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In October 2015, the OECD published the final reports on the Base Erosion and Profit Shifting ("BEPS") Project ("Final Reports"), which were fully endorsed by G20 leaders at the Antalya Summit in the following month. In February 2016, the G20 finance ministers meeting approved an inclusive framework proposed by the OECD, which is expected to encourage all interested jurisdictions, including non-OECD and non-G20 nations, to join in efforts to implement the recommendations of the Final Reports. With agreement being reached and implemented by not only developed countries but also developing ones, the project is acclaimed as marking a turning point for taxation, paving the way for the shift from an era of nation-state rivalry to a new era of international coordination.

A next step will be for the OECD to revise its Model Tax Convention and Transfer Pricing Guidelines and for each jurisdiction to enact and amend domestic legislation as needed, in compliance with the Final Reports' recommendations. We appreciate these moves to a certain degree, as they will help to create a new international tax system adapting to a globalizing economy, to discourage some multinational enterprises from making excessive tax-saving efforts, and to level the playing field among businesses.

On the other hand, transfer pricing documentation and other newly introduced rules will certainly increase compliance costs for businesses. In that environment, if any jurisdiction implements and interprets the recommendations in its own way and takes unilateral actions that undermine international coordination, not only would it lead to an even heavier administrative burden, but also it could result in a greater incidence of double taxation.

This must be prevented from happening at all costs. The international community will have to monitor each jurisdiction's actions to ensure consistent implementation of the recommendations. Of particular importance to Japanese companies is to ensure compliance with the recommendations in Asian nations, given our relatively large operations in the region.

The OECD and G20 members are to continue working on issues that have been left unresolved by the Final Reports.

Implementation is the most critical phase of the BEPS Project. In view of that, we would like to make the following proposals on the challenges faced by the future of international taxation:

1. Consistent Implementation and Monitoring

(1) General Comments

In February 2016, the OECD agreed on a new inclusive framework. Under the framework, all interested jurisdictions will be able to participate in the OECD's Committee on Fiscal Affairs and work on an equal footing with the OECD and G20 members on monitoring BEPS issues. At the same time, these jurisdictions will have to commit themselves to the implementation of the BEPS package that includes the four minimum standards set out in the Final Reports: complying with country-by-country reporting requirements, improving dispute resolution mechanisms, preventing treaty abuse, and fighting harmful tax practices.

Keidanren endorses this framework and urges global leaders to declare their full commitment to it at the G7 Ise-Shima Summit and the G20 Hangzhou Summit to be held on May 26-27 and September 4-5 of this year, respectively. Such commitment is particularly essential to the recommendations on country-by-country reporting and improvements in dispute resolution mechanisms, as they cannot work without the full compliance of each and every jurisdiction. With an eye to the G7 summit, the B7, a group of the leading business associations of the G7 nations, will separately prepare and issue a joint communiqué to that effect at the B7 Tokyo Summit to be held on April 20-21.

The recommendations on transfer pricing and permanent establishment taxation are classified as revisions of existing standards, a measure that is generally deemed less binding than a minimum standard. From the perspective of preventing double taxation, however, these rules need to be internationally harmonized and consistently interpreted to the extent possible.

(2) Country-by-Country Reporting

A multinational enterprise is required to file to the relevant tax administration its country-by-country report that quantitatively outlines the group's operations on a country-by-country basis. As such, introducing this reporting system itself is considered to have the effect of discouraging aggressive tax planning. The system also provides a benefit for enterprises, as preparing these reports enables them to identify unexpected tax risks by tabulating relative country-by-country tax positions and business activities within the group.

On the other hand, tax administrations need to be reminded that there is a limitation on the depth of the information provided in country-by-country reports. They should first focus on initiating the reporting system without turmoil, rather than expecting too much of it from the beginning.

Participating jurisdictions should follow the recommendations to the letter. The recommendations dictate confidentiality, consistency, and appropriate use as the conditions underpinning the obtaining and use of country-by-country reports. These reports are a tool for a high-level risk assessment and, as such, cannot be used either as a substitute for a detailed transfer pricing analysis or for formulary apportionment. They demand strict confidentiality as well.

The Japanese business community considers the following to be key to implementation:

(a) Treatment of first reporting fiscal year

Although the Final Report recommends that the first country-by-country reports be required to be filed for the fiscal year beginning on or after January 1, 2016, in Japan the first reports are to be filed for the fiscal year starting on or after April 1, 2016. This means that, in Japan, the rule is to come into effect three months later than recommended.

Such a slight difference in the timing of enforcement is found in other jurisdictions as well. In fact, the Final Report acknowledges that some jurisdictions may need time to make necessary adjustments to domestic legislation. As long as a delay in the enforcement of the rule in an enterprise's jurisdiction is reasonable, it should be strictly ensured that no jurisdiction in which the enterprise operates invokes the so-called secondary mechanism (a method whereby a tax administration obtains an enterprise's country-by-country report from its local subsidiary, as opposed to the primary mechanism that uses the network of bilateral and multilateral tax treaties). In other words, all tax administrations should respect the timing of enforcement stipulated by the tax law of the jurisdiction in which the ultimate parent is domiciled.

(b) Transparency in information exchange

Following and to the extent of a multilateral or bilateral agreement to be reached among competent authorities, country-by-country reports will become subject to automatic information exchange pursuant to tax treaties. As for the multilateral agreement, the number of the signatories to date is only 32, which needs to be increased.

A list of the jurisdictions between which this multilateral agreement on automatic information exchange is in effect is to be published on the OECD website. From the perspective of ensuring predictability, it is equally desirable for the OECD to gather information on the status of bilateral agreements coming into effect and publish the findings. As enterprises may appoint a subsidiary domiciled in a third country as surrogate parent entity, the list of such bilateral agreements will be useful.

Under these agreements, an enterprise's first country-by-country report is to be exchanged no later than 18 months after the end of its fiscal year to which the report relates, and its subsequent reports no later than 15 months after the end of each fiscal year. Given that the exchange of a country-by-country report signifies the start of a risk assessment in the recipient jurisdiction, we expect countries to provide a tool that enables taxpayers to see when and with which jurisdiction their reports were exchanged.

(c) Rules on requests for information

We understand that, as the template for country-by-country reporting has been set, individual tax administrations will never demand data not contained in the template, whether pertaining to constituent entities or others. It is also our understanding that, as information exchange will be conducted pursuant to tax treaties in principle, the tax administration receiving a country-by-country report through exchange and in need of clarifying the reported information will inquire of the tax administration sending the report in accordance with the tax treaty, rather than inquiring directly of the ultimate parent or a subsidiary of the multinational enterprise group.

Although the Final Report states that jurisdictions are not prevented from using the country-by-country report data as a basis for making further inquiries in the course of a tax audit, rules governing requests for information on country-by-country reports themselves warrant further clarification.

(d) Interpretation of country-by-country reports

Country-by-country reports have unique characteristics that require tax administrations in interpreting them to pay attention to a number of points, such as the following:

• As intragroup transactions do not need to be offset, the sum of data of individual group companies does not match the results reported on the consolidated financial statements.
• The scope of constituent entities, etc., does not match the scope of associated enterprises for transfer pricing purposes.
• Due to a difference between taxable income and accounting profit resulting from dividend exemption and other treatment, a statutory tax rate applied to an enterprise does not match its tax burden ratio defined as income tax divided by profit before tax.
• Deferred taxes are not taken into account.
• In the case of a conglomerate, data for each country is obtained by aggregating data for multiple businesses.

In light of these, tax administrations around the world are urged to share their views, as much as possible, of the circumstances in which an enterprise is determined to have the risk of engaging in BEPS, based on typical examples. When assessing the risk of a specific enterprise, caution should be exercised not to automatically regard a onetime loss for a single fiscal year as a high risk for transfer pricing purposes, by examining the country-by-country reports for multiple fiscal years.

In order to address these issues, the OECD and relevant organizations should develop guidance to ensure the proper use of country-by-country reports and make it available to tax administrations and taxpayers throughout the world. Then, an effective monitoring mechanism is hoped to be launched without delay. In the process of developing guidance, issuing a public discussion draft and holding a public consultation would be an option where appropriate. We would welcome such an opportunity.

The concern the Japanese business community has is the proposal made by the European Commission to make country-by-country reports public. These reports contain the confidential information of each enterprise, and the Final Report thus calls on tax administrations to take all reasonable steps to ensure that there is no public disclosure of such information. Furthermore, the exchange of country-by-country reports pursuant to tax treaties is premised on preserving the confidentiality of the reported information in each jurisdiction. These international accords should be honored under any circumstances.

(3) Master File and Local File

A master file and a local file are not defined as a minimum standard, and are considered to leave room for discretion on the part of each jurisdiction as to the information to be contained. However, as these files, together with a country-by-country report, constitute the three-tiered approach to transfer pricing documentation, information to be contained therein should be internationally consistent to the extent possible.

Creating new transfer pricing documentation rules was supposed to be aimed at both enhancing transparency to tax administrations and reducing the administrative burden on taxpayers. In the event that any tax administration demands information that overly deviates from those purposes, necessary steps should be taken through the monitoring mechanism, rather than waiting for the comprehensive review scheduled for 2020.

(4) Making Dispute Resolution Mechanisms More Effective

In recent years, the numbers have been increasing of requests filed for the mutual agreement procedure and of those requests not resolved, in relation to advance pricing arrangements and double taxation. Against this backdrop, the possibility is pointed out that the trend may be spurred by the BEPS Project. Enforcement uncertainty is likely to rise, especially in the fields of transfer pricing and permanent establishment taxation.

In these circumstances, it is a welcome development that the Final Report recommends some minimum standards, including the one requiring jurisdictions to seek to resolve mutual agreement procedure cases within an average timeframe of 24 months. The progress of implementation in each jurisdiction will need to be monitored, for example in terms of whether the jurisdiction is accepting requests for the mutual agreement procedure in a timely manner, making sincere efforts to reach an agreement, and properly implementing the agreement.

Nevertheless, even if the mutual agreement procedure is improved, the concern remains that double taxation may not be completely eliminated in cases where only a partial agreement is reached, for instance. The introduction of mandatory binding arbitration is essential to making dispute resolution mechanisms more effective. Keidanren strongly hopes that the number of jurisdictions introducing MAP arbitration will increase.

2. Addressing Remaining Issues

In this year and the next, the OECD is to continue working on the issues that have been left unresolved by the Final Reports. Below are our comments on those remaining issues that the Japanese business community deems particularly important. We hope a separate opportunity will be provided to submit in-depth comments through the release of a public discussion draft and/or the holding of a public consultation.

(1) Hard-to-Value Intangibles (Commensurate with Income Standard)

The revised Chapter VI (Special Considerations for Intangible Property) of the OECD Transfer Pricing Guidelines is to incorporate the so-called commensurate with income standard as a method of taxation on the transfer of hard-to-value intangibles. Compared to the June 2015 public discussion draft, the revised provisions give consideration to taxpayers by reducing the level of detail of "ex ante projections" that need to be provided, specifying the notion of "significant difference" between ex ante projections and ex post outcomes, and by permitting exemptions after the passage of a certain time period.

Nonetheless, one cannot help having reservations about the commensurate with income standard as an approach to charge taxes in hindsight, even though the standard is explained to be consistent with the arm's length principle. Hence, it is essential that the application of the standard be restricted as much as possible and detailed implementation guidance be developed.

Specifically, more guidance should be provided on the methods of identifying the amount of the transferee's profit, etc., derived from the transferred hard-to-value intangibles and correcting the amount (e.g., whether that is obtained by adjusting the transfer price itself or is treated as something like payment in installments linked to the transferee's profit). Additionally, appropriate exemption criteria need to be set, along with the presentation of examples of exemptions and non-exemptions. Any double taxation resulting from the application of the commensurate with income standard should be eliminated without exception.

(2) Transactional Profit Split Method

As stated in our comment letter on the December 2014 public discussion draft, we welcome the refinement of guidance on the transactional profit split method and have a high expectation for the OECD's follow-up work in that regard. Deeper discussion will be particularly needed about the meaning of "unique and valuable contributions" in cases that involve the performance of important functions relating to the development, enhancement, maintenance, protection, and exploitation of intangibles. Detailed guidance on profit splitting factors will also be useful.

On the other hand, we would like to emphasize once again that the follow-up work should not be aimed at expanding the application of the transactional profit split method as the most appropriate method. The Final Report itself states that, in some cases, an appropriate method using inexact comparables is likely to be more reliable than an inappropriate use of the transactional profit split method. This makes it necessary for the OECD to consider in which cases using the transactional profit split method is deemed inappropriate.

(3) Attribution of Profits to Permanent Establishments

Article 5 (Permanent Establishment) of the OECD Model Tax Convention is to be revised to broaden the scope of agent permanent establishments and substantively determine whether an entity's activities are of a preparatory or auxiliary character. In order to provide greater certainty for taxpayers, more examples need to be provided in the commentary with regard to cases that fall and do not fall under the definition of agent permanent establishments and activities of a preparatory or auxiliary character.

Some consider that, even if an entity is deemed to be a permanent establishment, profits attributable to it are usually limited when based on the authorized OECD approach. More discussion will be needed on the functions performed and risks borne by agents, warehouses, and other fixed places of business to develop detailed guidance on the attribution of profits.

Matters agreed upon, such as the scope of permanent establishments and the attribution of profits based on the authorized OECD approach, should be consistently implemented internationally, including non-OECD economies.

(4) Preventing Treaty Abuse

The OECD is expected to finalize its work on treaty anti-abuse rules by the end of the first half of this year, taking into account the revisions to the US Model Income Tax Convention.

Particular focus is likely to be placed on the limitation-on-benefits rule. The Japanese business community expects that treaty benefits are granted to holding companies including regional headquarters.

Suppose that a company exercises substantive economic functions in its investment or management activities and is engaged in a real business such as making decisions and providing assistance that contribute to increased value of the investees. In that case, the company should be regarded as engaged in the active conduct of a business. Also, whether activities constitute the active conduct of a business has to be determined taking all the relevant facts into consideration. Automatic classification based on industries could distort fair competition in the global market.

These views are fully in accord with an example provided in the Final Report's commentary concerning the principal purposes test, which concludes that it is not reasonable to deny treaty benefits to a company managing the group's regional business through which it exercises substantive economic functions. Similar provisions should be added pertaining to the limitation-on-benefits rule as well. When drafting those provisions, it is necessary to incorporate a recommendation in the Final Report that dictates that a determination on the active conduct of a business be made not based on a single entity, but on the basis that includes affiliates. Furthermore, it should be explicitly stated that treaty benefits are granted to a regional headquarters that holds shares in multiple subsidiaries it manages.

Additionally, we hope that more tax treaties that have the limitation-on-benefits rule will incorporate a derivative benefits test.

(5) Multilateral Instrument

The Final Reports' recommendations relating to tax treaties, including those on permanent establishment and treaty anti-abuse rules, entail the possibility of being reflected all at once in bilateral tax treaties following the coming into effect of a multilateral instrument. While the OECD is working to open the multilateral instrument for signature by the end of this year, the progress of the work should be disclosed in a timely manner and taxpayers' views sought as needed, from the perspective of enhancing predictability to enterprises.

Keidanren has been constructively involved in the BEPS Project by submitting comment letters on public discussion drafts, attending public consultations, and taking other necessary steps. We will continue to actively participate in the discussion going forward.