Global value chain integration a critical success factor in the new tax environment

June 10, 2015
More than ever, multinational enterprises are finding their global tax structures scrutinized by tax authorities, policymakers, the media, and the general public.

Dale W. Bond
Elizabeth A. Sweigart
PricewaterhouseCoopers LLP

Ben Lannan
Hamish J. McElwee
PricewaterhouseCoopers Australia

More than ever, multinational enterprises are finding their global tax structures scrutinized by tax authorities, policymakers, the media, and the general public. Much of this attention has been attributed to the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) Action Plan. Originally published in July 2013, the BEPS Action Plan addresses several areas of significance to offshore oil and gas companies-in particular, the contributions of risk, capital, and personnel to the global value chain-and raises questions as to whether established operating structures within the industry will continue to be respected from a tax perspective.

To succeed in this new tax regulatory milieu, offshore oil and gas companies should ensure that there is proper alignment between the way income is attributed across their global value chains and the underlying economic substance of their activities. Taking prompt action to address the potential challenges posed by the outcomes of the BEPS Action Plan is a critical success factor for offshore oil and gas companies in managing enterprise risk and enhancing stakeholder value.

The stated goal of the BEPS Action Plan is to provide a global framework for addressing perceived failings in international tax rules that tax authorities contend incorrectly allocate income and expense between different jurisdictions. Fundamentally, the OECD's objectives are to reduce incidents of double non-taxation (i.e., income that is not taxed in any country) and to better align the ultimate location of profits with the activity that created the value.

Aligning profit with value creation has long been an aim in structuring the tax affairs of offshore oil and gas companies. Historically, tax structures in the industry have followed the business organization and recognized the significant assets-such as mobile offshore drilling units, platforms, and floating production vessels-that drive enterprise revenues. Similarly, risk also has been linked closely with reward. Generally, this alignment has been reflected in the attribution of a greater share of profit (or loss) to the entities bearing the commercial risk as well as to the asset owners whose significant capital is at risk in harsh environments and, frequently, politically unstable locations.

When historical views of value creation in the industry are compared with the current tax policy environment, a potential dichotomy emerges. The BEPS approach represents a turn away from the established association of income with asset ownership and risk taking and toward rewarding labor and functional contributions. This change in approach is exemplified by the standardized data points that the OECD proposes for tax authorities to collect from multinational enterprises.

As part of their intercompany dealings-or transfer pricing-documentation, head companies soon will be required to prepare consolidated templates populated with information including revenue earned from related and third parties, headcount, and income taxes paid by jurisdiction. Tax authorities then would share this information to identify mismatches between business activity and income earned on a country-by-country basis. In isolation, however, these figures would be misleading at best for the offshore oil and gas industry.

For legitimate business reasons, significant capital assets in the offshore oil and gas industry often are owned by entities with few or no employees. In terms of value creation, these assets tend to be the significant revenue drivers. At the same time, the new thinking under BEPS postulates that personnel provide greater contributions to income generation. Again, the dynamics of the industry complicate the matter as both people and assets tend to be highly mobile.

Whether due to environmental conditions, political instability, or customer demands, rigs and other vessels frequently transfer between jurisdictions quickly, requiring corresponding movements of personnel and equipment. As a result, considering static data points related to short-term personnel headcount as a means of determining the appropriate level of income that should be earned in a particular jurisdiction is unlikely to produce an appropriate conclusion for oil and gas companies. This issue is exacerbated when considering the volatility that can exist in these returns in the short- to medium-term and the need for asset owners to take a long-term view on returns.

Other operating structures and norms within the industry also may attract attention in the future as a result of new thinking under BEPS. For instance, split contracts, which are frequently employed in the oil and gas sector to accommodate customer requirements or local content rules-in countries like Indonesia, Nigeria, and Brazil-are under review by some governments, which have expressed concern that such arrangements might inappropriately limit an enterprise's taxable presence in a country. Although the draft guidance explicitly states that the target is not legitimate operating structures driven by non-tax business purpose, in practice the new approach likely may not reach appropriate results, particularly as the broad policy intent of the OECD translates into practical application by local revenue authorities with their own interpretations and perspectives.

For example, due to local content rules, a drilling contractor may need to separate the rig charter from the provision of personnel, technical, administrative, and other services. As a result of the new BEPS guidance, the local tax authority may scrutinize this routine operating structure due to concerns that the contract splitting was intended to avoid the creation of a taxable presence in the country by the contractor.

Ultimately, although fundamental changes in tax administration and policy globally are creating uncertainty for offshore oil and gas companies, there are practical, positive steps that corporate leadership can take now to assess their readiness to operate in the new environment and, potentially, avail themselves of opportunities for greater efficiency in the future.

Oil and gas company leadership should involve corporate tax personnel early in the process of developing tenders and negotiating customer contracts with the goal of prospectively considering and addressing potential tax issues. Further, corporate tax personnel should monitor potential changes resulting from new legislation in the wake of BEPS in the jurisdictions in which the company operates and in which it intends to operate. By cooperating across corporate functions and appropriately engaging with external advisors, offshore oil and gas companies can position themselves to face the dynamic global tax landscape, take steps to proactively address enterprise risk, and drive greater value for their stakeholders. •