The EU has already issued several laws to try and hinder tax planning. Officially, its objective was to hinder the big companies’ strategies, but ultimately the reality is that the BEPS project, one of the most ambitious in this sense, also affects small entrepreneurs a lot. For those who don’t know; BEPS stands for “Base Erosion and Profit Shifting”.
As we were saying, the BEPS project also affects small to medium entrepreneurs, so it´s definitely worth dedicating a whole article to help discover how it can affect us and how we can avoid major problems.
Generalities about the EU initiative to help combat tax evasion
The OECD already played a key role in the implementation of the automatic exchange of information, and it was also involved of course in the recent measures carried out by the BEPS project. As the EU is one of the most preferred places to test new initiatives, its to be feared that these regulations could be adopted worldwide in a few years.
In general, it´s about combating the legal practices of tax evasion after bank secrecy has been eliminated through the CRS agreement (Common Reporting Standard). Although the priority of the BEPS project is to help fight against the aggressive tax evasion strategies of multinational groups, they also end up hindering small businesses options.
Above all we must consider the following three pillars.
- Effective taxation: every company must pay taxes where they obtain their profits
- Fiscal transparency: all Member States must ensure “fair” taxation
- Consideration of double taxation agreements: “Punishing” companies with double taxation in the common market is avoided
In addition to combating legal tax sifters, it also tries to go a step further. In 2016 it was expected to resume the initiative already planned in 2007 on CCCTB. This project known as the “Common Consolidated Corporate Tax Base” aims to introduce a common corporate tax to the entire EU, supposedly to help reduce the administrative expenses of international companies.
Despite competition still being possible at a tax level, since it doesn´t intervene in national sovereignty, the possibility of choosing this form of common EU taxation should be offered.
This, of course, would greatly replace the BEPS projects measures discussed here, since a transfer of profits from one country to another in order to save on taxes wouldn´t be possible.
Specific measures to help prevent legal tax evasion
But let’s get back to the BEPS projects current package of measures of the European Commission. This generally addresses the six forms of aggressive tax evasion that it seeks to prevent.
1. International tax laws / CFC rules
What was once only true for the most populated EU countries will soon become the norm across the whole EU. BEPS reports the laws that seek to stop tax evasion through the use of foreign companies. Initially designed to help hinder the transfer of profits from large groups, CFC rules (Controlled Foreign Entities) could also have a significant impact on small businesses.
Therefore, managing foreign or offshore companies, something that up until now was generally legal in many EU countries, would become illegal or at least significantly more difficult to do.
In specific cases, the profits of parent companies that move to countries with little or no taxation will remain taxable. CFC rules are applied when the effective taxation amounts to less than 40% of that of the Member State.
For small owners of offshore companies, this ultimately means that their companies, which are still tax-free, will soon be fully subjected to local corporate and industrial tax, just like in Germany.
The income transferred to the subsidiary is usually passive mobile income, as shown in the popular tax minimization strategies through an IP-Box (intellectual property box).
Until now, a common procedure was to transfer the right of ownership of intangible economic goods (for example, intellectual property rights) within a group first, to the controlled foreign company with few taxes. Then, considerable revenues were transferred in the form of royalties for the use of those economic goods to the controlled foreign company, which is already the owner of those goods and is the one that administers them.
2. Switchover rule
Due to the difficulties associated with the calculation of taxes paid abroad, States are becoming increasingly inclined to exempt foreign income obtained from the country of residence from being taxed.
The negative consequence that the States weren’t counting on is the creation of the incentive that allows tax-free income or income with very low taxes to flow into the common market, insofar as they can circulate (often without taxation) thanks to the tools available in the law of the Union.
BEPS´s switch-over clauses are frequently used to help combat these practices. This means that the income of the entity subject to taxes is taxed (and not exempt), and they also receieve a payment for taxes paid abroad. Thus, companies are prevented from transferring their profits from a region with high taxes to a low-tax region, provided there are no valid economic reasons to do so.
3. Exit tax
Entities subject to taxes try to reduce their tax burden as much as possible by relocating or moving their fiscal domicile and/or assets to regions with reduced taxation. This is completely legitimate and it should be able to be done relatively quickly, as long as local legislation allows it.
If a taxpayer transfers his tax domicile from a member state, that country loses the right to tax the taxpayer’s profits that have already been calculated but have yet to be realized. The same problem arises when the taxpayer withdraws assets that contain unrealized profits (without liquidating them) from a Member State.
The change of address levy (exit tax) is used to avoid the reduction of the tax base in the country of origin if the assets that contain the unrealized profits are withdrawn from that country without a change of ownership. Since the implementation of the change of address tax within the Union must be carried out in accordance with the fundamental freedoms and the jurisprudence of the European Court of Justice, the directive has also included the aspect of European law: the taxpayer is granted the possibility of a postponement or payment of taxes in instalments over a period of a few years.
In addition to the EU, Switzerland is also planning to introduce the change of address tax.
4. Deductibility of interests
Multinational groups often finance companies belonging to groups located in regions of high taxation through loans, causing them to pay “extremely high” interest to subsidiaries in low tax regions.
In this way, the calculation base for group taxation (or of those companies that pay “extremely high” interest) in regions with high taxation is reduced, while in the low tax areas to which the payments flow, it increases. The result is that the calculation base for the taxation of international groups is smaller overall.
The proposed provisions aim to oppose being practical by limiting the amount of interest that the taxpayer can deduct in a fiscal year (interest barrier). It´s hoped that this will also contribute to mitigating the reserves that internal financing arouses.
Net interest expenses will only be deductible up to a fixed rate based on the gross operating profit of the taxpayer.
Since this is minimum protection for the domestic market, the deduction rates maximum limit must be set in the spectrum recommended by the OECD (10% to 30%). Member States can implement stricter rules than those recommended in BEPS.
5. Hybrid structures
Hybrid structures result from differences between two tax systems in the legal classification of payments (financial instruments) or companies. This type of inconsistency often leads to double deduction or to be simultaneously deducted in one country but not in the other.
Taxpayers often take advantage of these inconsistencies between national tax systems -particularly in transnational structures- thus reducing their fiscal debt in the Union.
To help ensure that Member States issue provisions that effectively limit these inconsistencies, the BEPS directive provides that the legal classification of an instrument or a hybrid company of the Member State in which a payment, expenditure or loss originates is recognized by the other Member State affected by this inconsistency.
6. General anti-abuse rules (GAAR)
While tax planning strategies are extraordinarily differentiated, tax law doesn´t tend to develop so quickly in order to foresee all the necessary preventive measures to help control fiscal planning. Therefore, it is useful to have general regulation in a tax system to help avoid abuse; despite the lack of particular rules to help combat tax evasion, this way they can take action against abusive tax practices.
The general provision of the BEPS project fills any of the existing gaps in the special provisions laid down in a country to help avoid abusive tax evasion practices. Therefore, authorities can prevent taxpayers from misusing tax structures.
Despite this regulation already being in force in many countries such as Austria, its still relatively easy to bypass, while real economic interests can be invoked in the country of low taxes.
Further effects of the BEPS project
These, of course, are not all the measures that the BEPS project entails. Thus, for example, they want to force large companies to take greater transparency measures and to take coordinated action against third countries that offer tax conditions that are “too good to be true”. Of course, the latter is quite problematic in the long run.
We´ve already reached the point where most countries in the world have given in to the OECD´s and the EU´s pressure to participate in data exchange and BEPS is undoubtedly a step in the same direction, another form of imperialism trampling on others States´s sovereignty.
It wouldn´t be surprising if the EU soon introduced a blacklist of countries. Depending on the type of “crimes” they were accused of, it could result in heavy penalties.
From a politician’s perspective, BEPS is a problem rather than an advantage for exporting countries like Germany, since the likelihood of double taxation increases. This is something that with Google, Apple and others, which are protected from the US, will not happen, since these companies will be able to find gaps and fiscal opportunities.
You must be careful if you have companies abroad and reside in an EU country, as changes can happen at any time and you would have to pay taxes in your home country.
Thanks to the non-dom programs in Cyprus, the United Kingdom, Malta and Ireland and to the fact that there are still countries in the EU without CFC rules, we still have options in the EU to live without paying hardly any taxes, but who knows for how much longer this will be the case. The BEPS project could end in one fell swoop.
Undoubtedly, if you want to get rid of the weight of the State, the safest and easiest way to do so is to move your residence to outside of the European Union.
If you need help to move your residence, we can help you. Get in touch with us.