A report on base erosion and profit shifting (BEPS) commissioned by the G-20 has been published by the Organization for Economic Cooperation and Development (OECD). The report has already been considered by the G-20 at its mid-February meeting. The report highlights the main areas of concern and proposes a global action plan to deal with the problems.
The erosion of the tax base in major economies and the profit shifting from one jurisdiction to another (lower tax) jurisdiction are a well publicized problem of international taxation. Opportunities for such tax avoidance arise from a mismatch between the international tax rules and the current international economic realities. International tax rules developed at a time when there were fewer transactions between countries and before the development of the internet. Currently, the rise of electronic commerce and better communications generally have led to a much greater flow of international transactions and many of these now involve the use of intangible assets.
The first attempts to put together international tax rules were a response to the need to correctly allocate taxing rights between jurisdictions to avoid the possibility of double taxation or double non-taxation. These developments were seen as beneficial to international business and were seen as promoting economic growth. The interactions between domestic tax rules, including those in respect of international transactions, may however be exploited by multinational organizations to minimize their tax, an example being the use of hybrid entities and hybrid financial instruments to exploit differences between tax rules.
The OECD report looks at the available data in respect of the amount of base erosion and profit shifting occurring and considers the developments in the global economy that have influenced international corporate taxation. The report examines the fundamental principles of international taxation and considers how these may give rise to opportunities for base erosion and for profit shifting by multinational enterprises. For example, many tax systems give a tax deduction for interest payments but not for dividends distributed, thereby encouraging financing through debt and the development of transactions that may be characterized as interest when paid in one jurisdiction but as dividends in the jurisdiction where the income is received.
Increased transparency on the effective tax rates of multinational enterprises is required. The OECD report suggests that many multinational enterprises engage in strategies that enable them to pay rates of corporate tax as low as 5%, whereas smaller enterprises are required to pay tax at rates closer to 30%. These strategies may involve creating multiple subsidiaries in various countries to take advantage of favorable tax regimes, or claiming high expenses in high tax countries and declaring income in low tax jurisdictions. Such strategies by multinationals erode the tax base of many countries and are a threat to the stability and integrity of the international tax system.
The report identifies the key areas where action may be required to prevent base erosion. These include the inconsistency between tax jurisdictions in defining entities or financial instruments, leading to the use of hybrid instruments to avoid tax, and the tax treatment of intragroup transactions including debt financing. Further attention is required to transfer pricing in the area of the transfer of intangibles and risk, the ownership of assets within a group and the treatment of transactions within a multinational group that would not take place between independent entities. Tax rules also need to be updated to deal with the taxation of transactions involving electronic delivery of goods or services.
The continued existence of preferential tax regimes encourages base erosion and profit shifting and more work is required in this area with international coordination. Further examination needs to be given to the effectiveness of anti-avoidance measures such as controlled foreign company rules, thin capitalization measures, anti-treaty shopping measures or general anti avoidance rules.
A coordinated international approach is required to deal with the issues arising from base erosion and profit shifting. The report proposes the development of a comprehensive global action plan involving OECD member countries and non members. The plan would involve a detailed analysis of the relevant issues and the development of solutions that would lead to closer alignment of the international tax system with the economic realities of the global economic situation. Work already being conducted into relevant aspects of international taxation, such as the OECD work on transfer pricing and intangibles, will be accelerated where this is relevant to the global action plan.
