Article 16 – The Tax Challenges of the Digital Economy

Tackling BEPS in the digital economy In our 16th article in a series of articles on the tax challenges of the digital economy, we shall be providing you hereunder with a brief overview on two other measures that will address BEPS issues in both market and ultimate parent jurisdictions.  In this article, we shall be discussing […]

Written By Stephen Balzan

On April 11, 2016
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Tackling BEPS in the digital economy

In our 16th article in a series of articles on the tax challenges of the digital economy, we shall be providing you hereunder with a brief overview on two other measures that will address BEPS issues in both market and ultimate parent jurisdictions. 

In this article, we shall be discussing two other measures that will address BEPS issues in both market and ultimate parent company jurisdictions, that of countering harmful tax practices more effectively (Action 5) and that of assuring that transfer pricing outcomes are in line with value creation (Actions 8-10).

Companies engaged in the digital economy heavily rely on intangibles which are geographically mobile.  Over the past years, a number of countries have introduced preferential tax regimes for income arising from such intellectual property.

The work undertaken by Action 5 requires that a substantial activity must be in place for any preferential regime and an agreement was therefore reached on the ‘nexus approach’.  This ensures that tax payers can only benefit from IP regimes where they engage in R&D and incurred actual expenditure on such activities.

The objective of the transfer pricing actions is to bring the allocation of income within an MNE group of companies, more directly in line with the location of the economic activity that gives rise to that income.  The key transfer pricing issues that need to be focused on include (i) the transfer and use of intangibles including hard to value intangibles and cost contribution agreements (CCAs) (ii) the delineation of the actual transaction and business risks and (iii) global value chains and transactional profit split methods.

(i) the transfer and use of intangibles including hard to value intangibles and cost contribution agreements (CCAs)

A key feature of many BEPS structures, involve the transfer of intangibles or rights in intangibles to low tax jurisdictions at non-arm’s length prices (ALPs). This can occur with licensing arrangements, CCAs or tax structures that separate deductions associated with the development of the intangible from the income.  This can result from difficulties in establishing the ALP, unequal access to information between tax payers and tax administrations and because the transfer of hidden or unidentified intangibles can be effected without payment.

The BEPS work makes it clear that the compensation for the transfer of intangibles between related parties should be equivalent to those transfers between unrelated parties.  Secondly the work ensures that the entities within the MNE group must be compensated for their contribution to the value of the IP, whether the contribution consists of performing or managing development functions or by bearing and controlling risks.  Legal ownership will no longer entitle the owner to premium profits.

The work ensures that valuation techniques are used to determine ALPs and that post transfer profitability of an intangible can be taken into account in the valuation of IPs.  With respect to CCAs, the revised guidance will ensure that contributions will not be valued at cost, where this is unlikely to provide a reliable basis for determining the value of the relative contributions of participants.

In our next article, we shall be focusing our attention on two other key transfer pricing issues that needs to be focused on to assure that transfer pricing outcomes are in line with value creation (Actions 8-10), that of (ii) delineating the actual transaction and business risks and (iii) global value chains and transactional profit split methods.

How can we help?  

For further information, please contact one of the firm’s tax partners, Stephen Balzan on [email protected] or Elaine Camilleri [email protected]. ACT can help you understand the changes to the tax rules and how these can impact your business.  

Apart from its offices in St. Julian’s Malta, ACT operates from a second office in Gozo, which is situated in the capital city of Victoria.  For an appointment in our Gozo office, please call on 00356 21378672 or send us an email on [email protected]. 

Disclaimer: This article contains general information only and is not intended to address the circumstances of any particular individual or entity. ACT, by means of this article is not rendering any accounting, business, financial, investment, legal, tax, or other professional advice or service. This article is not a substitute for such professional advice, nor should it be used as a basis for any decision or action that may affect your finances or your business. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. Before making any decisions or before taking any action that may affect your finances or your business, you should consult a qualified professional adviser. ACT shall not be responsible for any loss whatsoever sustained by any person who relies on this article.