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Gabriel Biriș / About the taxation of multinationals – changing paradigms

de Gabriel Biris 6.11.2016

gabriel-birisThe other day I watched on TV how PNL leaders presented as a great achievement the submission of the draft law for implementing the ATAD Directive (2016 – Anti Tax Avoidance Directive) that, according to them, would allow the “taxation at 16% of multinationals”.

A few words about this initiative, the context in which it was approved, but mostly about the really important measures that will affect us in the years to come: CCCTB, the initiative of DG Competition, the anti-BEPS and CRS measures.

I. ATAD / Implementation law proposed by PNL

We should first say that this directive is NOT about transfer pricing rules and tax rates. Transfer pricing rules exist in the Romanian law for over a decade and are exactly the rules developed by the OECD, including the comments.

We have rules, but we do not have much administrative capacity to implement them effectively, capacity that is lacking mainly because we lack the political will to create it … I would only mention that, although the rules were introduced in 2004, the tool that allows their application has become available to ANAF only in 2011… ATAD does not introduce any changes / additions to these rules.

Regulations introduced by ATAD refer to:

  • Deductibility of interest;

  • Exit taxation of the transfer of assets;

  • General anti-abuse rule;

  • Computation of controlled foreign company income;

  • Non-unitary tax treatment of hybrid mismatches;

Deductibility of interest

The Directive introduces limitations for how much interest may be deducted by a company for corporate tax purposes. Thus, companies cannot deduct interest higher than 30% of EBITDA. Directive allows certain derogations, as meaning that member states may decide that this rule does not apply to standalone entities or is replaced with a 3,000,000 Euro threshold.

As the authors of the draft law do not know that this is exactly the role of the implementation law, to set limits for applying the Directive, we do not know the lawmakers’ intention regarding the way these limitations will operate… “Copy-paste” rules!

Given that Romania already has a set of limitation rules for the deductibility of interest (“thin capitalization rules”) that have been working well for over a decade, it would be good to not disadvantage again the Romanian companies and choose not to apply additional conditions to Romanian standalone companies, especially that the limitation to 30% of EBITDA also refers to bank interest, which are anyway higher for the Romanian companies in Romania, than the ones paid by their competitors in other EU countries.

In addition, this limitation could lead to the situation in which the interest paid at the early phase of the investment could not be deducted at all – which would be completely anti-economic for a country that needs to attract investment.

As a reminder, our Tax Code provides:

  • Interest paid to financial institutions (banks, IFN) are deductible regardless of the debt ratio;

  • Interest paid to other entities are deductible within the central bank benchmark interest (1.75% – for loans in lei) or 4% (for loans in other currencies) and only if the debt ratio (debt, other than to financial institutions / equity) is less than 3;

  • If debt ratio is higher than 3, within the above, the interest expenses can be carried forward until the debt rate allows deduction.

As we can see, our rules already make very difficult to transfer profits through interest.

Fair is to say that there is a possibility of “optimization” (easy to close, but the directive / PNL’s initiative says nothing), but – overall, what we have now is a set of effective measures, which justifies, I believe, keeping them for as many cases as possible and limit as much as possible (based on the options from the directive) the effects of this directive.

Exit taxation of the transfer of assets

The Directive introduces a set of rules that creates the obligation to pay corporate tax if assets of an entity from a member state are transferred to an entity from another country (EU member or third country), irrespective of how this transfer is made.

Few issues should be noted:

1. Romania already has provisions that set the obligation to pay the corporate tax in Romania, if an entity transfers assets from Romania to another state. It just needs for these rules to be properly applied, including the transfer pricing;

2. The provisions of the directive implemented by law subordinate to the double taxation conventions to which Romania is a party, so even if implemented, the Directive does not automatically guarantee the payment of tax in Romania;

3. Considering that there are quite a few cases of Western companies that have relocated production in Romania and less the other way around, this provision may even disadvantage Romania, so our politicians should be a little less enthusiastic when it comes to applying it …

General anti-abuse rule

The Directive provides that for the purposes of calculating the corporate tax liability, a Member State shall ignore an arrangement or a series of arrangements which, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of the applicable tax law, are not genuine having regard to all relevant facts and circumstances.

Sounds familiar?

Our Tax Code includes already, for many years, such a provision. In the first paragraph of art. 11 of the Code we find the following provision: “In determining the amount of a tax, a tax or a mandatory social contribution, tax authorities may not consider a transaction that does not have an economic purpose, by adjusting the tax effects thereof, or reframe a transaction / activity to reflect the economic substance of the transaction / activity”.

The same thing, but put in a much clearer wording than the translation of the Directive, translation that is not consistent with our legal language, according to which – for example, by “genuine agreement” we generally mean a notarised contract…

Going back to art. 11. (1), even if the implementing rules are (still) missing for this article (rules which should be approved by OPANAF), tax inspectors apply its provisions, even quite extensively.

Rules for controlled foreign companies

I confess that the way the directive is worded is cryptic, even for me. I read, reread, re-reread art. 7 of the directive and am still not sure that I understand what it means, which raises big questions from my point of view about how this provision could be understood and applied by the tax inspectors

It seems that the directive provides that the undistributed profits of foreign entities controlled by a company (from Romania) will be included in the company’s tax base (in Romania) if such profits derived from certain activities (interest, royalties, dividends and income from the disposal of shares, financial leasing, insurance, banking or other financial activities or invoicing companies) or are income from “non-genuine” arrangements.

Besides the strange wording, these measures obviously create quite a few “loopholes” so that they can be avoided, particularly because the directive does not also apply to individuals, but only to companies.

I recall a provision – similar in principle, but which would have applied to the final beneficiary, natural person, which I had proposed in the draft Emergency Ordinance that has been criticized at the time by all parties, including the promoters of this law.

Besides, the rule for controlled companies shall not apply where the controlled foreign company carries on a “substantive economic activity, supported by personnel, equipment, assets and premises”, which makes it completely useless in Romania, where we have both transfer pricing rules and art. 11 of the Tax Code, rules allowing even now the restatement of the income or expenses of a Romanian company.

Not to mention that, given that Romania has few taxpayers that control companies in third countries, it is more likely that the directive to benefit foreign companies that own entities in Romania than vice versa …

Non-unitary tax treatment of hybrid mismatches

This measure aims to regulate situations where, because of legislative differences between different countries, there is the possibility occurring that (i) the same expenses are allowed for deduction in both states (“double deduction”), or (ii) an expense is deducted in a state without a corresponding inclusion for tax purposes of the same expense in the other state.

In the first case, the deduction shall be given only in the member state where payment is made, while in the second case, member state of the payer shall deny the deduction of the payment.

It seems logical, but the application will be far from simple. Tax inspectors will have to receive information on the tax treatment of various payments, which will certainly lead to practical difficulties and extended period for controls …

Conclusion

This directive (which seems to be already amended) does not contribute anything to fighting tax base erosion in Romania.

The draft law on the implementation of the Directive brings though an absolute novelty for the copy-paste technique, casting ridicule upon both the legislative process and the topic.

The initiators, driven by their creative enthusiasm and wanting to counter-balance their political opponents who have passed in Parliament a running fire law that repealed more than 100 taxes at once, forgot (that’s if they ever knew) that the implementation law must regulate within the limits allowed by the Directive. It is embarrassing that, 10 years after the EU accession, we have an implementation law which states that “member states may provide for” or “member states may exclude” …

The way how the legislative initiative was presented to the public is also extremely harmful. Apparently, the initiators want to find a new hate deflator to be blamed for the inability of our politicians to create a strong state with efficient institutions, respected both by Romanians and foreigners.

After the banks were pointed to as guilty that people become indebted (and not the political factor that did not properly regulate citizens’ rights and left them to ignorance and abuse) now multinationals are indicated as being guilty of the lack of money in the budget

Not a word about the Czech Republic’s proposal to amend the VAT Directive to allow reverse charging, a step that we did not support in 2015 although it would allow us to block at least half of the VAT fraud, i.e. almost three times the amount collected as corporate tax! Nor about how ANAF’s informatization process has been politically blocked until now. Without efficient IT systems we cannot even think of efficiently applying the transfer pricing rules…

II. CCCTB

Common Consolidated Corporate Tax Base is a directive that refers to the companies operating in several EU countries, aimed at regulating the following:

  • Single set of rules to calculate the corporate tax base, irrespective of the member state where the company consolidates the results;

  • An allocation formula for the taxable income to each of the countries where the company operates. The allocation formula is based on assets, number of employees and wage fund;

  • Each member state would tax the allocated “slice” by the applicable tax rate (Directive thus preserves a mark of sovereignty).

The European Commission proposed the directive in 2010, but the proposal has been “parked” because it did not come even close to achieving a consensus among members. Noteworthy is that the impact studies made at the moment (2011) showed that Romania would have been the biggest loser

In October, this year, the CCCTB Directive has been relaunched by the Commission, also backed by a strong media campaign. Romania should therefore be very careful about the details of the allocation and the impact that this formula will have both on the budget and our country’s attractiveness to investors.

Uniform rules for all could help increase transparency and improve the level playing field and also ease the administrative burden and strengthen the good practices (our authorities could draw inspiration from others in the interpretation of the law, although that has not really helped in the VAT matter, where our legislation is based on the EU VAT Directive and also the ECJ Rulings apply.

Conclusion

CCCTB could be a useful tool for Romania’s “effort” (quotation marks are not random!) to fight erosion of the tax base, with one condition: the allocation formula to be correct, although I do not see how that could be, especially that losses registered in some states will reduce, as effect of consolidation, the tax base in other countries .

Comment

I hope my former colleagues from the government will understand, at least now, why it was and still is important to provide tax consolidation to the groups of Romanian companies, which will be clearly disadvantaged in relation to their European competitors.

The latter will not only be able to offset losses made by a company against profits made by another company in the same country (many can even do that now), but will do so including for the losses from abroad. Romanian groups of companies will not be able to do that at all, which obviously will not help them.

Moreover, the budgetary impact of the tax consolidation cannot even be a reason for denying the measure, as it would be a ridiculous low one. If anyone said otherwise, it would mean that the calculation method is wrong (and indeed it is!).

Let me give you an example: we have a “small group” of two companies, one having a profit of 200, the other a loss of 100. What is the budgetary impact of the consolidation? The answer I received was 16. Completely wrong!

The loss of 100 can no longer be carried forward, therefore the 16 does not represent lost income, but only deffered income. The correct answer should have been different: at a financing cost of, say, 3%, the impact of consolidation would be only the funding cost for the 16 and not 16. That is 16 * 3% = 0.48. Totally something else …

III. DG Competition’s initiative

Some time ago, Mrs Margrethe Vestager, European Commissioner for Competition, had an idea: to investigate whether some member states cheat by granting state aid in a disguised form of advance pricing agreements or advance rulings to attract investors to their countries over other EU member states.

Basically, Mrs. Vestager argues that any tax benefits, including the pricing agreements that deviate from the market conditions, which are only granted to an investor or economic sector constitutes state aid and must be approved in advance by the Commission. Any state aid granted without complying to this requirement must be recovered.

Results started to be seen: Starbucks in the Netherlands, Apple in Ireland were requested substantial amounts by way of reimbursement of illegally received state aid. And the discussion is just starting…

Mrs Vestager’s initiative is poorly understood in Romania; there is almost no public debate on this subject, although the impact for us is far higher than ATAD could ever have.

Basically, it solves much of the profit shifting problem through pricing from states that meet the requirements (like Romania) in countries that have created competitive advantages by offering multinationals preferential conditions that actually lowered very much the tax burden compared to the level resulted from the tax rates. The Netherlands, Ireland can be such examples, but not only …

Some may also have some problems with this approach even in Romania. I refer to those who benefit from sector facilities, such as the special tax for hotels and restaurants or even wage tax exemption for salaries in IT or R&D.

Conclusion

Romania will benefit from this initiative without even understanding why. Some will even maybe boast that the results are theirs…

IV. Anti-BEPS plan

In 2012, the G20 (Group of 20 most developed countries) urged the OECD to develop an action plan for creating more equity in the distribution of taxable profits between countries around the world. Three years later, the visionary head of OECD’s CFA (Committee of Fiscal Affairs) presented the plan called “Anti-BEPS” (Base Erosion and profit Shifting) and the G20 leaders approved it in their meeting, in Antalia.

The OECD decided to also open itself to non-member countries, such as Romania, creating a discussion framework with equal membership for all participating countries (“Inclusive Framework”). The first meeting took place in June in Kyoto. I had the privilege to represent Romania at this meeting.

The plan contains a set of 15 actions aimed at ensuring much higher transparency for the companies’ “tax affairs”, especially for multinationals, at the global level. A (small) part of them are the basis of ATAD. I shall not refer here to all 15 actions, but only to Measure 13 – Transfer Pricing Documentation and Country by Country Reporting (CbCR – not implemented though ATAD).

We already know about the transfer pricing documentation. It exists in our legislation, detailed according to the OECD’s rules. Much more interesting for us though is CbCR, a measure that requires for all the multinational companies with a turnover exceeding EUR 750 million to:

  • Draw up a report on their global operations that will be filed with all tax authorities in every country where they operate. This report (XML, standard) will provide to each and every tax administration information about total income, number of employees, assets, and their allocation among states where the companies operate;

  • Local transfer pricing documentation, similar to what already exists.

Obviously, as Romania is a country of profit “extraction”, it will be a net beneficiary of this measure.

Again, we have no merit in that, as we are beneficiaries of a global paradigm shift, not of an improvement of the administrative capacity or a better legislation that we developed internally.

V. Common Reporting Standards (CRS)

Until recently, the information exchange between tax authorities was something difficult to accomplish. Now, within the same paradigm that led to the anti-BEPS plan, the OECD also developed a common reporting standard, AUTOMATIC (and not just by request as before), which obliges the signatory states to submit information about the “fiscal affairs” of the residents from the other states.

Once these standards are implemented (they will probably become the norm at the global level by 2020), the information available to the tax authorities will make almost impossible to park profit in tax havens. As I said in the headline – the global tax system paradigm from the last decades is changing. And this change is taking place very, very quickly.

In conclusion:

  • ATAD is much less relevant than the impression given;

  • CCCTB should be closely monitored so that the allocation formula to disadvantage us as little as possible (there is no way to advantage us);

  • Anti-BEPS, CRS also the DG Competition’s actions are very important and can be very beneficial for us;

  • The OECD also has other tools that we can (easily) implement. One of them is SAF-T (Standard audit File for Tax), a detailed standard reporting that allows the remote tax control, efficient, without physical contact, but also risk analysis and both control and prevention policy development. This is one of the ongoing projects that I have left in the ministry, which I hope will to be abandoned in some drawers.

A thought before concluding this article: it is very important for us not to complicate things more than necessary and not put the burden of additional obligations on the Romanian companies that would make them uncompetitive.

Transfer pricing rules are designed to prevent the transfer of profits abroad and not to examine how profits are allocated in Romania.

Why requesting the transfer pricing documentation for a transaction between two Romanian affiliates, both on profit? There is no good reason for such obligation, because the adjustment at both ends of the transaction leads anyway to zero extra taxes collected.

Even this problem can be easily solved if we introduce tax consolidation for Romanian groups of companies, consolidation that CCCTB will anyway impose on us…

Solutions to increase the tax base exist, we should just be willing to use them.

We must not forget either the measures to fight VAT and excise fraud, because for us these (indirect) taxes have significantly higher contribution than the direct taxes.

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