The OECD agreed with surprising speed on a fix for multinational tax avoidance through profit shifting. Now, can it make its solution stick?
By Chris Wright
Has there ever been a global tax initiative as bold as the base erosion and profit shifting project – swiftly abbreviated to BEPS? Led by the Organisation for Economic Co-operation and Development (OECD), it is an attempt to rewrite the rules of global taxation in a hundred places at once, to change the behaviour of the world’s most powerful multinationals, and to do so at uncommon speed.
However, no project as ambitious as this one achieves its objectives without some casualties.
BEPS refers to tax avoidance by multinational companies, usually by shifting profits from a high-tax jurisdiction – often the US or a European country – to one with low or no tax. It has risen to prominence in part because of growing evidence that some of the world’s most profitable companies, including Google, Apple and Ikea, are shifting profits in this way.
These problems have worsened with the development of the digital economy, which can make profit shifting simpler. In the post-global financial crisis world, where every dollar matters to an economy a little more than it once did, governments can no longer overlook the issue.
“For decades, countries have entered into tax treaties to stop double taxing of the same profits,” says Paul Drum, head of policy at CPA Australia.
“The BEPS agenda is about ensuring that, as well as there being no double taxation, there is no double non-taxation.”
Driven by a sense of injustice
For people in countries that lose from BEPS activity, this tax avoidance looks unfair. They miss out on corporate tax revenue and their domestically focused companies are left at a competitive disadvantage to a tax-dodging international giant. On top of that, individuals may lose faith in the fairness of their tax system. For instance, a 2016 BDO survey of Australians found multinational profit shifting ranked as the number one tax issue requiring reform.
The latest case to concentrate attention on the problem is Apple, ordered by the European Commission (EC) in August to pay €13 billion in back taxes to Ireland. That case was a consequence of an investigation by European Competition commissioner Margrethe Vestager and was driven by the application of trade laws rather than tax. Nevertheless, it brought into the public eye Apple’s routing of much of its global profits through Ireland, which levies one of the developed world’s lowest corporate tax rates.
“BEPS ensures tax planning is part of the boardroom conversation.” Paul Drum, CPA Australia
This is the core problem that the OECD-led reforms seek to solve. The issue seems set to remain in the public eye, with media reports claiming that the EC is going after McDonald’s and Amazon next.
Pascal Saint-Amans is director of the Centre for Tax Policy and Administration at the OECD and the driving force behind the BEPS initiative. He argues that just as ordinary people object to the wealthy getting away with paying no tax because of bank secrecy, they also object to multinationals shirking tax.
As he points out, none of the OECD’s national legislatures has ever decided to exempt multinationals from paying tax. The “international framework of obscure tax rules” has simply made it possible for such companies to arrange their affairs so as to avoid incurring tax bills.
In February 2013, the OECD set up a project to do something about BEPS. It moved surprisingly quickly to produce an agreed solution: by October 2016, it had produced more than 1600 pages in its “final” reports on 15 BEPS action items. The next step, says Saint-Amans, is “all about proper implementation – we need to make sure all the countries implement minimum standards consistently”. This, he says, will involve a multilateral effort to limit the risk of people acting unilaterally.
Making it work
This creates a new problem. Countries will inevitably ratify and enact policy at different speeds, according to their progress through legislatures. Worse, some countries, including the US, UK and Australia, have chosen to do their own thing in parallel with, or ahead of, the OECD measures. Some observers now expect a period where global rules on multinational taxation are unclear and penalties are applied unexpectedly.
“We expect there will be situations where, as a consequence of countries moving at different speeds, there may be double, triple and quadruple taxation before we see the end of this,” says Drum.
He cites the example of an Australian company that has used Singapore as a marketing hub and paid tax on cross-border transactions in Singapore, rather than in Australia, at Singapore’s lower tax rate.
“If Australia then applies its diverted profits rule because it looks like a sham to them, and calls for tax to be paid in Australia, Singapore might not want to give up the tax they’ve already collected on that,” says Drum. In that instance, a company would be taxed twice in two countries for the same income.
Base erosion and profit shifting: Join David Bradbury as he discusses some of the key principles behind the OECD BEPS strategy
Concerns about this have been widespread throughout the BEPS discussion process and will come to a head with implementation. New Zealand’s Office of the Minister of Revenue warned in May 2016 that if individual nations are left to implement the OECD plan as they see fit, “it could actually make the problem worse or potentially cripple businesses who would face double or triple taxation as governments scramble to protect their own tax bases”.
The idea has also caused alarm for some corporates. “If the rules become more ambiguous and complex, and less-aligned – all of which appears to apply to the BEPS project – this will undoubtedly lead to more conflict and double taxation,” says Jesper Barenfeld, head of corporate tax at AB Volvo, speaking to EY’s Tax Insights for Business Leaders publication.
Sometimes, concerns relate to specific points that might yet be addressed. EY, for instance, highlights the US Government’s draft limitation on benefits rule, intended to block profit-shifting by companies that set up a shell company solely to avoid or minimise tax. EY says this rule “will result in double taxation on income that has already been taxed at operating company level – and triple taxation if ultimate shareholder taxation is included”.
EY also raises concerns about transfer pricing treatment of capital-rich companies that fund risk-taking opportunities but have little other relevant economic activity. Further, it says that an uncertain environment for cross-border financial payments “may well lead in some cases to double taxation”.
“The next step is about proper implementation – we need to make sure all the countries implement minimum standards consistently.” Pascal Saint-Amans, OECD
Concerns like this have also been voiced for some time by the real estate and investment trust industries, which manage cross-border flows into investment vehicles. In May 2014, representatives of the sector wrote to the OECD spelling out an example of a Luxembourg SICAV (société d’investissement à capital variable) scheme investing in French, German and Spanish shopping centres via local companies. “For taxable investors, there is even triple taxation,” said the submission to the OECD. “The property income is taxed in the hands of the local [property companies], non-creditable withholding tax is levied from the Luxembourg investment holding company, and corporate income tax will be due on the distribution of the proceeds at the level of taxable investors.”
Many global tax experts are confident that these issues can eventually be worked out. They say concerns about double taxation tend to arise in quite specific technical circumstances and are likely to be a temporary fixture of a new regime coming into place around the world. The OECD measures “may result in double taxation in the short term while the lines are redrawn and thought through,” says Grant Wardell-Johnson, global spokesman on BEPS at KPMG.
There are two main areas where the rules could strike trouble, explains Wardell-Johnson. The first is the expansion of permanent establishment, a definition which helps determine whether tax is to be paid in a partiular jurisdsdiction. BEPS expands the notion of a taxable presence in a country with very specific words, “but different countries will have different interpretations of those words”. The second potential trouble spot is the issue of intangibles in transfer pricing.
“There is increasingly a divide between developing and developed countries on where value is located in relation to intangibles,” says Wardell-Johnson. Take a handbag with a registered trademark in Switzerland.
“The West would think that’s where its value is; developing countries like China would say the value is the capacity to sell the product into the Chinese market. There is an inherent tension here that has not yet been worked out.”
View from the companies
Companies are taking a close look at what BEPS is going to mean for them as it moves toward implementation. In a 2016 Deloitte survey, 63 per cent of respondents said they were expecting significant legislative and treaty changes in their country as a consequence. Just over half had developed new corporate policies and procedures, and 55 per cent had changed the way they conduct tax planning for cross-border transactions. More than 90 per cent of respondents said they felt tax structures were under greater scrutiny by tax administrations than a year earlier.
Companies at once need to be across the nuts and bolts of legislation and the abiding spirit of the times. “You can see BEPS as a set of rules, or you can see it as a milieu, a general change in the way tax is viewed,” says Wardell-Johnson. Many multinationals will need to rethink their structures and how they do business.
BEPS has been a rapid response to a widely perceived injustice. “It took a major crisis for people to react,” says Saint-Amans, “but now it has strong political support that has helped to move things that people otherwise thought would never move.”
Drum adds: “BEPS ensures tax planning is part of the boardroom conversation.” Yet the reform’s greatest challenge – implementation – still mostly lies ahead. “Companies need to have a much better grasp of what BEPS means,” says Drum. “There are going to be risks, there are going to be double and triple taxation scenarios and there are going to be tears. It’s likely to be a tax lawyer’s picnic.”
Recent BEPS cases
The European Commission (EC) has taken the lead in contesting what it sees as BEPS activity by multinationals, pursuing them under European Union rules against state aid. Among its early targets:
Fiat: The EC found that a 2012 Luxembourg tax ruling had unduly reduced a Fiat subsidiary’s tax burden since 2012 by €20 million-€30 million.
Starbucks: An EC investigation showed that a Dutch tax ruling issued in 2008 had reduced a Starbucks subsidiary’s tax burden since 2008 by €20 million-€30 million.
Apple: The EC found in 2016 that Ireland had granted undue tax benefits of up to €13 billion to Irish-registered Apple subsidiaries that have the rights to use Apple’s intellectual property to make and sell its products outside the Americas. This allegedly allowed Apple to pay substantially less tax than other businesses.
BEPS consensus success
Whatever its short-term problems, most observers rate the BEPS process as easier and clearer than expected.
It embraces not just the 34 OECD countries and two further “accession countries”, but many others who’ve had a say without committing in full – in total, about 100 countries have been involved. They had to reach consensus rather than vote.
Given all that, KPMG’s Grant Wardell-Johnson calls the result “quite remarkable”. “It could have disintegrated into a fight between certain developing and developed countries trying to relitigate the basic divide between source and residence taxation,” he says. “It is very beneficial to the whole project that the framework of international tax rules remains largely the same, and what changes there are, are mainly within that framework.”
OECD plans to make corporations pay tax