OECD: Pillar Two and BEPS

Base Erosion and Profit Shifting

The OECD’s Base Erosion and Profit Shifting (BEPS) project commenced in 2013 to address concerns that international tax systems had not kept pace with the development of international business structures and fluid movements of capital, and that gaps and mismatches had appeared which could be exploited by taxpayers. The BEPS project contained 15 actions, which were published as recommendations in October 2015. The BVCA responded to OECD consultations, and the UK’s implementation of these recommendations.

The BEPS project had 15 actions and the BVCA’s work focused on:

Action 2: Neutralising the effects of hybrid mismatch arrangements
Action 4: Limiting base erosion involving interest deductions and other financial benefits
Action 6: Preventing the granting of treaty benefits in inappropriate circumstances

BVCA Publications

BVCA Submissions

Action 4 – Limitation on interest deductions

BEPS Action 2 called for the development of model treaty provisions and recommendations regarding the design of domestic rules to neutralise the effects of hybrid instruments and entities. Specifically, this examined the use of hybrid instruments and hybrid entities to obtain tax advantages as a result of double deductions or a deduction with non-inclusion of income. The UK introduced anti-hybrid legislation in TIOPA 2010 Part 6A, which came into force on 1 January 2017, and HMRC published draft guidance and ran a consultation from 9 December 2016 to 10 March 2017. The BVCA was in regular dialogue with HMRC to ensure PE/VC funds were appropriately treated by the regime, and further changes were introduced to the guidance in the Finance Act 2021 which provided further reliefs for PE/VC funds.

Action 4 - The limitation interest deductibility

The OECD published recommendations aimed at limiting “base erosion” through interest deductions, setting out a fixed ratio rule to limit the deductibility of net interest costs to a percentage of EBITDA. The UK introduced a general corporate interest restriction in TIOPA 2010 Part 10, with effect from April 2017. Some of the BVCA’s representations were taken on board, including a higher de minimis, the 30% limit (within the suggested corridor of 10-30%) and a group ratio rule. The group ratio rule permits some groups that have genuine third-party debt and a higher level of external gearing to deduct interest in excess of the amount allowed under the fixed ratio rule (30%).

Action 6 - Preventing treaty abuse

Private equity and venture capital funds typically raise funds from investors and invest in companies in a broad range of jurisdictions. In our representations on Action 6 we reiterated why PE/VC funds by their very nature are not used as vehicles for tax avoidance and are different to multinational enterprises. In its 2017 consultations on the topic, the OECD stated that more work was required in respect of 'non-CIV funds' (i.e. alternative investment funds), which includes private equity funds. In summary, the OECD proposed two different approaches to amending tax treaties to prevent treaty abuse: the inclusion of a Limitation On Benefits (LOB) provision and a Principal Purpose Test (PPT). The OECD suggested that in some circumstances it would be appropriate for treaties to include both approaches, but that a minimum standard would be to adopt either the LOB or the PPT, along with some other changes to the standard treaty text. Our feedback on the drafting of the LOB and PPT is included in our submissions above.

Pillars One and Two: Challenges arising from the Digitalisation of the Economy

In 2019, the OECD launched a programme of work to address the tax challenges related to digitalisation of the economy. This project builds on the findings of Action 1 of the BEPS initiative and is organised into two pillars.

Pillar One focuses on the distribution of profits and taxing rights among countries with respect to the largest MNEs, including digital companies. The aim is to re-allocate some taxing rights over MNEs from their home countries to the markets where they have business activities and earn profits, regardless of whether they have a physical presence there. Pillar Two seeks to address the remaining BEPS issues and establish a global minimum effective corporate tax rate (a 15% minimum effective tax rate for companies with revenue above EUR 750m). Legislation to implement Pillar Two in the UK came into effect from January 2024.

The BVCA has made several representations to the OECD and to the UK government to ensure that PE/VC funds are not inappropriately targeted by these proposals, as they are not MNEs.