Impacts of the OECD BEPS Project on companies operating in Nigeria
October 2015 by PwC, Nigeria
In brief On October 5 2015, the Organisation for Economic Cooperation and Development (OECD) released its final Base Erosion and Profit Shifting (BEPS) package containing measures that will significantly change existing international tax rules. The report is the result of a 2-year work and extensive consultations with a broad range of stakeholders including Nigeria that participated in the OECD Committee on Fiscal Affairs. The report provides guidelines for minimum standards which participating countries have agreed to put in place to tackle BEPS. The report also includes changes to the OECD’s Transfer Pricing Guidelines as well as some recommendations on “best practice” policies to prevent and tackle BEPS.
It is expected that different countries will begin to take steps to implement the BEPS recommendations through changes to existing legislation. Although Nigeria is not a member of the OECD, the BEPS documents will have an impact on the country’s tax regime. For instance, changes to the TP Guidelines will automatically become applicable as contained in the Nigerian TP Regulations.
In detail Base Erosion and Profit Shifting (BEPS) refers to tax planning strategies that exploit gaps and mismatches in tax rules across borders to artificially reduce tax base or shift profits to low or no-tax locations where there is little or no economic activity. The OECD estimates that over the years, this has resulted in reduced overall corporate tax paid by multinationals and an annual loss of tax revenues of between USD 100 to 240 billion.
In September 2013, governments of the G20 commissioned the OECD to develop a plan to combat BEPS. The need to boost government revenues in light of the recent global financial crisis was key amongst other reasons for this action. Although initiated by members of the G20, the BEPS project has been followed very closely by many African tax authorities.
The African Tax Administrator’s Forum (ATAF) and its members (including Nigeria) were involved in the project through various committees. With the release of the final BEPS recommendations, it is expected that African countries will start to work on implementing the recommendations. While some of the BEPS driven changes to international tax rules (e.g. changes to the TP Regulations) will automatically take effect in Nigeria, others will require legislative changes to become effective.
BEPS Action Plans
The OECD identified 15 actions for tackling BEPS. These actions were directed towards three key objectives: 1. ensuring coherence in the domestic rules that affect cross-border activities, 2. reinforcing substance requirements in the existing international standards, and 3. improving transparency as well as certainty.
The following sections provide a summary of the OECD’s work on each of the 15 action plans.
Action 1: Digital Economy This action plan sets out to identify the tax challenges that result from the digitalisation of many business models including increased digital presence without a physical taxable presence. The action plan does not recommend a new set of tax rules for the digital economy. Rather it is believed that the recommendations from other action plans regarding changes to the TP Guidelines, Permanent Establishment (PE) definitions and Controlled Foreign Corporation (CFC) rules will help address the BEPS risks associated with digital economy.
Action 2: Hybrid mismatch The OECD sets out to resolve BEPS issues (such as double non-taxation and double deductions) that result from hybrid entities or transactions. A common example of a hybrid transaction is an instance where the return on a financial investment escapes tax in the country of the investor and investee entities because it qualifies as deductible interest in the paying jurisdiction but is treated as non-taxable dividend in the receiving jurisdiction. This action plan sets out several recommendations which countries can adopt to deal with this issue.
Action 3: CFC Rules Controlled Foreign Company (CFC) rules respond to the risk that taxpayers can use foreign subsidiaries which they control to strip profits from their countries of primary operation. This action plan provides recommendations for the design of CFC rules to combat this risk.
Action 4: Interest deductions The work on interest deduction aims to reduce the erosion of tax base that could happen through:
funding exempt activities with tax deductible debt financing;
obtaining interest deductions in excess of group’s actual third party interest expense; and
placing debt in countries with higher tax burden. The recommendations for addressing this BEPS issue include the use of fixed interest to EBITDA ratios over which interest deductibility will not be granted as well as a group ratio rule which limits the deductible interest in a particular country to the group’s interest to EBITDA ratio.
Action 5: Harmful tax practices This report aims to address concerns about preferential tax regimes used for artificial profit shifting as well as the lack of transparency in connection with certain preferential tax rulings which make it difficult to identify instances of abuse. The report focuses on defining the substantial activity requirements which are to be used to assess whether preferential regimes are being used for profit shifting. The work also focused on improving transparency through the compulsory spontaneous exchange of certain rulings that could give rise to BEPS concerns in the absence of such exchanges.
Action 6: Treaty abuse The OECD, through this action point seeks to prevent taxpayers from claiming treaty benefits in situations where these benefits were not intended to be granted. Key outcomes of this action plan include the inclusion of Limitation of Benefit (LoB) rules and the Principal Purpose Test (PPT) in the OECD Model Tax Treaty.
Action 7: PE status Tax treaties generally allow business profits of nonresident companies to be taxed when their business activities cross a certain threshold (i.e. when they have created a permanent establishment – PE) in the contracting state. This action point aims to tighten the existing PE rules and prevent multinational enterprises (MNEs) from artificially avoiding a PE status. The OECD has expanded the PE definition (and hence threshold) to capture MNEs who have in the past managed to avoid creating a PE through the use of commissionaire arrangements, the fragmentation of core business functions into bits that appear to be preparatory and auxiliary in nature, and splitting of contracts.
Actions 8 – 10: Aligning TP outcomes with Value Creation These action points would result in amendments to the existing OECD TP Guidelines for Multinational Enterprises and Tax Administrations. The changes introduced to the OECD Guidelines deemphasise analysis of related party transactions based solely on contractual agreements and stress the need to consider the actual conduct of the parties. Action 8 focuses on intangibles and is aimed at preventing the allocation of profits to jurisdictions where no value is created. Action 9 aims to align rewards with risks and prevents instances where rewards are allocated to low value activities. Action 10 addresses profits shifting through certain types of payment such as management fees and head office expenses.
Action 11 – BEPS Analysis This aims to establish methodologies to collect and analyse data on BEPS. The idea is to monitor and evaluate the effectiveness and economic impact of all action points. The OECD will work with different governments in assessing existing data and identifying new types of data that should be collected.
Action 12 – Disclosure of aggressive tax planning Although audits remain a key source of relevant information to tax authorities, the timing of access to the relevant information does not allow for early detection of aggressive tax planning techniques. Hence, the OECD sets out to provide a framework for putting in place mandatory disclosure regimes as a measure to improve information flow about tax risks to tax administrations and tax policy makers.
Action 13 – TP Documentation & Countryby-Country (CbC) Reporting The report introduces the requirement for groups to prepare a master file containing information on the group’s activities which is to be shared with tax authorities in the various jurisdictions where the group operates. There is also a requirement for a local file which will contain specific TP analysis relating to a particular jurisdiction. The report also imposes an obligation on head office to prepare a CbC report which should include information on the group’s allocation of revenue, taxes, and business activities on a jurisdiction by jurisdiction basis. Participating countries are expected to introduce CbC reporting for fiscal years beginning on or after January 1, 2016.
Action 14 – Dispute Resolution Action 14 provides recommendations for making the resolution of cross border tax disputes involving two or more taxing authorities more effective. The report covers the agreed changes (to be adopted by OECD member states) in their approach to dispute resolution. In particular minimum standards have been adopted with respect to: ensuring that eligible taxpayers are able to access the Mutual Agreement Procedures (MAP) embedded in treaties; the implementation of administrative processes that promote speedy resolution of disputes; ensuring treaty obligations of treaty partners with regards to MAPs are fully implemented.
Action 15 – Multilateral instrument A multilateral instrument is to be developed which will automatically modify existing bilateral tax treaties. The multilateral instrument is essential to ensure that all action points take effect without having to amend each and every bilateral treaty between countries. The multilateral instrument will include treaty measures on hybrid mismatch arrangements, treaty abuse, permanent establishment and mutual arrangement procedures.
Many African countries including Nigeria see the BEPS project as providing useful recommendations for boosting their tax revenues. It is therefore expected that these countries will start to take steps to implement many of the recommendations.
Over the next two years, the OECD will be working hand in hand with developing countries, the IMF, the World Bank Group, the UN and regional tax organisations (including ATAF) to develop practical implementation toolkits for combating BEPS. BEPS Implementation in Nigeria The FIRS has followed the BEPS project very closely. It has contributed to the final set of recommendations both directly and through ATAF.
Some of the short term and long term impacts of the BEPS deliverables in Nigeria are summarised below:
immediate application of changes to the OECD Guidelines since regulation 11 of the Nigerian TP Regulations allows changes to the OECD Guidelines to automatically apply.
potential legislative and regulatory amendments to incorporate other recommendations which are not part of the OECD Guidelines.
increased scrutiny of preferential tax regimes and tax incentives provided to Nigerian businesses with a view to establishing instances where they have been granted inappropriately as well as whether the provision of those incentives provide any real economic benefit to the country.
an increase in the demand (by the FIRS) for financial and other information of offshore related parties. This could include demands made to the local subsidiary (e.g. master file information) as well as demands made to the tax authorities of the Head Office (e.g. CbC reports) or non-resident affiliate through the mechanisms of the Convention on Mutual Administrative Assistance in Tax Matters.
increase in transfer pricing audits and more focus on substance in evaluating the appropriateness of transfer prices.
increase in the ability of the FIRS to identify and challenge instances of abusive transfer pricing. What should enterprises operating in Nigeria do? Substance and consistency are the name of the game in this BEPS era.
We recommend that MNEs:
re-access their intercompany arrangements and business models with a view to determining the sustainability of such arrangements;
ensure that reported profits align with value created in Nigeria; and
take extra care to ensure consistency of information provided to tax authorities across borders.
Report prepared by PwC Nigeria