Direct Tax

Sustained progress demonstrated in the latest OECD peer review results on the prevention of tax treaty shopping

Excerpts from oecd.org, 21 March 2023

Members of the OECD/G20 Inclusive Framework on BEPS continue to make significant progress in implementating the BEPS package to tackle international tax avoidance. The OECD releases the latest peer review results assessing the actions taken by jurisdictions to prevent tax treaty shopping and other forms of treaty abuse under Action 6 of the OECD/G20 BEPS Project.

The Fifth Peer Review Report on Treaty Shopping, which includes data on tax treaties concluded by the jurisdictions that were members of the OECD/ G20 Inclusive Framework on BEPS on 31 May 2022, forms the basis of the assessment of the implementation of the BEPS Action 6 minimum standard.

The report reveals that members of the OECD/G20 Inclusive Framework on BEPS respect their commitment to implementing the minimum standard on treaty shopping. It further confirms the importance of the BEPS Multilateral Instrument (MLI) as the tool used by the vast majority of jurisdictions that have started implementing the BEPS Action 6 minimum standard.

The MLI has continued to significantly expand the implementation of the minimum standard for the jurisdictions that have ratified it. The impact and coverage of the MLI are expected to continue to increase as jurisdictions complete their ratifications and as other jurisdictions with large tax treaty networks prepare to join it. To date, the MLI covers 100 jurisdictions and around 1850 bilateral tax treaties.

As one of the four minimum standards, the BEPS Action 6 minimum standard identified treaty abuse, particularly treaty shopping, as one of the principal sources of BEPS concerns. Treaty shopping typically involves the attempt by a person to indirectly access the benefits of a tax agreement between two jurisdictions without being a resident of one of those jurisdictions. To address this issue, all members of the OECD/G20 Inclusive Framework on BEPS have committed to implementing the BEPS Action 6 minimum standard and participate in annual peer reviews to monitor its accurate implementation.

Transfer Pricing

Australia - Aligning the thin capitalization rules with the OECD’s best practice guidance

Excerpts from oecd.org, 21 March 2023

“Thin capitalization” refers to the situation in which a company is financed through a relatively high level of debt compared to equity. Thinly capitalized companies are sometimes referred to as “highly leveraged” or “highly geared”. Thin capitalization rules limit the amount of debt for which a foreign-owned subsidiary can claim deductions for interest paid. In order to strengthen the interest limitation (thin capitalization) rules, the Federal Government incorporated the proposed changes in the legislation to apply for income years beginning on or after 1 July 2023. The amendments focus on replacing the current asset-based rules with debt deductions based on ‘Tax Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA)’ for general class investors (i.e., all entities except for financial entities and Authorised Deposit-taking institution (ADIs)).

Existing rules

The existing rules included (i) Safe Harbour test, where the entity is allowed to have debt up to 60% of the book value of a company’s Australian assets (or a debt-to-equity ratio of 1.5:1) (ii) the worldwide gearing test where the entity is allowed debt to the extent of the level of gearing7 in its worldwide Group and (iii) Arm’s length debt test (ALDT) where the entity can claim interest deductions to the extent of debt the third-party lender is willing to provide basis certain assumptions.

The new tests were introduced, replacing the existing tests applicable to general-class investors. However, the financial institutions would still be able to apply the existing Safe Harbour and worldwide gearing tests.

The new rules introduced under the thin capitalization regime include:

Fixed Ratio Test (FRT)

(replacing existing Safe Harbour test) limits the interest deduction to 30% of EBITDA and allows carry-forward of denied deductions up to 15 years subject to fulfillment of the Continuity of ownership test (COT) test (i.e., maintaining the same majority owners).

Group Ratio Test (GRT)

(replacing the existing worldwide gearing test) is applicable to an entity that is a member of the GR Group8 and the EBITDA of the GR Group for the period is not less than zero. Thus, the GRT is relevant to the highly leveraged Group that allows claiming debt-related deductions to the extent of the worldwide Group’s net interest expense as a share of earnings. However, unlike the FRT there is no provision to carry forward denied deductions in the GRT.

External third-party debt test

(replacing ALDT) disallows debt deductions to the extent they exceed the entity’s debt deductions attributable to external third-party debt satisfying conditions as elaborated below:

  • Debt interest is not issued or held at any time in the income year by an associate entity9 of the issuing entity;
  • The holder of debt interest has recourse for the payment of the debt only to the assets of the entity; and
  • The proceeds of issuing the debt interest are used wholly to fund:
    • investments relating to assets attributable to entity’s Permanent Establishment (PE) or the entity holds to produce assessable income;
    • its Australian operations

Furthermore, debt interest issued by associate entities to conduit financer (commercial arrangements allowing one entity in a Group to raise funds on behalf of other entities in the Group) can apply external third-party debt test if it fulfills the additional rules as below:

  • Conduit financer financed amount loaned under the relevant debt interest only with proceeds from another debt interest (the ultimate debt interest).
  • Conduit financer issued the ultimate debt interest to another entity (the ultimate lender).
  • Ultimate debt interest satisfies external third-party debt conditions in relation to any income year.
  • The terms of the relevant debt interest are the same as the terms of the ultimate debt interest (other than terms as to the amount of the debt, the conduit financer may on-lend the funds across a number of borrowers in the Group).
  • The ultimate lender has recourse for the payment of the ultimate debt interest only to the assets of the ultimate borrowers and each asset of the conduit financer that is a relevant debt interest; and
  • An irrevocable choice has been made, in the approved form, by the conduit financer and ultimate borrowers.

The FRT is the default test applicable to general class investors, though the option is available for the entity for the income year to choose either GRT or a third-party debt test. However, there is no provision for revoking the test choice during the income year. Also, in case of a change in the test from FRT to the other alternative, the taxpayer losses its ability to carry forward denied deductions.

In addition to the above, there were other few amendments introduced, such as:

  • The definition of ‘debt deductions’ amended to include interest and amounts economically equivalent to interest (though they not be necessarily incurred in relation to the debt interest issued by the entity).
  • Interest expenses incurred to derive foreign equity distributions, which are Non-assessable non-exempt (Income that is not assessed and no taxes are paid) NANE be considered disallowed expenses.
  • The definition of the associate entity was amended to exclude the trustee of a complying superannuation entity (other than a self-managed superannuation fund).

The exemption from the thin capitalization rules is intact in the new legislation, which applies to entities where the total debt deductions of an entity and all its associate entities for an income year do not exceed USD 2 million and where the average Australian assets of the entity and its associates (in case of outward investing entities) represent, in the aggregate, at least 90% of the average total assets.

The change in the thin capitalization rules does not give relief from transfer pricing rules to the taxpayers’ associate entity debt under the Act, even though they are subject to the thin capitalization rules. In addition to determining arm’s length conditions for the interest rate, the general class investors would also be required to ascertain the arm’s length quantum of debt under the fixed ratio or the Group ratio rules.

7. Ratio of worldwide debt interests issued by Australian entity and its Australian controlled foreign entities, other than debt interests issued to each other to worldwide equity capital of the Australian entity and its Australian controlled foreign entities, other than equity interest held in each other.
8. Worldwide parent entity and all other entities whose accounts are consolidated in the parent’s audited consolidated financial statements
9. Thin Capitalization Control interest in an entity is 10% or more

Indirect Tax

Dubai reinstates former customs duty threshold for import consignments

Excerpts from khaleejtimes.com

Dubai has reinstated the previous threshold of AED 1000 for the exemption of parcels and shipments w.e.f. 1 March 2023. Earlier, this threshold had been reduced to AED 300.

Italy’s tax reforms may consolidate 3 reduced rates to 2

Excerpts from vatcalc.com

As part of the tax reforms announced by the Council of Minister, the reduced VAT rates of 4% and 5% in Italy could be consolidated.

UK’s Plastic Packaging Tax rate hiked to GBP 210.82 per tonne from 1 April 2023

Excerpts from gov.uk

The rate of Plastic Packaging Tax has increased from GBP 200 per tonne to GBP 210.82 per tonne from 1 April 2023. Accordingly, businesses must register for said tax if they:

  • expect to import into the UK or manufacture in the UK 10 tonnes or more of finished plastic packaging components in the next 30 days.
  • have imported into the UK or manufactured in the UK 10 tonnes or more of finished plastic packaging components in the last 12 months.

South Dakota Governor approves 4-year cut in sales tax rate (gross receipts tax) from 4.5% to 4.2%

Experts from vatcalc.com

The reduction, effective from 1 July 2023 until 30 June 2027, is to help alleviate the effect of recent inflation and was signed off by the state Governor, Kristi Noem, on 21 March 2022. The Governor had been insisting on an exemption for groceries - but abandoned this demand.

Tax Street March 2023