1. Debt bias and Base erosion and profit shifting (BEPS)
EC-IMF Conference on Corporate Debt Bias
23 February 2015
Tom Neubig
Deputy Head of the Tax Policy & Statistics Division
Centre for Tax Policy & Administration

2. What is BEPS? A system under pressure
Over time, MNEs have identified and taken advantage of some of the gaps that exist between the domestic tax laws and tax treaties
Treaties are negotiated on a bilateral basis and there are more than 3,000 of them in existence today
Rules designed to prevent double taxation are now facilitating:
Double non-taxation
Less than single taxation
Stateless income

3. What is BEPS? BEPS Strategies
These strategies are collectively referred to as BEPS and generally involve:
Separating the location where profits are reported from the location where the actual economic activity or value creation occurs
Shifting costs into high taxing countries and shifting profits into low taxing countries

4. The BEPS Action Plan The BEPS Action Plan 15 point Action Plan
Endorsed by the G20 Leaders at their meeting in St Petersburg, September 2013
OECD and G20 working together on an equal footing
OECD Member and accession countries
G20 countries
In consultation with developing, non-OECD and non-G20 countries

5. The BEPS Action Plan
The BEPS Action Plan is focused on achieving a better alignment between:
the location of taxable profits; and
the place where economic activities and value creation occurs
A key focus of the BEPS Action Plan is to eliminate double non-taxation, while avoiding double taxation

6. The BEPS Action Plan Secure revenues and protect tax bases
Improve integrity of international tax rules by creating a single set of consensus-based rules
Must act quickly to prevent the unravelling of the existing consensus-based international tax framework
Provide greater certainty and predictability to taxpayers
Need to avoid unnecessary compliance burdens and restrictions on legitimate cross border activity

7. The BEPS Action Plan - Timeline
G20 Leaders have adopted an ambitious timeline for the BEPS Action Plan:
2014 deliverables – 7 Actions (released September 16, 2014)
2015 deliverables – 8 Actions
OECD developing detailed plans for implementation of the 15 Actions
All actions due to be completed by end of 2015

8. The BEPS Action Plan - Timeline
2014 deliverables
2015 deliverables
A1: Digital economy
A2: Hybrid mismatches
A3: CFCs
A5: Harmful tax practices
A4: Interest
A6: Treaty abuse
A7: PEs
A8: Transfer pricing (TP): Intangibles
A9: TP: risks & capital
A10: Other highrisk TP
A11: Analyse data
A12: Disclosure of aggressive tax planning
A13: TP documentation
A14: Dispute resolution
A15: Multilateral instrument

9. Actions addressing BEPS using interest
Action 2: Neutralize the effects of hybrid mismatch arrangement which generate two tax deductions for same payment, or payments which are deductible in the payer but not taxed as ordinary income in the recipient
Action 3: Strengthen CFC rules to address interest income in controlled companies in low tax jurisdictions
Action 4: Limit base erosion via interest deductions and other financial payments, and transfer pricing guidance for related party financial transactions
Action 9: Transfer pricing of risks and capital focuses on entities that are overcapitalized or assume excessive contractual risks

10. Debt bias in cross-border context
Differences in the tax treatment of the payer and payee of debt creates a tax-induced bias, in the cross-border context, towards debt financing.
Distortion compounded by tax planning techniques to reduce or eliminate tax in the jurisdiction of the payee.
Creates competitive distortions between groups operating internationally and those operating only in a domestic market, and tax preference for assets to be held by overseas groups.

11. Interest deductibility (Action 4)
Develop recommendations regarding best practices in the design of rules to prevent base erosion through the use of interest expense …
… for example, through the use of related party and third party debt …
… to achieve excessive interest deductions or to finance the production of exempt or deferred income …
… and other financial payments that are economically equivalent to interest.
In connection with and in support of the foregoing work, transfer pricing guidance will also be developed regarding the pricing of related party financial transactions 11

12. Interest deductibility: Two tests
Group-wide tests
Fixed ratio tests
Combination of the two tests

13. Interest deductibility: Group-wide test
A group-wide test would limit a company’s net interest deductions to a proportion of its group’s actual net third party interest expense, based on a measure of economic activity such as earnings or asset value
Aims to allow groups to claim tax relief for their real cost of funds, while protecting countries from excessive deductions
Groups can continue to centralise third party borrowings in the entity/country which is most efficient for non-tax purposes, while tax relief for interest is matched with economic activity
A best practice recommendation could include an agreed approach to be applied consistently by all countries or provide flexibility for a country to incorporate existing tax principles within its rule.

14. Interest deductibility: Fixed ratio test
A fixed ratio test operates by applying a fixed benchmark ratio to an entity’s earnings or asset value
Should be more straight-forward for groups and tax authorities to apply
Relatively inflexible, applying the same benchmark ratio to all entities
Difficult to establish the correct benchmark ratio
Work based on published data suggests that, where countries currently restrict interest deductions based on a fixed interest/EBITDA ratio, these ratios may be set at a level which is too high to tackle BEPS

15. Net third-party interest expense/EBITDA ratio for large non-financial MNE groups

16. Interest deductibility: Combined approach
A combined approach would allow lower risk companies to apply a simple fixed ratio test, while more highly geared companies could claim higher deductions by applying a group-wide test:
Approach 1
Approach 2
Main rule
Group-wide test
Fixed ratio test
Carve-out
For companies which meet a low fixed ratio test (or opt to apply the fixed ratio as a limit on deductions)
For companies which exceed the fixed ratio but can demonstrate they are within the equivalent ratio of their group

17. Interest deductibility (Action 4)
Discussion draft released 18 December 2014 for comment by 6 February 2015
Public consultation held in Paris on 17 February 2015
Final report with recommendations for best practices in the design of rules to address BEPS using interest by September 2015

18. Contact details Tom Neubig
Deputy Head of the Tax Policy and Statistics Division Centre for Tax Policy and Administration