ASIA VIEW: The anti-establishment

Governments across the globe, including those of Asia’s major economies, are continuing their clampdown on perceived tax evaders. By the end of the year, a new multilateral agreement will be signed by the G20 group of the world’s major economies, among others, which will alter tax treaties in a project known as the Base Erosion and Profit Shifting (BEPS) Action Plan.

BEPS is the blueprint for how the G20 will tackle tax avoidance and was written by the thinktank Organisation for Economic Co-operation and Development (OECD). The real estate sector has previously voiced major concerns with many aspects of the BEPS rules, including the restriction on the tax deductibility of debt, which would make debt more expensive and increase the cost of capital for businesses.

In Asia, real estate investment managers are being warned of another potential danger within BEPS. More government tax authorities in the region have recently been challenging overseas companies on their presence in the jurisdiction and whether it creates a ‘permanent establishment,’ which would thereby put the company on the hook for a local tax bill.

In the past, the majority of countries relied on a tax treaty model from the OECD. The model was flexible enough to allow executives who were locally based in an Asian country but whose parent company was based elsewhere to do identification and origination work, and a degree of negotiation on deals, without that activity constituting a permanent establishment. However, the firm had to prove that the decision to buy or sell was not taken by the locally-based executives but by other executives based outside of the country.

So, if a fund manager had an investment committee offshore, say in Hong Kong, it could argue that the investment activity of the executives based in, say China, is not enough to create permanent establishment in China.

With the changes to BEPS, however, the rules have become more ambiguous. Under the revised plan, if an executive is substantially involved in a negotiation, such activity would potentially be grounds for creating a permanent establishment, even if approval of the deal is being made outside of the country where the executive is based.

In many cases, a firm that requires its dealmakers to go back to the investment committee, which approves or rejects deals and deliberates on other matters such as pricing, is likely to remain on the right side of the rules. But, some other firms give their executives a fair amount of autonomy in executing deals, provided that they invest within certain defined parameters. The question for these managers now is whether or not such autonomy is advisable, given that it now has implications for creating a permanent establishment.

Fund managers are now undertaking analysis and looking at what they are currently doing in order to ascertain that they are not going create a permanent establishment, and by extension, whether they need to modify the process by which they make decisions.
Based on the current timetable, the multilateral agreement that will bring the new rules into effect will be signed by the end of the year. But, some countries are already start implementing these rules ahead of that date by amending tax treaties. Australia, for instance, is negotiating a new treaty with Germany, while China and Chile have also made amendments to their existing tax treaties. The advice from tax experts in Asia is to start undertaking analysis ahead of time or risk falling afoul of the establishment.