Comments Received on the Public Discussion Draft BEPS ACTIONS 8 - 10 Financial transactions Part II 14 September 2018 Table of contents (Part II) DTEK Energy .......................................................................................................................... 3 Duff & Phelps ........................................................................................................................ 4 EBIT ....................................................................................................................................... 22 Embridge Economics B.V ...................................................................................................... 32 Erste Group Bank AG............................................................................................................. 37 European Banking Federation .............................................................................................. 42 European Captive Insurance and Reinsurance Owners` Association ................................... 53 Eversheds Sutherland ........................................................................................................... 61 EY ........................................................................................................................................... 66 Fantozzi & Associati - Studio Legale Tributario ..................................................................... 96 Federation of European Risk Management Associations ..................................................... 115 Federazione Nazionale Imprese Elettrotecniche ed Elettroniche (ANIE) ............................. 138 FTI Consulting ........................................................................................................................ 146 Grant Thornton International ............................................................................................... 150 Hardeep Singh Chawla .......................................................................................................... 165 International Chamber of Commerce (ICC) .......................................................................... 170 Insurance Company Working Group on BEPS ....................................................................... 182 Insurance Europe .................................................................................................................. 193 International Fiscal Association (Mexican Branch) Transfer Pricing Committee .................. 196 Japan Foreign Trade Council ................................................................................................. 201 KPMG .................................................................................................................................... 209 2 3 Tax Treaties, Transfer Pricing and Financial Transactions Division September 7, 2018 OECD Centre for Tax Policy and Administration 2, rue André Pascal 75775 Paris Cedex 16 France Response to Invitation for Public Comments on the BEPS Discussion Draft on Financial Transactions Andrew Cousins, Beau Sheil, Erando Halilaj, Kate Brennan, Kristen Cote, Mark Bronson, Michelle Johnson, Pilar Barriguete, Ricky Yu, Sophie Wang, Stefanie Perrella, Vasileios Perakakis, Zachary Held, Duff & Phelps LLC1 Executive Summary Duff & Phelps welcomes the opportunity to comment on the Organization for Economic Cooperation and Development’s (the OECD) discussion draft titled BEPS Actions 8-10, Financial Transactions, 3 July – 7 September 2018 (referred to herein as the “Discussion Draft”). We commend the OECD on its efforts to raise and address some of the most difficult questions surrounding intercompany financing transactions as guidance on the topic of intercompany financing has been highly anticipated by taxpayers, advisors, and authorities alike. As the OECD works to finalize its guidance on this topic, we encourage the OECD to balance the desire of countries to combat earnings stripping with the arm’s length principle. Proposed guidance that excessively deviates from the arm’s-length principle may have other pitfalls, which the OECD should thoughtfully weigh. This Executive Summary will summarize specific areas in the Discussion Draft that we consider potentially problematic, noting that these viewpoints are expanded upon in our commentary. The remainder of our commentary is dedicated to clarifying technical points and responding to the Discussion Draft’s specific questions to commentators. First, with respect to the accurate delineation of transactions, we recommend that guidance avoid creating a framework for tax authorities to recharacterize loans simply because the 1 The opinions and views expressed in this letter are those of the authors and not necessarily those of Duff & Phelps or its clients. Duff & Phelps, LLC T +1 212 871 2000 [email protected] 55 East 52nd Street www.duffandphelps.com Floor 31 New York, NY 10055 4 OECD Centre for Tax Policy and Administration September 10, 2018 Page 2 of 18 issuance could be seen as relatively risky or speculative. We note that there exist many highly levered, unsecured, high yielding debt issuances in the market. As such, riskier characteristics (e.g., unsecured, subordinate) should not be a means for automatic recharacterization. Instead, as in market practice, risk should be assessed in the context of the lender’s availability of funds and appetite for the risk associated with the deployment of these funds and the borrower’s intent and ability to meet the debt obligations arising from such an issuance. Further, risk should be adequately reflected in arm’s-length compensation (e.g., interest). Also on this topic, we recognize the perceived merits of the OECD’s proposed approach of bifurcating intercompany financing instruments into part debt and part equity (as opposed to an “all-or-nothing” approach), but we also urge the OECD to consider the potential repercussions of loose guidance on this topic that may arise when countries attempt to implement it. Second, with respect to risk free returns, we urge the OECD to reconsider and clarify its guidance with respect to situations in which it is found that a funder lacks the capability to perform decision-making functions and therefore cannot earn more than a risk-free rate as it applies to intercompany loans (and any return that a funder would earn in excess of the risk- free rate would be allocable to the entities that do perform decision making functions). Unlike prior guidance on Action Items 8 to 10 wherein the framework prescribed by the OECD removed potentially unlimited equity returns from what it called “cash boxes”, this guidance could remove fixed, contractual and readily benchmarkable returns from funding entities and overly compensate decision-making entities for what could be a relatively routine function in assessing and arranging lending opportunities. As such it is important that the OECD clarify this guidance in the context of intercompany loans, particularly with respect to defining decision making and control. Finally, the Discussion Draft discusses the impact that the MNE group credit rating should have on the credit rating of a particular MNE within the MNE group. We have not opined on the appropriateness of considering the MNE group rating versus a stand-alone credit rating, but recommend that the OECD’s final guidance have a more clearly defined and objective framework. Group and stand-alone credit ratings are often different from one another, which would likely lead economic analyses to result in different arm’s-length interest rates. As such, introducing these different approaches for determining a MNE’s credit rating and potential rebuttable presumptions could lead to double taxation risk if countries interpret and implement this guidance differently. 5 OECD Centre for Tax Policy and Administration September 10, 2018 Page 3 of 18 Section B. Interaction with the guidance in Section D.1 of Chapter I Discussion of Accurate Delineation Firms operating at arm’s-length (both as lenders and as borrowers) have flexibility in deciding how to invest and capitalize. With respect to investing, a risk versus return framework, often depicted as a diagonal upward sloping line (shown below) is commonly referenced. Based on all available information at a given point in time, all investments on the line are considered by the market to provide adequate expected return for the level of assumed risk. B A Expected Expected Return Risk Increased risk corresponds with movement to the right along the X axis. Increased risk, does not in and of itself dissuade a reasonable investor, so long as the increased risk is in turn met with commensurate increased return. In the context of the graph, this would correspond with movement up the Y axis, increasing compensation in order for the investment to be considered adequately priced given its level of risk (i.e., moving from point A to point B). Reasonable investors would not consider investments falling below the line as there are theoretically alternatives that either offer greater return for the same level of risk or the same return for less risk. However, when faced with multiple investment opportunities that are adequately priced (i.e., on the line, for example points A and B, among others), investors’ choices then come down to preferences, one of which may be risk appetite. Many of the attributes of an instrument that are highlighted in the Discussion Draft (e.g., credit rating, collateralization, etc.) impact the risk associated