Base Erosion and Profit Shifting (BEPS): Explanatory Note and Implications for Nigeria
On 5 October 2015, the Organization for Economic Cooperation and Development (OECD) released the final reports of the Base Erosion and Profit Shifting (BEPS) project. The final package was negotiated by OECD members, the G20 and non-OECD members (including Nigeria) on an equal-footing basis.
The project seeks to fix a global tax system which is believed by some to allow multinational enterprises (MNEs) to reduce their effective tax rate in a jurisdiction without corresponding reduction in value-creating economic activities. The purpose of the BEPS’ Actions is to ‘ensure that profits are taxed where economic activities take place and value is created’. There is concern that the international tax rules that were designed more than a century ago may no longer be adequate to address the current business environment. The BEPS approach focuses on three broad measures:
- Coherence in tax systems globally;
- Economic substance in cross border dealings; and
- Transparency with respect to relevant taxpayers’ data to assist revenue administrations’ tax investigation efforts.
The Actions will be implemented through changes to domestic laws and practices and provisions of tax treaties. The Federal Inland Revenue Service (FIRS) has already incorporated some of the principles in its audit procedure. For instance, the FIRS is scrutinizing transactions between Nigerian subsidiaries and their foreign related parties especially those located in tax-friendly jurisdictions. The aim is to ensure that these entities actually provide the services contracted and are not simply letter-box companies.
This newsletter reviews the BEPS’ Actions and their impact on tax administration in Nigeria:
Addressing the tax challenges of the digital economy:
The emergence of new information technology has significantly altered the way businesses are conducted. Information now flows real time and it is possible for a service provider to operate in a location different from that of the recipient. As a result, tax authorities believe that companies can artificially reduce taxable income or shift profits to low-tax jurisdictions in which little or no economic activity is performed.
The first BEPS’ Action recommends adoption of destination principle for collection of Value Added Tax (VAT). This is to circumvent artificial tax avoidance scheme when the tax is collected at any other point other than the end of the value chain. The other major recommendations aimed to prevent artificial definition of permanent establishment (PE) are discussed under the relevant sections below. OECD expects that the Actions recommended will be helpful in preventing the MNEs from taking advantage of perceived tax loopholes within the digital economy.
Neutralizing the effects of hybrid mismatch arrangements
OECD defined hybrid mismatch as arrangements that ‘exploit differences in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions to achieve double non-taxation, including long-term deferral’. It therefore recommends that countries deny taxpayer’s deduction for a payment to the extent that it is not included in the taxable income of the recipient in the counterparty jurisdiction or it is also deductible in the counterparty jurisdiction.
This may expose profits from related party transactions derived by special purpose vehicles (SPVs) or letterbox companies based in tax-friendly jurisdictions to Nigerian tax. FIRS is currently probing some of these transactions. The Nigerian tax authority may however not be able to penalize any established case of mismatch until the tax laws are amended, unless it can prove that the transactions are artificial.
Designing effective Controlled Foreign Company (CFC) rules:
CFC can simply be described as companies that are incorporated in jurisdictions other than where the companies’ shareholders are based. CFC rules are therefore designed to address the risk that taxpayers with a controlling interest in a foreign subsidiary can strip the base of their country of residence and, in some cases, other countries, by shifting income into a CFC. The rule, once promulgated in a country, will permit the tax authority of the jurisdiction where the shareholders are resident to subject the profit earned by CFC to tax. The tax will be based on the percentage of control or influence. Nigeria does not currently have CFC rules. It is however very likely that the rule will soon be put on the gazette. This may affect some Nigerian conglomerates that currently use SPVs incorporated in tax-friendly jurisdictions as intermediate holding companies (IHCs). The profit earned by the SPVs will be exposed to Nigeria tax if the tax rate in those jurisdictions are much lower.
The impact of BEPS’ Actions cannot be overemphasized. It is expected to impact how businesses are conducted, compliance with tax laws and companies’ final tax liabilities. Most countries will also seize the opportunity provided by the introduction of the BEPS’ Actions to shore up their revenue base. Companies are therefore encouraged to proactively examine the potential gaps that may arise from full implementation of the BEPS’ Actions, perform in-house cleaning and be ready to comply to help mitigate significant tax risk exposures.
Get more details on the BEPS’ Actions and their impact on tax administration in Nigeria by clicking here
For further information, please contact Victor Onyenkpa: NG-FMTAXEnquiries@ng.kpmg.com