Base erosion and profit shifting (OECD project)

The Base Erosion and Profit Shifting (BEPS) Project is an ongoing project headed by the OECD that aims to set up an international framework to combat tax avoidance by multinational enterprises (MNEs).^[1] The project, under the jurisdiction of the OECD’s Committee on Fiscal Affairs, began in 2013 and originally only involved OECD and G20 countries.^[2] Currently, the contents of the framework are complete; the project is now in its implementation phase, and more than 100 countries are involved.^[3]

Content

Aim

The aim of the project is to mitigate tax code loopholes and country-to-country inconsistencies so that corporations cannot shift profits from a country with a high corporate tax rate to countries with a low tax rate, known as tax havens. The practice is usually legal, but often involves complex maneuvers within tax law. BEPS is costly for all parties involved, save the firm. A conservative estimate has annual tax revenue losses at 240 billion USD due to profit shifting around the globe.^[2] A study by the Tax Justice Network estimated that around 660 billion USD of corporate profits were shifted in 2012.^[4] In developed countries like those comprising the OECD, BEPS undermines the integrity of tax systems. In developing countries, where there is heavy reliance on corporate taxes, revenues are trimmed, leaving states underfunded and underinvested.^[5]

Furthermore, the project serves as an alternative to the deterioration of international tax norms. The project’s Action Plan states that a failure to address BEPS would spawn “the emergence of competing sets of international standards, and the replacement of the current consensus-based framework by unilateral measures, which could lead to global tax chaos marked by the massive re-emergence of double taxation."^[5] In this respect, the BEPS project serves as an example of cooperation in game theory. The project prevents both double taxation and double non-taxation, as well as countries undercutting others by lowering tax rates to attract business. Countries cooperating yields a better outcome than noncooperation.

Inclusive Framework

In October 2015, after two years of negotiations and development, a 15-point Action Plan was announced by the OECD and G20 to address BEPS.^[2] However, at a conference in 2016, it was deemed necessary that for an effective international tax framework, developing countries must be involved.^[6] To gain membership, non-OECD/G20 countries must commit to the BEPS package, a plan to “equip government with domestic and international instruments to address tax avoidance, ensuring that profits are taxed where economic activities generating the profits are performed and where value is created.”^[7] All countries in the framework work on equal footing to set minimum standards for the international tax framework. The package consists of 15 action plans that standardize tax codes, treaties, and data sharing, among other provisions. A fee must be paid for membership as well (discounted for developing countries). As of April 2017, 96 countries had signed on to the project.^[8]

BEPS Well Known Examples

A spate of BEPS scandals in the past decade has served as an impetus for the OECD’s action. The largest firms are often U.S. companies avoiding the high (35%) corporate tax rate in the United States. The following are prominent examples of the corporate behavior this project seeks to eliminate.

• Apple Inc. – Apple found a gap in U.S. and Irish tax law that allowed it to set up a subsidiary to shift profits to in Ireland, which taxed the corporation as little as 3%, despite having little economic activity there. The European Union recently ordered Apple to pay 14 billion USD in back taxes.^[9]
• Alphabet Inc.- Alphabet listed its taxable address in Bermuda to shift most of its profits to the tax haven. In 2015, they reported saving 3.6 billion USD using the technique.^[10]
• Caterpillar Inc.- Despite its concentrated economic activity in the U.S., Caterpillar shifted its profits to Switzerland, where its income was taxed at 4-6%. It is estimated that Caterpillar saved more than 2.4 billion USD from 2002 to 2012.^[11]

Structure

The BEPS project consists of 15 Action Plans, agreed to by all partcipating countries who have committed to consistent implementation. Some measures can be used immediately, others require renegotiating bilateral tax treaties.^[12]

Action Plan

Action 1: Address the Digital Economy

• The BEPS project recommends avoiding new direct taxes on digital activity, and expects other Actions to be generalized to tackle the digital economy as well.
• For indirect taxes, a shift to tax collection in the jurisdiction of consumption is recommended.
• This Action also paves the way for more taxes to be collected on low-value e-commerce transactions by shifting value added tax obligations to the vendor.^[13]

Action 2: Hybrids

• Advises the creation of domestic mismatching rules, which addresses the different treatment of corporate taxable activity by nations.
• Recommends tax treaty provisions that eliminate issues like double nontaxation or double deduction.^[5]

Action 3: Controlled Foreign Companies (CFC) Rules

• Seeks to establish a standard definition of a CFC and its income, and proposes rules that eliminate mismatches or holes that allow CFCs to shift income elsewhere.^[13]

Action 4: Interest Deductions

• Outlines a common approach to end base erosion by interest deduction rules for eligible MNEs.
• Suggests rules that account for a firm’s debt level and interest deductions, creating a ratio standard that prevents MNE from favorable tax deductions.^[14]

Action 5: Harmful Tax Practices

• Allows for a methodology that assesses harmful tax practices, like preferential regimes.
• Creates a framework for compulsory spontaneous exchange of information regarding tax rulings and practices.^[15]

Action 6: Treaty Abuse

• Creates several provisions for a minimum standard to combat treaty shopping that all participating countries have agreed to implement.
• Suggests specific anti-abuse rules be included in domestic legislation.^[16]

Action 7: Permanent Establishment Status

• Greatly expands the definition of a permanent establishment to counter MNE tactics used to avoid having a taxable presence in a country.^[17]

Actions 8-10: Transfer Pricing

• Moves to align transfer pricing outcomes with value creation.
• Creates stronger guidelines to transactions involving the transfer pricing of intangibles and contractual arrangements.^[18]

Action 11: BEPS Data Analysis

• Establishes the synchronization of data collection, which indicators to look to, and methodologies to analyze data.^[13][19]

Action 12: Disclosure of Aggressive Tax Planning

• Recommends mandatory disclosure of aggressive tax planning to increase transparency.^[5]

Action 13: Transfer Pricing Documentation

• Guidelines for documentation of transfer pricing, including country-to-country disclosure.^[5]

Action 14: Dispute Resolution

• Stipulates minimum standards for treaty disputes and arbitration.^[5]

Action 15: Multilateral Instrument

• Lays out the legal and technical difficulties the BEPS project faces in its mission to create a multilateral tax framework.^[5]

References