David Rosenbloom Comments on OECD's BEPS Proposals in Europe
Excerpt taken from the article "New Analysis: Is Europe Ready for BEPS" by Lee A. Sheppard for Tax Notes Today.
Apropos of accounting, H. David Rosenbloom of Caplin & Drysdale Chtd. argued that financial accounting is correct to ignore intragroup debt. "We're just playing games," he said. "The underlying problem is our religious worship of the individual entity. Intercompany debt does not exist. It's a unicorn. Accountants recognize that."
"We're telling a country to tax what it doesn't want to tax: 'You limit the deduction,'" Brauner said. Rosenbloom concurred that a country might not want to act to limit or eliminate interest deductions just because the OECD said so, belittling the latter's perceived power of peer pressure. Both agreed that a lack of consensus would doom interest limitations. Australia has let it be known that it will not enact new interest limitations, but it does apply transfer pricing rules to interest deductions.
"There's a fundamental assumption the income must be taxed once somewhere in the world. That didn't come down from the heavens," said Rosenbloom. "There isn't something called the world tax system," he said, calling the BEPS effort quixotic. He argues that a solid set of interest deduction limitations could take the place of anti-hybrid rules.
"I wonder if you would need this entire action item if you had appropriate limits on interest deductibility," said Rosenbloom.
U.S. law tolerates hybrids not limited to checked entities, Rosenbloom explained. There are dual-resident companies covered by specific rules for losses. There are repos, which the Anglo-Saxon world treats as secured financing. There are U.S. debt classification rules enshrined in common law, which treat perpetual debt -- a favorite of Europeans -- as equity.
The United States isn't going back on any of these characterizations, Rosenbloom maintained. Moreover, mandatory arbitration under treaties cannot sort out these differences because they are not treaty problems, he added. They are domestic law problems. Much desired by multinationals, mandatory arbitration is not a catchall equitable forum for all business tax problems encountered in host countries.
There are treaty problems, Rosenbloom explained. The United States put a transparency clause into article 1, paragraph 6 of its model treaty and paragraph 8.8 of OECD model commentary on article 4 by means of the 1999 OECD report "The Application of the OECD Model Tax Convention to Partnerships." Article 1, paragraph 6 of the U.S. model treaty states:
It is a residence country concept, Rosenbloom explained. So far so good. But the source country concepts propounded by the BEPS drafters in the hybrid mismatches discussion draft clash with that concept. Rosenbloom posited the common situation in which a third-country hybrid intermediary company stands between the investors and the host country. The U.S. derivation concept would say the investors should get treaty benefits. The beneficial ownership concept would say that the intermediary company is not entitled to treaty benefits because it is not the owner of the income item http://www.oecd.org/tax/treaties/47643872.pdf).
Then there's the imported mismatch rule, a linking rule intended to prevent leakage of the basic rules when European tax havens inevitably fail to act. It would deny a payer deduction in a third country when a hybrid was combined with back-to-back lending. It would preserve the hybrid taint for an affected third country when the first two countries have not adopted anti-hybrid rules. Rosenbloom complained that it would affect group finance companies with cash pooling arrangements. (Prior analysis: Tax Notes, Aug. 18, 2014, p. 819 .)
Rosenbloom's argument points out an interesting aspect of the BEPS action 2 hybrid mismatches draft. The Europeans got into the troubles they're in by respecting the formal characterization of instruments and entities. If the contract says indenture at the top of the page and has mermaids around the border, it's debt, gosh darn it! The Europeans seem to understand that some of their archaic domestic corporate law characterizations of financial contracts are inconsistent with modern financial practice, but they're going to adhere to them anyway and attack the tax consequences instead.
Rosenbloom concurred with observers who saw the BEPS project as a reinstatement of source country tax jurisdiction. "Action 2 stands for the whole BEPS project. It's the thin end of the wedge," he said. He argued that the United States would be foolish to stick with its existing residence-bound policies. "Our treaty policy needs to be radically changed" in the face of BEPS, he said. (Prior analysis: Tax Notes Int'l, May 25, 2015, p. 759 .)
Ultimately, however, finding a PE may not result in much income being allocated to it and a deduction allocated to the payer, Schön and Rosenbloom agreed. The system hasn't figured out how to deal with risk allocation -- an elusive concept. Schön said that any group member inevitably shares some of the overall risk incurred by the group. Theoretically, arm's-length compensation for the member in question should settle the matter. (Prior analysis: Tax Notes Int'l, July 1, 2013, p. 10 .)
But the point of finding a PE where one might not have existed under previous interpretations is precisely to allocate more income to it. Schön and Rosenbloom did not believe that finding a PE should increase the total group income pot available for allocation among members. On an arm's-length basis, however, a commissionnaire or distributor has to be paid its fee even if the group as a whole is losing money. But the pair wondered what should happen if the arm's-length result was lower than the taxpayer's fee structure.
There are no takers for the U.S. LOB clause, but a walk-through of the BEPS version by William Barker of Penn State Dickinson School of Law demonstrated that the U.S. version could be radically simplified, as Rosenbloom has argued. But simplification is not really the point. In many U.S. treaties, the LOB clause is a vehicle for taking care of important taxpayers for which each side wants special favors. Technically, LOB provisions cover income items, not taxpayers, meaning that some items can be eligible for treaty relief and some cannot.