The OECD’s BEPS Project

The OECD’s BEPS Project will have a seismic effect on property investment and development

At BDO’s recent International Tax Day, held in London last month, we addressed some of The outcomes from the OECD’s Base Erosion and Profit Shifting (‘BEPS’) initiative, and the sectors that may be particularly affected. In terms of real estate investment, there are a number of areas addressed in the BEPS Action Plan which I discussed with London Tax Partner, Hira Sharma, which we’ll look at in this post.

The BEPS action plan will undoubtedly have a wide-ranging and enduring impact upon property investment and development. Some of the proposals mean a seismic shift from current practices.

Final recommendations were published by the OECD in relation to each of the 15 BEPS Actions on 5 October 2015; they were subsequently taken-up by the G20 Heads of State at their meeting on 15-16 November 2015.  Since then, the OECD’s recommendations have been progressively introduced around the world by OECD member states into their national tax legislation, with the UK being an early adopter. 

The core objective of the OECD’s BEPS initiative is to counteract aggressive tax planning through a series of 15 specific initiatives, termed Actions. The OECD has recognised that legislation in many countries has not been able to keep on top of of business operations carried out by multinational companies in an increasingly digital economy where the location of assets and operations can be changed with relative ease, and where there is an increasingly fluid movement of capital. Rather disappointingly, the UK Government has, to date, not offered any specific concessions to property investors in order to cushion the potential impact of the changes. For this reason the impact of the changes is likely to be more profound and, as such, likely to place a check upon certain commercial activity.

Adoption of the recommendations across member countries is not uniform; both in scope and timescale.  Furthermore, a certain amount of discretion is being applied by certain States which, arguably, dilutes the core objectives of  the OECD.  By way of example in relation to Action 4 governing interest deductions for tax purposes: -

  • the UK is enthusiastically embracing the proposals.
  • Australia has said it will not follow the proposals and maintains that domestic legislation is sufficiently robust.
  • Germany and France (both of whom already have principles similar to those recommended by the OECD) are unlikely to make any further changes. 
  • The US does not anticipate making any changes in relation to interest deductions and is generally adopting a ‘wait and see’ approach.

There are a number of factors in the 15 point action plan that will have particular effect on the real estate landscape globally. Some the more poignant considerations are outlined below.

  1. Interest deduction for taxation purposes[1]

The UK already has a complex set of rules governing the deductibility of interest from a taxation perspective which have been continually revised in order to counteract perceived tax abuse. 

A core principle underlying the legislation is the concept that an “arm’s length principle” applies in determining the quantum of interest for which a tax deduction is available.  This contrasts with the more mechanical tests (generally as a fixed percentage of EBITDA) which are found in some of our continental neighbours, for example Germany and France.   

Essentially for the UK, HMRC allows a tax deduction for the amount of interest which an investor would be able to secure from an independent party acting on an ‘arm’s length basis’ in light of the security offered by the asset.  Practically speaking this means that in an environment where debt is readily available for the right type of asset; it is possible to leverage up to a very high level using third party finance and, at the same time, secure a tax deduction for the interest charges arising.

This position will fundamentally change from 1 April 2017. For groups which have an interest charge of more than £2 million per annum (and are not able to benefit from specific exemptions), HMRC will limit the interest deduction for corporation tax purposes to a maximum of 30% for EBITDA. It is expected that these provisions will be extended to companies within the charge to income tax – for example non-resident landlords.

Whilst final legislation is awaited, we consider that this move will result in additional tax costs for investors in UK real estate. The effect is likely to mean: -

  • Detailed review of financial models in relation to existing investments in order confirm continuing profitability
  • Reassessment of prospective real estate investments
  • Amending investment structures and financing models

     

  1. Neutralising the effect of hybrids[2]

Many pan-European investment structures rely upon the use of hybrid financing instruments in order to allow the tax efficient transmission of cash and profits through investment structures.  Commonly these are designed so that they are treated as ‘debt’ by the issuing entity (so the deduction represents ‘interest’ and enables a tax deduction) and as ‘equity’ by the company holding the instrument (which means that the return represents ‘equity’ so that the receipt is taxed at a lower or nil rate of tax). This type of arrangement has been commonplace within Luxembourg based real estate investment structures but the moves by the OECD mean that the status quo is unlikely to remain.  As a result we are likely to see:-

  • An increase in the ‘tax cost’ of routing investments through certain jurisdictions
  • Certain type of historic planning carried out by taxpayers to be simply ineffective.

     

  1. Preventing Treaty Abuse[3]

The OECD has felt minded to move against taxpayers who use double tax treaties in order to avoid a liability to taxation.  From a real estate perspective (and by way of example) some developers have organised their affairs so as to avoid a charge to tax their UK property developments by the careful use of double tax treaties. Although not necessarily directly linked to the OECD’s BEPS initiative (but clearly supported by it), HMRC have moved to counteract this type of planning by specific provisions which will be enacted in the Finance Act 2016. As a result: -

  • Historic planning techniques will simply not be available
  • Certain projects are likely to be made commercially unviable

Whilst the underlying objectives of the OECD BEPS initiative are to be applauded, we consider that the recommendations of the OECD will have a disproportionate impact on the real estate sector.  This sector has not really been recognised as a special case by the OECD deserving of any specific concessions. The moves by the OECD in relation to the BEPS project are unique in its history and highly significant. The impact on taxpayers will be profound; for real estate investors and developers some of the initiatives will represent a seismic shift in relation to current practice. .

Now, more than ever, players in the real estate sector need advisors with in-depth understanding to help them navigate through the changes, minimise risks, and help them identify legitimate tax saving opportunities that may exist.

Contact your BDO adviser for more information on how the OECD’s BEPS Actions could impact your business.

Hira Sharma, London Tax Partner [email protected]

Solly Benaim, Global Head of Real Estate [email protected]

 

[1] OECD, BEPS Action 4: Limiting Base Erosion Involving Interest Deductions

[2] OECD , BEPS Action 2: Neutralising the Effect of Hybrid Mismatch Arrangements

[3] OECD, BEPS Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances