulars about the factual assumptions and relevant factors taken into account, for the arm’s length debt account.

Latin America | Inter-American Centre of Tax Administrations preparing the “Sixth Transfer Pricing Method”

The Inter-American Centre of Tax Administrations is preparing a transfer pricing database for the application of the “sixth transfer pricing method.” The sixth transfer pricing method is an offshoot of the first transfer pricing method – the comparable uncontrolled price (CUP) method and would primarily be applicable to developing countries. The method is designed to record and reflect commodity prices from a database that includes agricultural and non agricultural products such as corn, wheat, soybeans, oil, banana, barley, malt, and hake, depending on the jurisdiction involved. Ten Latin American counties are participating in this module: Argentina, Bolivia, Brazil, Costa Rica, the Dominican Republic, Ecuador, Guatemala, Paraguay, Peru, and Uruguay.

Morocco | Introduction of Transfer Pricing Documentation requirements

Morocco’s 2019 Finance Bill introduced the obligation for certain Moroccan taxpayers to prepare specific documentation to justify their transfer pricing policies before tax authorities. This new provision is intended to align the Moroccan transfer pricing legislation with international practices and comes after the introduction of an Advance Pricing Agreement program between tax authorities and companies, which came into effect in 2018. The broad requirement introduced were as follows:

  • The TP documentation requirement will be applicable for the tax audits open after 1 January 2020. There is no annual obligation to prepare or transmit the documentation, but it must be provided electronically to the tax administration, upon request.
  • No specific language for drafting TP documentation.
  • The documentation obligation is applicable for companies that have direct or indirect relationships with companies located outside Morocco.
  • The documentation requirement covers all intra-group cross-border transactions carried out by the taxpayer, without any minimum materiality threshold.
  • The TP documentation must contain the information on all related companies’ activities, the overall transfer pricing policy of the group and the worldwide repartition of profits and activities.
  • Failure to provide the transfer pricing documentation during audit would lead the taxpayer to lose the right to defend and justify its transfer pricing policy before tax commissions. However, penalty for failure to provide transfer pricing documentation or submission of incomplete documentation is not foreseen.
  • Furthermore, Morocco is also likely to implement the CbCR declaration.

The introduction of the transfer pricing documentation requirement will increase the compliance and reporting burden for companies, but it also will allow multinational groups to have greater tax certainty due to the implementation of a standardized transfer pricing documentation framework.

Japan: Transfer Pricing Tax reforms 2019

The 2019 tax reform outline proposes to amend Japan’s transfer pricing rules to align with the BEPS Action Plan 8 (Intangibles). A list of amendments that would be applicable for taxable years beginning on or after 1 April 2020 and beginning 2021 for corporations and individuals respectively are as follows:

  • Clarifications - intangibles have been stated as property other than tangible property or financial assets & investments and consideration paid for transfer or lease of property if such transfer/lease is carried out between unrelated parties.
  • Discounted cash flow method is proposed to be included in the transfer pricing methods recognized by the OECD TP guidelines which describe that the DCF method may be useful to reach an arm’s length price for intangibles where comparable transactions cannot be identified.
  • Japanese tax authority has been authorized to make an assessment if the discrepancy is 20% or more without proper documentation between the outcome and projected value.
  • Six years statue of limitations under the transfer pricing rules will be extended from six years to seven years.

Implications due to Discontinuance of LIBOR

In July 2017, the Chief Executive of the UK Financial Conduct Authority (FCA) announced that firms should discontinue the use of the London Interbank Offered Rate (LIBOR) in favour of overnight risk-free rates (RFRs). The transition must be completed by the end of 2021, as the continuation of LIBOR will not be guaranteed to market participants after that date. In several countries, alternative rates have been introduced such as SOFR (Secured Overnight Financing Rate); reformed Sterling Overnight Index Average (SONIA); The Euro Short term rate (ESTER).

Various MNE’s have inter-company financing transactions or structures which would be impacted by the move to an alternative rate instead of LIBOR. A list of key transfer pricing pieces that would need to be relooked before LIBOR is discontinued is as follows:

Intercompany agreements - The existing intercompany loans that apply LIBOR as a base rate, which are going to mature after 2021 should consider amending their intercompany agreements to include fall-back clauses along with agreed actions and timelines by the parties to adjust the pricing to determine the interest rate considering the alternative base rate.

TP Policy - The differences in information contained in LIBOR and the new proposed rates may create comparability differences with the benchmarks applied to price intercompany financing arrangements that currently apply LIBOR as a base rate. MNEs should re-asses their transfer pricing policies to evaluate consistency and produce arm’s length results.

Debt Capacity – If the MNEs make amendments to the pricing or terms of the agreements that trigger a significant modification and a new debt instrument, MNEs should document that prior conclusions remain applicable in the current market environment.

Hedging – Hedging contracts often considered LIBOR as a reference rate and accordingly treasury groups and in-house banks should plan for the discontinuance of LIBOR and the resulting impact on their existing intercompany funding and hedging structures.

Indirect Tax

US states in favor of removing transaction threshold limits

[Excerpts from online issue of Bloomberg Tax, 12 April 2019]

Most US states have turnover and transaction volume based threshold limits to determine whether a business is liable to register under the state sales tax law. However, in an emerging trend, states are working towards having only a monetary limit to determine applicability of state tax laws. The transaction volume threshold limit is being considered as an obsolete criteria resulting in small taxpayers attracting attention of state authorities, where the cost of targeting such taxpayers can exceed the possible tax revenue from them.

Malaysian parliament approves bill to levy its new Sales and Service Tax (SST) on Foreign Service providers of digital services to local Malaysian customers

In 2018, Malaysia scrapped the Goods and Services Tax (GST) and switched back to the SST regime. Now, the Malaysian parliament has approved a bill to levy 6% SST on digital services such as gaming, e-books, etc., provided by foreign service providers to Malaysian consumers.