For people outside of the tax world it is difficult to understand that a rather boring topic such as international corporate taxation can have a game-changing impact on the attractiveness of certain jurisdictions over others. But the current BEPS initiative launched three years ago by the Organization for Economic Cooperation and Development can by all accounts be labeled as truly “disruptive” to the way multinational companies structure their value chains across countries and continents.
BEPS stands for “Base Erosion and Profit Shifting” and is the answer of the OECD — a club of leading industrialized countries — to shrinking tax incomes from multinational companies for its members.
The Buzzword: Substance
Taxes have always been a significant consideration for biopharmaceutical companies, which have as their main assets mainly intellectual property (IP) and brands — in other words, intangible assets which can be easily shifted from one location to another and thus are instrumental to reduce the global effective tax rate (ETRs) of the companies who own or exploit them.
In order to counter the excessive use of special tax regimes which often include special tax treatments for income from IP, the OECD has developed a BEPS action plan designed to reduce the arbitrage between different tax rates and different interpretations of tax principles that arise as a result of tax sovereignty of individual countries.
The OECD plan was outlined in detail in late 2015, and it is now up to the individual countries to adjust their national tax laws accordingly. In essence, BEPS requires that for multinational companies (MNCs) to be able to allocate profit to a certain locations, there must be sufficient qualifying substance located there. Mere holding of assets (i.e. IP) without enough substance in a certain (tax beneficial) jurisdiction does not qualify any longer for shifting profit to this jurisdiction. How is substance defined? The OECD sees substance as a combination of functions (FTEs), assets (i.e IP or manufacturing plants, etc.) and risks (i.e. contractual risks).
In addition, OECD also suggests to its member states to share information on taxation of MNCs through a so-called Country-by-Country Reporting (CbCR) system. MNCs above a threshold of €750 million (approximately US$845 million) in annual revenues will be required to report how much profit they generate in each country where they are active and how much tax they are paying per jurisdiction. This transparency will help national tax authorities challenge national tax filings of MNCs which operate in different countries.
Leaving the Island
Biopharmaceutical companies traditionally have been in the forefront of tax planning via the usage of low-tax jurisdictions for the exploitation of intellectual property.
With the BEPS being implemented in across Europe into the national tax codes, and the looming CbCR, biopharmaceutical companies are now reviewing their use of low-tax jurisdictions for the management and exploitation of intellectual property. Until now the management of intangible assets was focused on cost sharing and economic risk, whereas the BEPS Action Plan will require a closer alignment of actual “value generation” (profit) to “economic activity.”
In other words, the transfer of IP to low-tax jurisdictions such as Bermuda or the Cayman Islands with little or no substance is a model of the past. Basically all biopharmaceutical firms of significant size are therefore currently unwinding these structures.
Who Wins, Who Loses?
The fact that mere allocation of IP or other passive income generation assets to a low-tax jurisdiction is not a sustainable tax planning strategy any more not only has an impact on the value chain of the companies but also on the jurisdictions where such structures were mostly incorporated.
Offering a stable legal and political environment, operational grade infrastructure and little to no taxation will not be sufficient to keep these companies in a given country. The classic offshore locations already feel the decrease in demand for such structures with the respective impact on employment, GDP, etc.
There are basically three types of countries in the way they can be affected by BEPS in their attractiveness for foreign direct investment from life sciences companies:
How to Find Out?
Compliance with BEPS requires an in-depth understanding of where functions, assets and risk are located, and how they contribute to profit generation. A holistic and comprehensive value chain analysis sheds light on the existing structure and provides the base for realigning the business and the tax model in a way that makes the value chain sustainable and scalable. Such “future proofing” of the value chain is mandatory for biopharmaceutical companies in order to preserve value and to allow for future growth. From now on, value chain analysis should therefore be part of every sustainable tax planning and site selection process.
André Guedel is an expert in site selection for life sciences companies in Europe. He is the publisher of the KPMG “Site Selection Report for Life Sciences Companies.” This year’s report, in collaboration with EuropaBio and Venture Valuation, will be launched at BIO 2016 in San Francisco. André is the Head Sales and Business development at KPMG Tax Switzerland.
Dr. Hans Mies is a leading expert for value chain analysis and an advisor to many Fortune 500 companies. He is also a Director within the Tax Group of KPMG Switzerland.
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