Harmful Tax Practices - 2018 Progress Report on Preferential Regimes

Annex A. Output of BEPS Action 5 mandate for considering revisions or additions to FHTP framework

1. Introduction

1.  The 1998 Report on Harmful Tax Competition: An Emerging Global Issue (“the 1998 Report” (OECD, 1998[1]) sets out the framework to identify harmful tax practices, with specific criteria for assessing harmful preferential regimes and for assessing “tax havens” (as they were then called).

2.  The criteria set out in the 1998 Report (OECD, 1998[1]) are still used by the Forum on Harmful Tax Practices (“FHTP”) to determine whether a preferential regime within the scope of the FHTP’s work is potentially harmful. This framework used four key factors and eight other factors. The four key factors were the following:

a) The regime imposes no or low effective tax rates on income from geographically mobile financial and other service activities.

b) The regime is ring-fenced from the domestic economy.

c) The regime lacks transparency (for example, the details of the regime or its application are not apparent, or there is inadequate regulatory supervision or financial disclosure).

d) There is no effective exchange of information with respect to the regime.

3.  The eight other factors were the following:

a) An artificial definition of the tax base.

b) Failure to adhere to international transfer pricing principles.

c) Foreign source income exempt from residence country taxation.

d) Negotiable tax rate or tax base.

e) Existence of secrecy provisions.

f) Access to a wide network of tax treaties.

g) The regime is promoted as a tax minimisation vehicle.

h) The regime encourages operations or arrangements that are purely tax-driven and involve no substantial activities.

4.  The criteria set out in the 1998 Report (OECD, 1998[1]) for assessing no or only nominal tax jurisdictions, a significant part of which is carried out by the Global Forum on Transparency and Exchange of Information for Tax Purposes, is:

a) whether a jurisdiction imposes no or only nominal taxes;

b) lack of effective exchange of information;

c) lack of transparency and

d) the absence of a requirement that the activity be substantial

5.  Action 5 of the BEPS Action Plan committed the FHTP to the following:

“Revamp the work on harmful tax practices with a priority on improving transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, and on requiring substantial activity for any preferential regime. It will take a holistic approach to evaluate preferential tax regimes in the BEPS context. It will engage with non-OECD members on the basis of the existing framework and consider revisions or additions to the existing framework.”

6.  The Action Plan specified that the FHTP would deliver the following three outputs: (i) finalisation of the review of OECD/G20 preferential regimes, (ii) a strategy to expand participation to non-OECD/non-G20 countries, and (iii) consideration of revisions or additions to the existing framework.

7.  As part of the first output, the FHTP elaborated both the substantial activities factor (the eighth other factor) and the transparency factor (the third key factor) over the course of the BEPS Project. The 2015 Final Report for Action 5 (“the 2015 Final Report”) (OECD, 2015[2]) focused primarily on the first output, but the 2015 Final Report (OECD, 2015[2]) also briefly addressed the third output, regarding revision of criteria. The 2015 Final Report (OECD, 2015[2]) stated, “The OECD and G20 countries involved in the FHTP…consider that it is too early to accurately identify areas in which the existing criteria might fall short because the impact of the work on substance and transparency cannot yet be fully evaluated. In addition the benefits of involving third countries in this aspect of the work are recognised (OECD, 2015[2]).1”

8.  The 2015 Final Report (OECD, 2015[2]) then went on to discuss two factors “that could benefit from further consideration once the FHTP is better able to identify the impact of the other outputs considered in the 2015 Final Report (OECD, 2015[2])”: the ring-fencing factor and the factor that focuses on “an artificial definition of the tax base (OECD, 2015[2]).2”

9.  Since the BEPS Action 5 Report (OECD, 2015) was published, the FHTP has discussed various approaches to revising the framework of the 1998 Report (OECD, 1998[1]).

10.  Consensus has been reached in the FHTP on a number of issues, including that it has been agreed to resume the substantial activities factor for no or only nominal tax jurisdictions. Given the speed at which jurisdictions with preferential regimes are making changes to their legal and administrative frameworks governing those regimes, and the importance of a level playing field, the outcome of that work was published immediately after approval, in November 2018. For convenience, it is reproduced herein.

11.  The FHTP also discussed additional issues relating to the scope of its work. This included whether a jurisdiction with a general no or low corporate tax rate could be considered harmful per se (without having regard to any of the other factors). In a similar vein, the FHTP also discussed whether a jurisdiction with a territorial tax system could be considered harmful per se, for example where the design of the source rules may facilitate double non-taxation, and whether territorial tax systems should be included in the scope of the new standard on substantial activities. The FHTP also considered whether its work should include preferential regimes that apply to the taxation of individuals as well as corporate taxation. The FHTP will continue its work on all relevant issues of harmful tax practices, such as the application of the no or low effective tax rate factor and whether further consideration is needed with respect to territorial tax systems, taking into account the ongoing work within the Inclusive Framework, including on the digital economy.

12.  The following table sets out the issues considered and the outcome. The issues are grouped according to: (i) substantive updates to the FHTP framework; and (ii) interpretive guidance on the application of existing factors for assessing regimes. The analysis of each issue is then described in detail below.

Table A.1. Substantive updates to the FHTP Framework

Issue	Outcome
Substantive updates to the FHTP Framework
Updating the key factors in the 1998 Report for assessing regimes.	There are five key factors, including substantial activities as one of the key factors. The factor regarding access to a wide network of tax treaties is no longer useful for assessing regimes. The factor regarding promotion of a regime as a tax minimisation vehicle is no longer useful, in itself, for assessing regimes, although such promotion could prompt inquiry by reference to other factors.
The resumption of the application of the substantial activities factor for assessing no or only nominal tax jurisdictions.	The work on no or only nominal tax jurisdictions should be resumed, and the substantial activities criterion will be applied to those jurisdictions.
Interpretive guidance on the application of existing factors for assessing regimes
The relationship between the key factors for assessing regimes and the other factors.	The other factors do not on their own indicate that a regime is potentially harmful, but provide evidence that one or more of the key factors may be met.
Whether other peer reviews related to transparency and exchange of information should inform the factors related to transparency and exchange of information.	To the extent that peer review results on the Action 5 transparency framework are relevant to the concerns underlying the transparency factor, they should be taken into account, but should not be determinative. The FHTP’s transparency factor should not be modified to consider Global Forum peer review results regarding transparency. When assessing regimes under the exchange of information factor, the FHTP should consider Global Forum peer review results where relevant.
Whether the ring-fencing factor should be interpreted to include “de facto ring-fencing”.	The ring fencing factor should not be modified to consider de facto ring-fencing, pursuant to which a preferential regime could be found to be ring-fenced due to a relatively small number of resident investors or beneficiaries in the regime even when the jurisdiction has no legal, administrative, or other implicit barriers to domestic investment.
Interpretation of ring-fencing considerations related to regimes that apply to transactions in foreign currency	A regime that only applies to transactions undertaken in foreign currency may not be considered ring-fenced if the regime otherwise permits residents to access the regime, the foreign currency in question is available to residents, is used as an alternative functional currency in the jurisdiction providing the regime and there are no exchange controls or other legal or practical limits that prevent resident taxpayers from entering into transactions in the currency that would qualify them for benefits under the regime.

2. Substantive updates to the FHTP framework

2.1. Updating the factors in the 1998 Report for assessing regimes

13.  As noted above, the 1998 Report (OECD, 1998[1]) contained four key factors, and eight other factors when reviewing preferential regimes. As part of the BEPS Project, two of the existing twelve factors were elaborated: the transparency factor (resulting in the minimum standard on compulsory spontaneous exchange of information on rulings) and the substantial activities factor. Given these changes, together with the experience gained in reviewing regimes in practice and other outcomes of the BEPS project, it was appropriate to reconsider some of the existing “other factors” and whether they were needed as separate elements.

14.  The role and relevance of three of the “other factors” contained in the 1998 Report (OECD, 1998[1]) have been considered: substantial activities; access to a wide network of tax treaties; and promotion of the regime as a tax minimisation vehicle.

15.  First, as part of the BEPS Project, the FHTP elevated the substantial activities factor. As such, the substantial activities factor has been elevated from being an “other factor” to a “key factor.” In the context of IP regimes (which include any regime that provides benefits to income from any type of IP asset), this factor mandates that jurisdictions must provide no more benefits than those permitted under the nexus approach (OECD, 2015[2]).3 In the context of non-IP regimes, the FHTP requires substantial activities whereby (1) jurisdictions must require core income generating activities to be performed and establish mechanisms to review compliance with this requirement, and (2) the FHTP will monitor the jurisdiction’s effective implementation of the substantial activities requirement. In terms of the activities that jurisdictions must require, the FHTP agreed that jurisdictions must require taxpayers to have an adequate number of full-time employees with necessary qualifications and to incur an adequate amount of operating expenditures to undertake the core income-generating activities associated with the income that may benefit from a regime (OECD, 2017[3]).4

16.  Second, the factor relating to access to a wide network of tax treaties for assessing regimes was originally intended to prevent tax treaty abuse, but this factor does not in practice have any effect on tax treaty abuse. Furthermore, BEPS Action 6 has eliminated the need for this factor, given that it is one of the of BEPS minimum standards being implemented by members of the Inclusive Framework, and which is subject to a peer review. It was therefore concluded that this factor was no longer useful for assessing preferential regimes.

17.  Third, the factor relating to the regime being promoted as a tax minimisation vehicle is difficult to apply in practice. For example, ministerial publicity could rise to the level of government promotion in the eyes of some observers and not in the eyes of others. In addition, the use of this factor to assess a particular regime as harmful is difficult given that most jurisdictions promote their regimes in order to encourage the use of such regime, and determining whether such promotion was harmful in one case as opposed to another would be difficult and not likely to advance the discussion. It was concluded that this factor was no longer sufficiently useful, in itself, as a secondary factor, but that such promotion could prompt inquiry by reference to other factors.

18.  Given these changes, there are now five key factors for assessing regimes:

(i) The regime imposes no or low effective tax rates on income from geographically mobile financial and other service activities.

(ii) The regime is ring-fenced from the domestic economy.

(iii) The regime lacks transparency.

(iv) There is no effective exchange of information with respect to the regime.

(v) The regime fails to require substantial activities.5

19.  The secondary factors are:

(i) An artificial definition of the tax base.

(ii) Failure to adhere to international transfer pricing principles.

(iii) Foreign source income exempt from residence country taxation.

(iv) Negotiable tax rate or tax base.

(v) Existence of secrecy provisions.

2.2. Resumption of application of substantial activities factor to no or only nominal tax jurisdictions

Introduction

20.  The 1998 Report (OECD, 1998[1]) sets out a framework for approaching the problem of how certain no or only nominal tax jurisdictions (“tax havens” as they were then referred to in the 1998 Report (OECD, 1998[1]) and harmful preferential tax regimes “affect the location of financial and other service activities, erode the tax bases of other countries, distort trade and investment patterns and undermine the fairness, neutrality and broad social acceptance of tax systems (OECD, 1998[1]).6” The 1998 Report (OECD, 1998[1]) referred to certain no or only nominal tax jurisdictions and harmful preferential regimes collectively as “harmful tax practices,” (although each discipline is mutually exclusive) and built a framework for how to assess these practices. There was a need to include both aspects of these practices, in order to deliver a level playing field between jurisdictions in a context where taxpayers can easily relocate their mobile activities in response to tax considerations.

21.  Given the elevation of the substantial activities requirement in the work on preferential regimes as part of the BEPS Project, it was appropriate to resume the application of the substantial activities requirement set out in the 1998 Report (OECD, 1998[1]) for no or only nominal tax jurisdictions and provide guidance on the application of the requirement.

Background

22.  The framework of the 1998 Report (OECD, 1998[1]) used for assessing preferential regimes used four key factors and eight other factors. The four key factors set out in the 1998 Report (OECD, 1998[1]) are the following:

a) The regime imposes no or low effective tax rates on income from geographically mobile financial and other service activities.

b) The regime is ring-fenced from the domestic economy.

c) The regime lacks transparency (for example, the details of the regime or its application are not apparent, or there is inadequate regulatory supervision or financial disclosure).

d) There is no effective exchange of information with respect to the regime.

23.  The corresponding framework for assessing whether a jurisdiction was a “tax haven” is based on four criteria: (a) whether a jurisdiction imposes no or only nominal taxes; (b) lack of effective exchange of information; (c) lack of transparency and (d) the absence of a requirement that the activity be substantial (OECD, 1998[1]).7

24.  With regard to the substantial activities factor, the 1998 Report (OECD, 1998[1]) noted that “the absence of a requirement that the activity be substantial is important because it suggests that a jurisdiction may be attempting to attract investment and transactions that are purely tax driven. It may also indicate that a jurisdiction does not (or cannot) provide a legal or commercial environment or offer any economic advantages that would attract substantive business activities in the absence of the tax minimising opportunities it provides (OECD, 1998[1]).8” Notably, this is essentially the same rationale as applies in the case of preferential regimes.

25.  However, in 2001 the FHTP decided to only seek commitments and to determine whether or not a jurisdiction was considered uncooperative on the basis of the first three criteria.9 This was followed by the release in 2002 of a list of uncooperative jurisdictions based on the first three criteria. The fourth criterion on substantial activities remained within the analytical framework of the work, but had no practical application.

26.  Subsequently, the Global Forum on Transparency and Exchange of Information for Tax Purposes grew out of the FHTP and took on the work on transparency and exchange of information, without distinction on the basis of tax rates or tax systems and with all jurisdictions participating on an equal basis. These developments meant that the FHTP’s work then focussed on preferential regimes rather than no or only nominal tax jurisdictions.

27.  Therefore, until the BEPS Project, both of the frameworks in the 1998 Report (OECD, 1998[1]) (i.e., those on no or only nominal tax jurisdictions and on preferential regimes) included a criterion based on substantial activities, but in neither case was it in itself applied as a decisive factor for identifying, and eliminating, harmful tax practices.

28.  This changed with the creation of the BEPS Action Plan, which elevated the substantial activities requirement as it applied to preferential regimes, and the Inclusive Framework subsequently agreed guidance on what is required to meet this criterion10 (OECD, 2017[3]). It is now an essential requirement, and without meeting this criterion a preferential regime that meets the gateway criterion and is within scope will be found to be potentially harmful. This now applies across the membership of the Inclusive Framework, which has grown to over 125 jurisdictions, and is a global standard.

29.  However, this leaves the analytical framework underlying the BEPS Action 5 work exposed to a potential incoherence: the substantial activities criterion has now been elevated as a key factor in one pillar of the work and is being applied, whereas it is not being applied in the other pillar of the work despite having been included as a key factor in the 1998 Report (OECD, 1998[1]) in that context.

30.  It also leaves the Inclusive Framework in a situation where, in elevating the substantial activities criteria for preferential regimes only, it has created a perceived level playing field issue. The specific concern that has been raised is that business could simply relocate to a no or only nominal tax jurisdiction to avoid having to meet the substance requirements that apply to preferential tax regimes. For example, some Inclusive Framework members which have a corporate income tax system offer international business company regimes, and these jurisdictions have been assessed and committed to amend or abolish the regimes. If the regime is being amended, this includes the addition of substantial activities requirements. At the same time, similar international business company laws apply in no or only nominal tax jurisdictions, but based on the current application of the criteria, the Inclusive Framework would not ask for the same amendments or abolition of the corresponding legislation. It has been argued that this may even increase the pressure on taxing jurisdictions with low rates of corporate income tax to consider abolishing them – possibly triggering a race to the bottom that the FHTP was created to address.

31.  It was agreed to address this potential incoherence and address the perceived challenge to the level playing field, by drawing on the existing guidance agreed by the Inclusive Framework on the substantial activities factor that applies for preferential regimes. This would hold similar mobile business activities to a similar standard, irrespective of whether they are taxed under a preferential regime or a no or nominal tax rate.

32.  The resumption of the application of the substantial activities factor for assessing no or only nominal tax jurisdictions would address the particular level playing field challenges that have been raised, and recognise the particular risks that such jurisdictions create in attracting income without substantial local activities.

33.  However, this does not suggest that the absence of a corporate tax rate, or any particular level of corporate income tax is in itself harmful. This is analogous to the analytical framework for preferential regimes where the no or low effective tax rates criterion is a gateway criterion for the analysis of preferential regimes, but not in and of itself a harmful feature.

Translating the substantial activities requirements to a no or only nominal tax jurisdiction

Scope

34.  In order to translate the FHTP guidance on substantial activities to a no or only nominal tax jurisdiction, the starting point is to identify the jurisdictions to which it would apply. It would apply to jurisdictions which do not impose a corporate income tax. It would also apply to jurisdictions which impose only nominal corporate income tax to avoid the requirements.11 It would not apply to jurisdictions which have been reviewed on the basis of the preferential regimes they offer (unless they subsequently significantly undertook reforms which abolished or substantially abolished their corporate income tax altogether).

35.  The next step is to identify the type of activities that are within the scope of the 1998 Report (OECD, 1998[1]). These are geographically mobile activities, such as financial and other service activities, including the provision of intangibles. The FHTP has typically identified these types of mobile activities as falling into the categories of headquarters, distribution centres, service centres, financing, leasing, fund management, banking, insurance, shipping, holding companies and the provision of intangibles.

36.  In respect of those activities, substantial activities requirements apply. The FHTP’s guidance on substantial activities falls into two basic categories: activities earning non-IP income (which is set out in Annex D of the 2017 Progress Report (OECD, 2017[3])), and activities for the exploitation of IP assets (which is the nexus approach set out in the Action 5 Report (OECD, 2015[2])).

Non-IP income

37.  For activities within scope earning non-IP income, this would mean that the no or only nominal tax jurisdiction would be required to meet the same substantial activities criterion (OECD, 2017[3]);,12 meaning that it would need to introduce laws to (i) define the core income generating activities for each relevant business sector; (ii) ensure that core income generating activities relevant to the type of activity are undertaken by the entity (or are undertaken in the jurisdiction); (iii) require the entity to have an adequate number of full-time employees with necessary qualifications and incurring an adequate amount of operating expenditures to undertake such activities; and (iv) have a transparent mechanism to ensure compliance and provide an effective enforcement mechanism if these core income generating activities are not undertaken by the entity or do not occur within the jurisdiction.

38.  In order to implement these requirements in a context where there may be no corporate income tax that can be levied, and in some cases, no tax administration, a jurisdiction would need to implement rules that translate those requirements within the context of its legal and regulatory framework. Legislation may, for instance, be included in the financial services regulatory framework or the company incorporation framework.

IP income

39.  Where the business activities are the exploitation of IP assets, the substance requirements used by the FHTP are the “nexus approach”. The nexus approach is essentially comprised of two elements: a first part which sets out a formula to determine the amount of eligible income which can benefit from a lower tax rate, and a second part which is a consequence for the non-eligible income which is then taxed at the normal (higher) tax rate. For a no or only nominal tax jurisdiction, the challenge is that even though the formula could be applied (the result of which might be that there is zero eligible income), it is unclear how to apply the second part.

40.  In other words, the nexus approach would clearly not function as intended because it is designed to operate within the context of a corporate income tax system. In such a system, the consequence of a taxpayer having income which does not qualify under the nexus formula (e.g. income earned from trademarks, or income earned where the IP has been acquired rather than developed by the entity) is the application of ordinary (non‑preferential) corporate income tax rates to such income. This cannot translate by analogy to no or only nominal tax jurisdictions as there is no corporate income tax to impose.

41.  In order to translate the principle underlying the nexus approach to no or only nominal tax jurisdictions and deliver a level playing field, the best way forward is to apply a similar concept as applies for non-IP income, which is the core income generating activities guidance.

42.  At the outset, in all cases, the substantial activities requirements for IP income would always be insufficient if the entity only passively held IP assets which had been created and exploited on the basis of decisions made and activities performed outside of the jurisdiction. Similarly, the test would never be met if the only activities contributing to the income were the periodic decisions of non-resident board members in the jurisdiction.

IP income – patents and similar assets

43.  This would mean that if an entity is earning income from exploiting a patent (or similar IP assets as defined in paragraphs 34 – 37 of the Action 5 Report (OECD, 2015[2])), the entity should demonstrate that it has conducted the core income generating activities with the adequate number of qualified full-time employees and adequate amount of operating expenditures. The core income generating activities in this context would be conducting research and development (rather than simply acquiring or outsourcing it), which reflects the same concept as the nexus approach.

IP income – marketing intangibles

44.  An adjustment would be needed from the nexus approach where an entity is exploiting marketing IP assets such as trademarks.13 The nexus approach provides that this type of IP asset is not permitted to benefit from a preferential regime, given that the policy rationale of an IP regime is to encourage and reward scientific innovation rather than marketing activity, with the consequence that a taxpayer engaged in exploiting marketing intangibles is required to pay tax at the ordinary rate. However, in the context of a no or only nominal tax jurisdiction, there is no (or no significant) “ordinary” tax to apply. An analogous approach would be to apply a similar substantial activities principle as set out in the preceding paragraph, where the core income generating activities are branding, marketing, and distribution.

IP income – exceptional cases and rebuttable presumption

45.  It is possible that an entity exploiting IP assets in a no or only nominal tax jurisdiction could in fact be conducting substantial activities, even if this did not involve research and development (for patents and similar assets) or branding, marketing and distribution (for marketing IP assets). Although such situations should be the exception rather than the rule, there may be some situations where it will be appropriate to give the entity some flexibility to demonstrate that it is performing the core income generating activities with the adequate number of qualified full-time employees and adequate amount of operating expenditures. Such activities could include conducting the strategic decision-making, managing and bearing the principal risks relating to the development and subsequent exploitation of the IP asset, or carrying on the underlying trading activities through which the asset is exploited.

46.  However, as the absence of substantial activities in the form of research and development, or marketing, branding, and distribution (as the case may be depending on the type of IP asset) creates additional risks, the ability to conduct other types of activities and still meet the substantial activities test should be prima facie excluded for higher risk scenarios.

47.  Higher risk scenarios would be cases where (i) the entity has acquired the IP asset from related parties or through the entity funding research and development activities which took place outside the no or only nominal tax jurisdiction; and (ii) the IP asset is licensed or sold to related parties, or the exploitation is conducted by related parties outside the jurisdiction (e.g. foreign related parties are paid to develop and sell a product in which the intangible asset is embedded).

48.  In these higher risk scenarios, there should be a “rebuttable presumption” that the substantial activities test is not met in the absence of research and development (for patent and similar IP assets), or in the absence of marketing, branding, and distribution (for marketing intangibles). This would be the case notwithstanding that a transfer pricing analysis would allocate some profits to the entity.

49.  However, similar to the rebuttable presumption created in BEPS Action 5 in the context of the nexus approach, a company in a higher risk scenario could rebut the presumption, by providing evidence that the income generated is directly linked to activities undertaken in the local jurisdiction rather than in a foreign jurisdiction.

50.  Given the risks, this would need to be a high evidential threshold. Entities would need to provide evidence that there was, and historically has been, a high degree of control over the development, enhancement, maintenance, protection and exploitation of the intangible asset, exercised by an adequate number of full-time employees with the necessary qualifications that permanently reside and perform their activities within the jurisdiction. This would need to be demonstrated by providing additional information including:

• detailed business plans which demonstrate the commercial rationale for holding the IP assets in the jurisdiction;

• employee information, including level of experience, type of contracts, qualifications, and duration of employment; and

• evidence that decision making is taking place within the jurisdiction, rather than periodic decisions of non-resident board members.

51.  In keeping with the agreed approach for certain aspects of the nexus approach, this rebuttable presumption would be subject to a review by the FHTP no later than 2020.

52.  A graphic providing an overview of the requirements as they apply for IP income is included in Table A.2.

Table A.2. Application of substance requirements for IP income

Lower risk scenarios

Higher risk scenarios (i.e. involvement of foreign related parties)

1. IP assets (e.g. patents) Substantial activity = R&D

+

Necessary staff, premises, equipment, expenditure, decision-making etc.

+

Filing information Type A. Business type, gross income, expenses and assets, premises, employees, proof of core income generating activities, etc.

=

✓

1. IP assets (e.g. patents) Substantial activity = R&D

+

Necessary staff, premises, equipment, expenditure, decision-making etc.

+

Filing information Type A. Business type, gross income, expenses and assets, premises, employees, proof of core income generating activities, etc.

=

✓

2. Marketing assets (e.g. trademarks) Substantial activity = branding, marketing and distribution

+

Necessary staff, premises, equipment, expenditure, decision-making etc.

+

Filing information Type A. Business type, gross income, expenses and assets, premises, employees, proof of core income generating activities, etc.

=

✓

2. Marketing assets (e.g. trademarks) Substantial activity = branding, marketing and distribution

+

Necessary staff, premises, equipment, expenditure, decision-making etc.

+

Filing information Type A. Business type, gross income, expenses and assets, premises, employees, proof of core income generating activities, etc.

=

✓

3. Other Core Income Generating Activities (CIGA) Substantial activity = Strategic decision-making, managing and bearing principal risks, underlying trading activities, etc.

+

Necessary staff, premises, equipment, expenditure, decision-making etc.

+

Filing information Type A. Business type, gross income, expenses and assets, premises, employees, proof of core income generating activities, etc.

=

✓

3. Other Core Income Generating Activities (CIGA) Substantial activity = - High degree of DEMPE; and - Historical DEMPE; and - Full time highly skilled employees that permanently reside and perform CIGA in the no or only nominal tax jurisdiction

+

Necessary staff, premises, equipment, expenditure, decision-making etc.

+

Filing information Type A information PLUS Type B information - Detailed business plans; - Employee information; - Proof of decision-making in jurisdiction

=

✓

Scenarios which are not sufficient to meet substance requirements for IP income

4. Merely passively holding the IP asset in the jurisdiction

=

✘

5. Periodic decisions of non-resident board members

=

✘

Ensuring compliance

53.  A key element of the substantial activities requirements is that there is an effective mechanism to ensure compliance. In the context of a taxing jurisdiction offering a preferential regime, this can be done, for example, by collecting information in tax returns, and denying tax benefits to the extent the requirements are not met. As this does not apply in the context of a no or only nominal tax jurisdiction, other approaches are needed to provide an equivalent means to ensure compliance.

54.  First, there should be a mechanism to identify the entities conducting the relevant categories of mobile activities and to detect whether the core income generating activities were being carried out. To be able to do so, the relevant entities would need to report information in the jurisdiction on:

• the type of mobile activity being conducted;

• the relevant core income generating activities the entity has conducted;

• the amount and type of gross income (e.g. rents, royalties, dividends, sales, services);

• the amount and type of expenses incurred, and assets and premises held, in the course of carrying out the business; and

• the number of full-time, qualified employees.

55.  Second, there should be a mechanism to take action in the event an entity failed to meet the substantial activities requirements. Given that there is no ability to apply a higher rate of tax as would be the case in the context of a preferential regime, there should be a sanction mechanism that is rigorous, effective and dissuasive. The determination of whether a sanction mechanism is rigorous, effective, and dissuasive will depend on the context. If relevant and appropriate, such a mechanism would include striking an entity off the register where this is an effective sanction. The no or only nominal tax jurisdiction would also need to continue enforcement efforts and remedy any shortcomings in the enforcement process.

56.  Third, there should also be the following enhanced spontaneous exchange of information of the information filed with the jurisdiction based on, subject to and limited by the applicable exchange of information instruments. The framework for spontaneous exchange of information will consist of two parts. First, for any entities that do not comply with the substantial activities requirement, all no or nominal tax jurisdictions would be required to spontaneously exchange all relevant information with the jurisdictions of residence of the immediate parent, ultimate parent, and ultimate beneficial owner.

57.  Furthermore, outside the context of non-compliant entities, the scope of further spontaneous exchange will depend on whether a no or nominal tax jurisdiction can demonstrate that it has a fully equipped monitoring process. This means a monitoring process operated by a tax administration or other governmental authority with all resources, processes and procedures in place to ensure not only an effective data collection process but also a high-quality review of the substantial activities standard with proactive follow-up where necessary. The FHTP will determine whether monitoring mechanisms are equipped with the appropriate resources and effective processes and procedures.

58.  If a jurisdiction does demonstrate that it has a fully equipped monitoring process, it would only be required to spontaneously exchange information on entities engaged in high-risk scenarios, as defined in paragraph 34. In such scenarios, the exchange would be a two-step process. The first step would be the annual exchange of the name and address of the entity; the type of mobile income; the name of the immediate parent, ultimate parent and ultimate beneficial owner; and the amount and type of gross income (e.g. rents, royalties, dividends, sales, services). In the second step, the recipient jurisdiction could then make a follow up request for further information, subject to the applicable exchange of information instrument.

59.  If a jurisdiction does not demonstrate that it has a fully equipped monitoring mechanism, it would be required to spontaneously exchange all relevant information on entities engaged in high-risk scenarios, as defined in paragraph 34. For all other entities conducting activities in scope, as set out in paragraph 22, the jurisdiction would be required to use the two-step exchange process described in paragraph 45.

60.  All exchanges would provide information to the jurisdictions of residence of the immediate parent, ultimate parent, and ultimate beneficial owner.

61.  The tables on the next pages set out the different types of information to be exchanged in different scenarios.

Table A.3. Jurisdictions with fully equipped monitoring mechanisms

Scenario requiring exchange	Content of exchange	Recipient jurisdictions
Non-compliance by the entity	Entity name and address Summary of what elements of the core income generating activities test the entity has failed to meet Name of the immediate parent, ultimate parent, and ultimate beneficial owner Type of mobile income Amount and type of gross income Amount and type of expenses incurred, and assets and premises held, in the course of carrying out the business Number of full-time, qualified employees Any other relevant information.	Residence jurisdictions of: Immediate parent Ultimate parent Ultimate beneficial owner
In high risk cases (see paragraph 34) that are not also cases of non-compliance by the entity	Step 1: annual exchange of: Entity name and address Type of mobile income Name of the immediate parent, ultimate parent, and ultimate beneficial owner Amount and type of gross income (e.g. rents, royalties, dividends, sales, services) Step 2: recipient jurisdiction makes follow up request for further information	Residence jurisdictions of: Immediate parent Ultimate parent Ultimate beneficial owner

Table A.4. Jurisdictions without fully equipped monitoring mechanisms

Scenario requiring exchange		Content of exchange	Recipient jurisdictions
Non-compliance by the entity and in high-risk cases (see paragraph 34)		Entity name and address Summary of what elements of the core income generating activities test the entity has failed to meet (for non-compliant entities) Summary of the core income generating activities performed by the entity (for high-risk scenarios) Name of the immediate parent, ultimate parent, and ultimate beneficial owner Type of mobile income Amount and type of gross income Amount and type of expenses incurred, and assets and premises held, in the course of carrying out the business Number of full-time, qualified employees Any other relevant information.	Residence jurisdictions of: Immediate parent Ultimate parent Ultimate beneficial owner
In all other cases involving entities engaged in activities within scope (see paragraph 22)		Step 1: annual exchange of: Entity name and address Type of mobile income Name of the immediate parent, ultimate parent, and ultimate beneficial owner Amount and type of gross income (e.g. rents, royalties, dividends, sales, services) Step 2: recipient jurisdiction makes follow up request for further information	Residence jurisdictions of: Immediate parent Ultimate parent Ultimate beneficial owner

62.  To activate the exchanges set out above, recipient jurisdictions would need to opt in to receive spontaneously exchanged information.

63.  The modalities of the above exchange framework, including the terminology used in the framework, timing for such exchanges, the precise data points, the details of what constitutes a fully equipped monitoring mechanism, the mechanism for opting in, and the development of a standardised template and XML schema, will be developed in cooperation with Working Party 10, drawing also on other reporting regimes, in 2019 and prior to the first exchanges under the framework.

64.  To ensure the effectiveness of the information collection and exchange mechanism, a review will take place in 2022 in cooperation with Working Party 10, which should provide enough time to allow jurisdictions to gain experience with the mechanism. Should particular issues surface in the operation of the exchange mechanism, the FHTP could also have an earlier discussion.

3. Interpretive guidance on the application of existing factors for assessing regimes

3.1. Introduction

65.  This second part provides interpretive guidance on applying the factors in the review of preferential regimes. This relates to: the relationship between the key factors and other factors and how the secondary factors can inform the key factors; guidance on interpreting transparency and exchange of information factors; and guidance on the ring-fencing factor, relating to de-facto ring-fencing and foreign currency regimes.

3.2. The relationship between the key factors for assessing regimes and the other factors

66.  The first key factor must be met in order for the FHTP's analysis of a regime's harmfulness to continue. If any one of the following four key factors is also met, then the regime will be found to be potentially harmful.

67.  When determining whether the five key factors are present, the FHTP may consider any relevant information, but several secondary factors could be particularly relevant. These factors do not on their own indicate that a regime is potentially harmful, but they provide evidence that one or more of the key factors may be met. The subsections below outline both the relevant secondary factors to be considered and further areas related to the key factors. The examples included therein are illustrative. The FHTP may consider the secondary factors in the context of any of the key factors, and one secondary factor may be relevant to more than one key factor.

Consideration of whether a regime imposes no or low effective tax rates

68.  In considering whether a regime imposes no or low tax rates, the FHTP may consider the following secondary factors:

• An artificial definition of the tax base: The 1998 Report and the Consolidated Application Note (CAN) both make clear that the first key factor considers effective tax rates as well as statutory rates. Therefore, consideration of how the tax base is defined is appropriate when determining the effective tax rate.

• Negotiable tax rate or tax base: The 1998 Report and the CAN both make clear that the first key factor considers effective tax rates as well as statutory rates. Therefore, consideration of whether the tax rate or tax base is open for negotiation is appropriate when determining the effective tax rate.

• Failure to adhere to international transfer pricing principles: The CAN makes clear that failure to adhere to international transfer pricing principles is likely to arrive at a different tax base with respect to intra-group transactions which may result in a lowering of the tax base and therefore of the effective tax rate.

Consideration of whether a regime is ring-fenced

69.  In considering whether a regime is ring-fenced, the FHTP may consider the following secondary factor:

• Foreign source income exempt from residence country taxation: The 1998 Report (OECD, 1998[1]) states that this secondary factor is to be considered because “[a] country that exempts all foreign-source income from tax, i.e., the regime is a territorial system, may be particularly attractive since the exemption reduces the effective income tax rate and encourages the location of activities for tax rather than business purposes. Since entities which take advantage of these regimes can be used as conduits or to engage in treaty shopping, they may have harmful effects on other countries.” However, the CAN (OECD, 2004[4]) notes that no case of ring fencing arises with respect to measures that are part of a jurisdiction’s general system of taxation or if the non-taxation of foreign source income is a measure designed to eliminate or mitigate double taxation, as set out in paragraphs 243-244 of the CAN (OECD, 2004[4]).14Consistent with the 1998 Report, the secondary factor on exempt foreign income can inform consideration of whether a particular regime is ring-fenced.

• Failure to adhere to international transfer pricing principles: The CAN makes clear that this factor may indicate ring-fencing, where benefits available under a transfer pricing regime are explicitly or implicitly restricted to foreign-owned enterprises or if taxpayers benefiting from the regime and associated enterprises abroad were treated in a more beneficial way than similar transactions with associated enterprises in the domestic market.

Consideration of whether a regime lacks transparency

70.  In assessing whether there is a lack of transparency, the FHTP may consider the following secondary factors:

• Failure to adhere to international transfer pricing principles: the 1998 Report notes that the inconsistent or negotiable application of transfer pricing rules can be non-transparent (e.g. where the principles for the allocation of income are not clearly stipulated in the laws and regulations or where an individual taxpayer can negotiate a transfer price with the tax authorities). Therefore, the absence of rules requiring consistent application of transfer pricing rules may inform consideration of whether a regime lacks transparency.

• Negotiable tax rate or tax base: where a taxpayer can negotiate the rate or base within a preferential regime, this may give rise to concern that the regime is not transparent.

Consideration of whether there is no effective exchange of information

71.  In assessing whether there is no effective exchange of information, the FHTP may consider the following secondary factor:

• Existence of secrecy provisions: No revisions to this secondary factor are needed, but it may inform the determination of whether the exchange of information factor is met.

Summary

72.  Examples of how the secondary factors can inform the key factors are:

(i) An artificial definition of the tax base. This secondary factor can inform determinations of whether the key factors are met, including whether a regime imposes no or low effective tax rates.

(ii) Failure to adhere to international transfer pricing principles. This secondary factor can inform determinations of whether a regime imposes no or low effective tax rates, whether a regime is ring-fenced, and whether a regime fails to meet the transparency factor.

(iii) Foreign source income exempt from residence country taxation. This secondary factor can inform determinations of whether the key factors are met, including whether a regime is ring-fenced.

(iv) Negotiable tax rate or tax base. This secondary factor can inform determinations of whether the key factors are met, including whether a regime imposes no or low effective tax rates and lacks transparency.

(v) Existence of secrecy provisions. This secondary factor can inform determinations of whether the key factors are met, including whether a regime lacks exchange of information.

3.3. Additional guidance on interpreting transparency and exchange of information factors

73.  The Action 5 minimum standard has already revised what the FHTP must take into account when assessing whether a regime lacks transparency with respect to rulings. In the context of a regime that provides a ruling, information on the ruling must be spontaneously exchanged as required by the Action 5 Final Report (OECD, 2015[2]) (the “transparency framework”).15

74.  It was also discussed whether the FHTP should take peer review results regarding a country’s compliance with the transparency framework into account when determining whether a regime lacks transparency. It was agreed that, to the extent that these peer review results are relevant to the concerns underlying the transparency factor, they should be considered but should not be determinative.

75.  However, with respect to the peer reviews on exchange of information on request carried out by the Global Forum on Transparency and Exchange of information for Tax Purposes (“Global Forum”) the transparency factor from the 1998 Report (OECD, 1998[1]) focuses on the legal and administrative operation of a regime, which is fundamentally different than the transparency considered by Global Forum peer reviews, which consider transparency in the context of the availability of information (bank, ownership, identity and accounting), that tax authorities can access and have a legal basis to exchange with another tax authority. It was therefore concluded that the Global Forum peer review ratings, to the extent that they did contain any relevant information for the transparency factor, should be taken into account, but cannot be determinative for assessing a regime under the transparency factor.

76.  However, it would be reasonable to assume that a negative peer review could be symptomatic of a jurisdiction’s deficiencies in areas such as exchange of information and it would seem counterintuitive to disregard the results of Global Forum peer reviews entirely when applying the exchange of information factor. It was therefore concluded that Global Forum peer reviews should be considered in assessing the exchange of information factor for preferential tax regimes where relevant.

3.4. Additional guidance on ring-fencing

De facto ring-fencing

77.  The issue of whether this factor should be regarded as applying where a regime is “de facto ring-fenced” because only a small number of resident taxpayers in fact take advantage of the regime was also considered.

78.  Ring-fencing occurs when a regime is “partially or fully isolated from the domestic economy.”16 As will be outlined in the following paragraphs, de facto ring-fencing is not included in the definition of ring-fencing in the 1998 Report (OECD, 1998[1]) or subsequent reports or guidance.

79.  The 1998 Report (OECD, 1998[1]) considered two versions of ring-fencing. In the first version, a regime would “explicitly or implicitly exclude resident enterprises from taking advantage of their benefits”. In the second version, “investors who benefit from the tax regime are explicitly or implicitly denied access to domestic markets.”17 Both of these versions focus on legal or administrative barriers, either to residents who attempt to use the regime or to non-residents who attempt to access the domestic market. The 1998 Report (OECD, 1998[1]) did, however, mention that the second version of ring-fencing could include implicit denial of market access. In discussing this possibility, the 1998 Report (OECD, 1998[1]) stated, “Market access may be denied on a de-facto basis through special tax privileges not applying or being otherwise neutralised insofar as the enterprises carry on business in the regime-country’s domestic market.” Although this statement uses the term “de facto,” it is focused only on de facto neutralisation of benefits to certain investors, not on a small number of resident taxpayers taking advantage of the regime even though they have access to the benefits under the regime. It is therefore focused on implicit ring-fencing, whereby legal or administrative barriers prevent access to the domestic market, but they do so less explicitly than legal barriers that on their face limit access to resident taxpayers. This discussion of implicit ring-fencing does not address de facto ring-fencing, where there are no legal barriers preventing access but there are instead only a small number of resident taxpayers who benefit from the regime.

80.  Therefore, explicit ring-fencing occurs when a regime by its own terms excludes access to resident taxpayers or to the domestic market. Implicit ring-fencing occurs when a regime does not exclude access to resident taxpayers or the domestic market in the letter of the law but instead through administrative or legal barriers that prohibit or inhibit resident taxpayers or domestic market participants from benefiting from the regime. De facto ring-fencing, in contrast, would occur when, even in the absence of any administrative or legal barriers, resident taxpayers still make up only a small percentage of the taxpayers benefiting from the regime.

81.  To clarify this distinction between implicit ring-fencing, which is already included in the definition of impermissible ring-fencing, and de facto ring-fencing, which is not, consider two examples. First, consider a regime that by its terms is available to all qualifying taxpayers but where the administrative practice of the jurisdiction has the effect of limiting the regime to foreign taxpayers. This regime is implicitly ring-fenced, and it would already be included in the definition of ring-fencing as defined by the 1998 Report (OECD, 1998[1]) and the CAN. Second, consider a regime that by its terms is available to all qualifying taxpayers and where the jurisdiction does nothing administratively to limit this regime to foreign taxpayers. In practice, however, the regime is provided by a jurisdiction with a relatively small economy, so the majority of taxpayers that can benefit from the regime are foreign taxpayers. Even if every possible qualifying resident taxpayer benefits from the regime, the jurisdiction’s population and economy mean that resident taxpayers only make up a minority of beneficiaries. This situation is not included in the definition of ring-fencing, but it illustrates the type of de facto ring-fencing that certain jurisdictions proposed including in the definition of ring-fencing.

82.  The fact that the 1998 Report (OECD, 1998[1]) does not include the type of de facto ring-fencing proposed by delegates in its definition of ring-fencing is made explicit in the CAN, which states that:

“a mere absence of domestic operators in the preferred sector or the absence of an existing domestic market for the services qualifying for the preferential regime does not constitute ring-fencing. There must be a deliberate legal restriction, or other restriction with similar effect, on access to the domestic market, i.e., access must be denied or residents must be excluded from taking advantage of the preferential regime. What is at issue, therefore, is whether there are measures that a country takes to protect itself from the potentially harmful effects of its own preferential regime and not a requirement that there should be a domestic market or domestic users for the preferred activities. In short, the 1998 Report is not concerned with situations where enterprises qualifying for a preferential regime are permitted to operate in the domestic market but in practice do not. (OECD, 2004[4])”18

83.  In considering whether to expand the definition of ring-fencing to include de facto ring-fencing several practical issues arise.

84.  First, including de facto ring-fencing in the second factor would require a definition of this term, which in turn raises significant questions. For instance, how low must resident investment be in order to be treated as de facto ring-fencing? Should the percentage of resident investors be proportional to the portion of the world population in the country in question, or to the portion of world GDP in the country in question, or to some other comparable ratio? Or should there be a set number below which domestic investment cannot fall, or else there will be a finding of de facto ring-fencing?

85.  Second, finding regimes to be ring-fenced due to a low number of resident investors would be likely to affect only smaller countries with high rates of foreign investment, and such an approach would be likely to affect all the regimes of those countries, whether or not they are in fact harmful. Additionally, focusing on the percentage of resident investors in a regime would not determine whether the regime is isolated from the domestic economy. It could instead reveal that the domestic economy has a limited number of investors able to benefit from the regime or that the domestic economy is dependent on foreign investors. Neither of these general characteristics of an economy would automatically mean that all regimes in that economy were potentially harmful, but a definition of ring-fencing that includes de facto ring-fencing would lead to just such a finding.

86.  Third, basing a decision on the extent to which resident taxpayers make use of a regime could result in a situation where identical regimes in different countries would be treated differently by the FHTP solely because there was significant domestic use of the incentive in one country but not in the other.

87.  Fourth, examining regimes for de facto ring-fencing based on domestic use of the incentive would also suggest that there would need to be ongoing monitoring of all regimes which the FHTP determines not to be ring-fenced in order to verify that domestic use of the incentive remained significant enough to conclude that the regime continued not to be de facto ring-fenced. It is nevertheless true that the FHTP engages in ongoing monitoring already. Therefore, this particular issue may be most relevant to considerations of burden on tax administrations and certainty for taxpayers benefitting from preferential regimes.

88.  Therefore, it was agreed not to expand the definition of ring-fencing to include de facto ring-fencing. However, the FHTP can consider the relative number of resident taxpayers benefiting from a regime as an indicator of whether further inquiry is necessary to identify whether there are administrative or legal barriers that would amount to implicit ring-fencing. This does not change the definition of ring-fencing to mean that a relatively small number of resident taxpayers leads to a conclusion that a regime has been ring-fenced.

Foreign currency regimes

89.  A further ring-fencing issue that arose was whether a regime that provides benefits only to transactions carried out in a foreign currency can ever be considered not to be ring-fenced. The 1998 Report clearly lists as an example of ring-fencing a situation where “the regime may not permit transactions in the domestic currency, thus ensuring that the domestic monetary system is not affected by the regime. (OECD, 1998[1])”19 The CAN (OECD, 2004[4]) supports this conclusion, stating that one example of ring-fencing “would be cases where the ability to operate domestically is restricted, or made more cumbersome, through the requirement that entities qualifying under the regime do business only in foreign denominated currencies. (OECD, 2004[4])”20

90.  There is therefore no question that a regime that requires that transactions be undertaken in a foreign currency is on its face ring-fenced from the domestic market. Some jurisdictions, however, questioned whether there could be a policy exception for such regimes if the regimes were designed not to attract investment but instead to attract foreign currency in order to address balance of payments concerns. In order for such a regime to be consistent with the requirements of the 1998 Report (OECD, 1998[1]) and the CAN (OECD, 2004[4]), it seems that foreign currency would have to be accessible to domestic residents and used as an alternative functional currency in the jurisdiction providing the regime. If the foreign currency were in general circulation throughout the domestic economy and there were no legal or practical limits on resident taxpayers accessing that foreign currency, then a regime that applied only to transactions in that foreign currency would be less likely to be seen as ring-fenced. Such regimes would need to be assessed by the FHTP on a case-by-case basis. If, however, resident taxpayers were not easily able to use the foreign currency, then such a regime would have the practical effect of applying only to foreign transactions, which would lead to a conclusion that it was ring-fenced. For example, a jurisdiction may have legal limitations that prohibit resident taxpayers from accessing foreign currency, or practical limitations that require resident taxpayers to automatically convert all or a portion of foreign currency they receive into the domestic currency, or a requirement that the approval of the central bank be obtained in order to convert domestic currency into foreign currency, thereby hampering their free access to foreign currency.

91.  It was concluded that the definition of ring-fencing includes regimes that apply only to transactions in foreign currencies, but that such regimes may not be ring-fenced if:

• the regime otherwise permits residents to access the regime;

• the foreign currency in question is available to residents;

• the foreign currency is in general circulation throughout the domestic economy such that the foreign currency is effectively used as an alternative functional currency in the jurisdiction providing the regime; and

• there are no exchange controls or other legal or practical limits that prevent resident taxpayers from entering into transactions in the currency that would qualify them for benefits under the regime.

92.  Such regimes will be assessed by the FHTP on a case-by-case basis.

References

[3] OECD (2017), Harmful Tax Practices - 2017 Progress Report on Preferential Regimes: Inclusive Framework on BEPS: Action 5, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, https://dx.doi.org/10.1787/9789264283954-en.

[2] OECD (2015), Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance, Action 5 - 2015 Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, https://dx.doi.org/10.1787/9789264241190-en.

[4] OECD (2004), Consolidated Application Note - Guidance in applying the 1998 report to preferential tax regimes, OECD, Paris, http://www.oecd.org/tax/transparency/about-the-global-forum/publications/1998-consolidated-application-note.pdf.

[1] OECD (1998), Harmful Tax Competition: An Emerging Global Issue, OECD Publishing, Paris, https://dx.doi.org/10.1787/9789264162945-en.

Notes

← 1.  Para. 155.

← 2.  Para. 156-158.

← 3.  For a detailed description of the nexus approach as applied to IP regimes, see Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance, Action 5 - 2015 Final Report, pp. 24-36.

← 4.  For a detailed description of the substantial activities requirements as applied to all other regimes, see Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance, Action 5 - 2015 Final Report, pp. 39-44.

← 5.  This includes the OECD reports Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance, Action 5 - 2015 Final Report, Harmful Tax Practices - 2017 Progress Report on Preferential Regimes: Inclusive Framework on BEPS: Action 5, and any guidance on substantial activities agreed by the FHTP and Inclusive Framework thereafter.

← 6.  Para. 4.

← 7.  Para. 52.

← 8.  Para. 55.

← 9.  This decision was driven in large part by technical challenges in applying the criteria, and the fact that at the time the jurisdictions affected by it were not participants in the work. Both of these aspects are significantly different now from what they were then, given the agreed guidance on substantial activities in preferential regimes, and the institutional changes brought by the Inclusive Framework.

← 10.  See Annex D of Harmful Tax Practices - 2017 Progress Report on Preferential Regimes: Inclusive Framework on BEPS: Action 5.

← 11.  Harmful Tax Competition: An Emerging Global Issue uses the terminology of “no or low effective tax rates” for preferential regimes and “no or only nominal taxes” for jurisdictions that were then called “tax havens” without defining either term by reference to a set or a specific rate. The purpose of considering nominal tax jurisdictions along with zero tax jurisdictions is to ensure that there is not an incentive for zero rate jurisdictions to shift to a rate near zero.

← 12.  Within the non-IP income category, there is specific guidance that applies given the nature of pure equity holding companies and shipping activities. For holding companies, see paragraph 8 of Annex D of Harmful Tax Practices - 2017 Progress Report on Preferential Regimes: Inclusive Framework on BEPS: Action 5. For shipping companies see note 1 under the table of results on shipping regimes in Chapter 2 of the Progress Report.

← 13.  The normal rule under the nexus approach, whereby marketing-related IP assets such as trademarks cannot qualify for tax benefits, remains unchanged. However, there is a difficulty in applying the nexus approach to no or only nominal tax jurisdictions. Under the nexus approach, the preferential tax treatment cannot apply to income from such assets and instead tax is to be paid at the ordinary rate. However, in the case of no or only nominal tax jurisdictions, there is no preferential rate and no ordinary rate to apply where income from such assets is earned. The application of the nexus rule would mean as a matter of law or otherwise that entities in a no or only nominal tax jurisdiction would not be allowed to hold and receive returns on marketing intangibles at all. This would seem disproportionate.

← 14.  Consolidated Application Note: Guidance in Applying the 1998 Report to Preferential Tax Regimes (hereafter “CAN”), paras. 243-244.

← 15.  See chapter 5 of Harmful Tax Practices - 2017 Progress Report on Preferential Regimes: Inclusive Framework on BEPS: Action 5.

← 16.  Harmful Tax Competition: An Emerging Global Issue (hereafter “1998 Report), para. 62.

← 17.  Harmful Tax Competition: An Emerging Global Issue, para 62. The 1998 Report also briefly identified a third version of ring-fencing: a regime where transactions are not permitted in the domestic currency. See discussion in paragraphs 77 - 80.

← 18.  Consolidated Application Note: Guidance in Applying the 1998 Report to Preferential Tax Regimes (hereafter “CAN”), paragraph 68 (emphasis added).

← 19.  1998 Report, para 62.

← 20.  CAN, para 76.