1. International Tax Forum September 19 th 2013 St. Petersburg Prof. Dr. Wolfgang Kessler Lehrstuhl für Betriebswirtschaftliche Steuerlehre Albert-Ludwigs-Universität Freiburg – Lehrstuhl für Betriebswirtschaftliche Steuerlehre – StB Prof. Dr. W. Kessler Werthmannstr. 8 – 79085 Freiburg i.Br. – Telefon 0761/203-9200 – Telefax 0761/203-9202 BEPS: Base Erosion and Profit Shifting – the lack of harmonization and the double taxation as a result

2. 19.09.2013 | Prof. Dr. Wolfgang Kessler 2 1.Fundamentals 2.Tax planning structures  Google  Apple 3.OECD measures  Report Addressing BEPS (10/02/2013)  Action plan on BEPS (19/07/2013) 4.Implications of the OECD measures Agenda

3. 19.09.2013 | Prof. Dr. Wolfgang Kessler 3 USA Inc.AG OpCo DE 1.Fundamentals (1/6) - tax credit method vs. exemption method - IE active income 100 EBT./. 12,5 CIT 87,5 profit dividend 87,5./. 35 CIT 65 profit + 12,5 FTC dividend 87,5./. 1,3 * CIT 86,2 profit active income 100 EBT./. 12,5 CIT 87,5 profit *) Exemption method (tax base = 0), but 5% of dividend deemed as non deductible expenses.

4. 19.09.2013 | Prof. Dr. Wolfgang Kessler 4 Inc. OpCo 1.Fundamentals (2/6) - tax deferral vs. CFC rules - USA Inc. CFC IE USA IE no dividend 0 EBT./. 0 CIT 0 profit no dividend 0 EBT./. 35 CIT -22,5 loss + 12,5 FTC active income 100 EBT./. 12,5 CIT 87,5 profit passive income 100 EBT./. 12,5 CIT 87,5 profit

5. 19.09.2013 | Prof. Dr. Wolfgang Kessler 5 1.Fundamentals (3/6) - calculation - tax credit methodexemption methodtax deferralCFC-rules IE-OpCo 100EBT./.12,5CIT (IE) =87,5profit IE-OpCo 100EBT./.12,5CIT (IE) =87,5profit IE-OpCo 100EBT./.12,5CIT (IE) =87,5profit IE-OpCo 100EBT./.12,5CIT (IE) =87,5profit US-Inc. 87,5EBT =dividend [+12,5gross up]./.35CIT (US) +12,5tax credit =65profit DE-AG 87,5EBT =dividend [./.87,5exemption method]./.1,3CIT (DE) =86,2profit US-Inc. 0EBT =dividend./.0CIT (IE) =0profit US-Inc. 0EBT =dividend [+100CFC-income]./.35CIT (US) + 12,5tax credit =- 22,5loss affiliated group =65profit affiliated group =86,2profit affiliated group =87,5profit affiliated group =65profit

6. 19.09.2013 | Prof. Dr. Wolfgang Kessler 6 1.Fundamentals (4/6) - US Corporate Income Taxes - Federal tax: Corporate Income Tax  residence: place of incorporation (not place of management)  U.S. taxation of worldwide income – as a basic principle  stepped rates up to 35% + state/local taxes (approx. 2-6%)  avoidance of international double taxation: foreign tax credit- method (FTC) with option to “deemed paid tax credit” (gross up)  Subpart F: current inclusion of passive income (e.g. dividends, interest, royalties) from controlled foreign corporations (CFC)  “check the box”-regulation (Form 8832): option to treat a corporation as permanent establishment (disregarded entity) US-GAAP  expected effective tax rate (ETR) of 35-41%!  exception: no deferred taxes, “if sufficient evidence shows that the subsidiary has invested or will invest the undistributed earnings indefinitely …” (APB 23)

7. 19.09.2013 | Prof. Dr. Wolfgang Kessler 7 intangible assets USA US Inc. BM Offshore-Co EU EU-OpCo ② cost sharing agreement (buy-in) ③ IP transfer 1.Fundamentals (5/6) - transfer of intangible assets from the USA - intangible assets ① research & development ④ license

8. 19.09.2013 | Prof. Dr. Wolfgang Kessler 8 1.Fundamentals (6/6) - jurisdiction to tax for CIT purposes - state of residenceUSAU.K.IrelandGermanyOECD place of incorporation (or place of formation) XXX ( * ) X- place of (effective) management (  daily business) --XXX place of management (  strategic decisions) -X--- *) There is an exception to this rule if a related company is controlled or is regularly traded on a recognized stock exchange.

9. 19.09.2013 | Prof. Dr. Wolfgang Kessler 9 Google Inc. Google Ireland Holdings ( * ) ⑦ royalties ⑧ dividends (deferred) ⑤ fees clients ① IP transfer ② license ③ sublicense ④ online promotion ⑥ royalties *)The Google Ireland Holdings was founded in Ireland, but the place of management is in Bermuda. NL IE BM USA 2.Tax planning structures (1/4) - Google: structure - DE Google Ire- land Ltd. Google NL Holding B.V.

10. 19.09.2013 | Prof. Dr. Wolfgang Kessler 10 USA:  Google Inc.: US CIT on dividends (but deferral in Bermuda) and no CFC taxation (active income from Irish subsidiaries)  Google Ireland Holdings: intangible assets transferred via cost sharing arrangement (APA) from the USA to Bermuda (no super royalty rule)  Google Ireland Ltd. / Google NL Holding B.V.:  no tax resident (both companies are not incorporated in the USA)  no CFC taxation (check-the-box-election  active revenues from Irish subs) Bermuda: Google Ireland Holdings: no CIT and no withholding tax (tax haven) Netherlands:  Google Ireland Holdings: no withholding tax on royalties outgoing (local tax code)  Google NL Holding B.V.: ruling on royalty net income (handling fee) Ireland:  Google Ireland Holdings: no tax resident (no place of management in Ireland)  Google NL Holding B.V.: no withholding tax (Council Directive 2003/49/EC)  Google Ireland Ltd.: CIT = 12,5%, but low net income (high TP on royalties) Germany: Google Ireland Ltd.: no CIT (no permanent establishment) 2.Tax planning structures (2/4) - Google: CIT -

11. 19.09.2013 | Prof. Dr. Wolfgang Kessler 11 Apple Inc. Foxconn IE USA Apple „OpCo“ International clients TW 2.Tax planning structures (3/4) - Apple: structure - DE ① IP transfer Apple Retail Germany Apple Sales International Apple OpCo Europe Apple Distri- bution Int. Apple Retail Holding Europe ② sale ③ sale ④ sale

12. 19.09.2013 | Prof. Dr. Wolfgang Kessler 12 USA:  Apple Inc.:  no CFC taxation (active income from disregarded “Irish” sub-subsidiaries)  Apple OpCo International / Apple OpCo Europe / Apple Sales International:  incorporated in IE, but have no tax residency in Ireland (no employees, no PE) and in the USA (ghost company) – board meetings in CA!  intangible assets transferred via cost sharing arrangement from the USA  no CFC taxation (check-the-box-election  sales income of Irish subsidiaries is active income of AOI) Ireland:  Apple OpCo International / Apple OpCo Europe / Apple Sales International:  subject to non-resident taxation, but special tax rate of 2%  Apple Distribution International / Apple Retail Holding Europe:  tax resident, but low net income (TP: low risk distributor) Germany:  Apple Distribution International: no CIT (no permanent establishment)  Apple Retail Germany: tax resident, but low net income (TP: low risk distributor) Taiwan: Foxconn: tax resident, but low net income (TP: low risk distributor) 2.Tax planning structures (4/4) - Apple: CIT -

13. 19.09.2013 | Prof. Dr. Wolfgang Kessler 13 3.OECD measures & EU Code of Conduct - timeline - 1997EU: Code of Conduct for business taxation 1998Report: Harmful Tax Competition – An Emerging Global Issue 2001Discussion paper: The Impact of the Communications Revolution on the Application of “Place of Effective Management" as a Tie Breaker Rule 2004TAG Final Report: Are the Current Treaty Rules for Taxing Business Profits Appropriate for E-Commerce? 12/02/2013BEPS-Report (diagnosis) 15/02/2013G20 Finance Ministers meeting in Moscow 19/07/2013G20 Finance Ministers meeting in Moscow OECD Action Plan on BEPS (therapy) 05/09/2013 G20 Leader’s Summit in St. Petersburg

14. 19.09.2013 | Prof. Dr. Wolfgang Kessler 14 Source: OECD, 2013. 3.OECD report addressing BEPS (10/02/2013) - Global Foreign Direct Investments in 2010 - value of retained offshore profits ≈ 1.7 trillion $ ==> deferred US CIT ≈ 600 billion $ (Source: Pinkernell, IStR 2013, p. 180-187)

15. 19.09.2013 | Prof. Dr. Wolfgang Kessler 15 (1) address the tax challenges of the digital economy (2) neutralise the effects of hybrid mismatch arrangements (3) strengthen CFC rules (4) limit base erosion via interest deductions and other financial payments (5) counter harmful tax practices more effectively, taking into account transparency and substance (6) prevent treaty abuse (7) prevent the artificial avoidance of PE status (8) assure that transfer pricing outcomes are in line with value creation (intangibles) (9) assure that transfer pricing outcomes are in line with value creation (risks and capital) (10) assure that transfer pricing outcomes are in line with value creation (other high-risk transactions) (11) establish methodologies to collect and analyse data on BEPS and the actions to address it (12) require taxpayers to disclose their aggressive tax planning arrangements (13) re-examine transfer pricing documentation (14) make dispute resolution mechanisms more effective (15) develop a multi- lateral instrument 3.OECD action plan on BEPS (19/07/2013) - 15 actions -

16. 19.09.2013 | Prof. Dr. Wolfgang Kessler 16 Action 1: address the tax challenges of the digital economy  expected output:  report identifying the main difficulties that the economy poses for the application of existing international tax rules  development of detailed options to address these difficulties  object of investigation:  companies with a significant digital presence in the economy of another country without being liable to taxation (no nexus)  attribution of value for digital products and services and characterization of income of these digital products and services  application of related source rules  ensure the effective collection of VAT/GST with respect to the cross- border supply of digital goods and services  implications for the tax structures of Google & Apple:  possibly non-resident tax liability in EU via the fiction of a (virtual) PE  possibly tax residency of the „ghost“ companies in the USA or in Ireland  global formulary apportionment? 4.Implications of the OECD measures (1/5) - actions -

17. 19.09.2013 | Prof. Dr. Wolfgang Kessler 17 Action 3: strengthen CFC rules  expected output:  recommendations regarding the design of domestic rules  object of investigation:  design of rules for controlled foreign companies  implications for the tax structures of Google & Apple:  currently: US CFC taxation is avoided via check-the-box-election  in theory the CFC taxation in the USA could be strengthened so that CFC legislation would work properly  companies which are resident in EU member states: no relevance due to the judgments of the ECJ (Cadbury Schweppes), if the subsidiary has substance (not fully artificial)  thus CFC legislation is in fact a phase-out model 4.Implications of the OECD measures (2/5) - actions -

18. 19.09.2013 | Prof. Dr. Wolfgang Kessler 18 Action 5: counter harmful tax practices more effectively, taking into account transparency and substance  expected output:  finalized review of member countries’ regimes  revision of existing criteria  object of investigation:  revamping the work on harmful tax practices with a priority on improving transparency (including compulsory spontaneous exchange on rulings related to preferential regimes)  requirement of a substantial activity for any preferential regime  implications for the tax structures of Google & Apple:  no rulings for conduit companies in the Netherlands  no special tax rates for IP companies (IE) or IP-boxes (NL, Lux, UK)  no preferential tax regimes for artificial holding companies 4.Implications of the OECD measures (2/5) - actions -

19. 19.09.2013 | Prof. Dr. Wolfgang Kessler 19 Action 7: prevent the artificial avoidance of permanent establishment status  expected output:  changes to the OECD Model Commentary and Tax Convention  recommendations regarding the design of domestic rules  object of investigation:  prevention of the artificial avoidance of the PE status – e.g. commissionaire arrangements and specific activity exemptions  implications for the tax structures of Google & Apple:  currently: non-taxable direct business activities in EU member states  in the future: non-resident tax liability in EU member states via a sales agent PE, no exemption for facilities solely for the purpose of storage, display … and activities of preparatory or auxiliary character (Art. 5 P 4) 4.Implications of the OECD measures (3/5) - actions -

20. 19.09.2013 | Prof. Dr. Wolfgang Kessler 20 Action 8: assure that transfer pricing outcomes are in line with value creation (intangibles)  expected output:  changes to the Transfer Pricing Guidelines (WP6 discussion draft on intangibles)  changes to the Model Tax Convention  object of investigation:  broad and clearly delineated definition of intangibles  appropriate allocation of the profits associated with the transfer and use of intangibles (in accordance with the creation of economic value)  development of TP rules for transfers of hard-to-value intangibles  updating the guidance on cost contribution arrangements  implications for the tax structures of Google & Apple:  preventing a tax-free transfer of intangible assets from the USA to a tax haven 4.Implications of the OECD measures (4/5) - actions -

21. 19.09.2013 | Prof. Dr. Wolfgang Kessler 21 missing measures  Coordination of tax residency of corporations  place of incorporation vs.  place of (effective) management (  daily business) vs.  place of management (  strategic decisions)  OECD Discussion paper: The Impact of the Communications Revolution on the Application of “Place of Effective Management” as a Tie Breaker Rule (2001)  withholding tax on interest and royalties (for non-EU countries!)  alternative taxation concepts  global formulary apportionment  full inclusion system 4.Implications of the OECD measures (5/5) - actions -

22. 19.09.2013 | Prof. Dr. Wolfgang Kessler 22 Conclusions Controversial and open-ended project due to the clash of interests / distortion of competition  biggest problems in USA, massive export subsidy and offshore dilemma  while Germany is a model student who does even more than enough – earning stripping rule, taxation at „transferring“ and transfer of functions, strength CFC taxation, treaty override, intentional double taxation, …  CH, NL, Lux, UK, … are juvenile delinquents due to their preferential regimes E-Commerce discussion: New Wine into Old Wineskins Possible improvements:  country-by-country-reporting  abolition of preferential regimes („level playing field“)  revised version of Art. 5 P 4 OECD Model Tax Convention  tie-breaker rule for anti-avoidance measures  fundamental US tax reform Worst case scenario:  massive treaty override, massive double taxation, endless TP disputes, …

23. 19.09.2013 | Prof. Dr. Wolfgang Kessler 23 Thank You for Your Attention!