Base erosion and profit shifting — what the BEPS does it mean? Catherine Schultz is Vice-President of Tax Policy at the National Foreign Trade Council On July 19, 2013, the Organization for Economic Cooperation and Development (OECD) released the Base Erosion and Profit Shifting (BEPS) Action Plan. The BEPS project was born out of a growing concern about how large multinational enterprises handle their tax planning, and that aggressive tax minimization has led to base erosion and double non-taxation of certain corporate income. As governments desperately try to reduce large fiscal deficits against a backdrop of international fiscal turmoil, tax planning by large multinational corporations has been denounced as immoral and unpatriotic. Complex tax issues are often reduced to sound bites and facts are used selectively by politicians to make their case against perceived aggressive tax planning. The G-20 met in Mexico in June 2012, and instructed the OECD to undertake a study of base erosion and profit splitting. On February 13, 2013, the OECD released the first BEPS report. The report provided a comprehensive analysis of the current tax environment and considers how BEPS may be addressed. The report did not prescribe specific measures to deal with BEPS, but it suggested that changes to established tax principles are required that could have significant implications for international taxation. The report acknowledged that multinationals engage in entirely legal and legitimate tax planning and comply with the tax laws of the countries in which they do business. The report states that current international tax principles and approaches are no longer adequate to ensure a fair tax system in the current era of globalization and e-commerce. The report suggested that increased globalization requires changes to major international tax principles, including: 1) reconsideration of the balance between source and residence taxation; 2) better alignment of rights to tax with ‘real economic activity;’ 3) quick changes to existing tax treaty provisions where they present ‘difficulties;’ 4) calls for cooperation and action at both the OECD and national levels; 5) calls for ‘immediate’ action by tax administrators to improve ‘compliance;’ and 6) acknowledges the need for the OECD to hear input of ‘all stakeholders’ including the BRICS, business and civil society (non-governmental organizations). The key areas of concern pointed out in the report, were elaborated on in the BEPS Action Plan. The BEPS Action Plan released in July, calls for new international standards ‘to ensure the coherence of corporate income taxation at the international level’ and new transfer pricing rules that address the use of ‘intangibles, risk, capital and other high-risk transactions to shift profits.’ The Action Plan sets forth work to be done in 15 areas of law and tax practice. The Action Plan is supposed to be completed by the end of 2015, with the possibility that some of the work will take longer. The 15 BEPS action areas include: 1) tax challenges of the digital economy; 2) hybrid mismatch arrangements; 3) CFC rules; 4) the deductibility of interest and other financial payments; 5) harmful tax practices of countries; 6) tax treaty abuse; 7) artificial avoidance of permanent establishment (PE) status; 8) transfer pricing for intangibles; 9) transfer pricing for risks and capital; 10) transfer pricing for other high-risk transactions; 11) development of data on BEPS and actions addressing it; 12) additional disclosure of aggressive tax planning arrangements; 13) country-by-country transfer pricing documentation; 14) effectiveness of tax treaty dispute resolution mechanisms; and 15) the development of a multilateral instrument for amending bilateral tax treaties to implement measures developed in the course of the work on BEPS. The G-20 Finance Ministers meeting in Moscow supported the BEPS Action Plan. The G-20 leaders will meet in St Petersburg in early September, and are expected to support the Action Plan as well. The February BEPS report discussed certain studies focused on BEPS that analyzed the effective tax rates of multinationals in an attempt to demonstrate the existence of BEPS. The report concluded that there are few studies using the same method and it is difficult to show the existence of BEPS on the basis of effective tax rates since a low effective tax rate may be the result of tax incentives voluntarily created by governments to promote investment rather than aggressive tax planning. Some commenters believe that the US international tax system is riddled with loopholes that were not intended to allow base erosion. Conversely, some believe that because the United States has the highest corporate tax rate among OECD countries and a worldwide system of taxation, that the provisions were added to the tax code intentionally as relief valves so that American multinational corporations could better compete with companies who are in territorial tax systems that have lower effective tax rates. Some believe the rules were designed to be porous. It doesn’t matter if BEPS actually exists, there is a growing perception among governments that they are losing substantial revenue because of BEPS and that the rules must be changed. The issues surrounding the BEPS project are not new. For the past several years, before the on-set of the BEPS project, the OECD had already been doing a great deal of work in the various working parties on many of the items included in the BEPS Action Plan. Recent OECD reports on aggressive tax planning include: Tackling Aggressive Tax Planning Through Improved Transparency and Disclosure (2011), Corporate Loss Utilisation Through Aggressive Tax Planning (2011), Hybrid Mismatch Arrangements—Tax Policy and Compliance Issues (2012), Aggressive Tax Planning based on After-Tax Hedging (2013), the OECD Model Tax Convention: Revised Proposals Concerning the Interpretation and Application of Article 5 (Permanent Establishment (October 19 2012-January 2013), and the Discussion Draft on the Revision of the Special Consideration for Intangibles in Chapter VI of the OECD Transfer Pricing Guidelines and Related Provisions (June 6-September 2012). The OECD spent many years working on electronic commerce, including: OECD, Clarification on the Application of the Permanent Establishment Definition in E-Commerce: Changes to the Commentary on the Model Tax Convention Article 5 (December 2000). The OECD Working Party 6 continues to work on valuing risks, and ownership of intangibles, specifically looking at how you can accurately value risks and intangibles, which are inherently difficult to price and are very mobile. The OECD also has the work underway in Working Party One on the various tax treaty issues, including a 2010 Report on the Attribution of Profits to Permanent Establishment, and the discussion draft on the definition of ‘permanent establishment’. Now that the BEPS Action Plan has been released, where do we go from here? The BEPS Action Plan says that the work will largely be completed in a two-year period, with some actions identified as likely to be delivered over 12 to 18 months and others requiring more than two years. Once the Action Plan is completed, the actions must be accepted by all of the OECD and non-OECD countries especially if there are altered requirements for transfer pricing. In closed-door meetings, US Treasury officials say they are concerned that no harm is done to long-standing tax rules that work in the majority of situations. For example, the French government requested and strongly pushed for Action Item Number 1, calling for a task force to study the tax challenges of the digital economy. The French issued a report of the topic in January that called for a change to the OECD’s permanent establishment rules to create a ‘virtual establishment’ principle. A virtual PE would enable the OECD countries to tax companies in proportion to the volume of user data they use within those jurisdictions. The U.S. Treasury does not support that proposal, and feels no need to go along with a consensus that is unprincipled, or in its view, fundamentally wrong. The United States would like to strengthen the controlled foreign corporation (CFC) rules as part of the BEPS project. The United Kingdom, as part of its recent tax reform efforts, and in a lengthy consultation with the business community, revamped its CFC rules. The BEPS project may look to the UK rules as a model to follow, but if it the governments decide to take a different approach than the British CFC rules, would the British accept the BEPS changes? The British have also recently adopted a patent box as a way to attract more foreign direct investment. How willingly would the United Kingdom surrender these new changes to its tax code? Coming to agreement on BEPS could mean giving up some sovereignty on taxing rights. How likely is it that all of the G-20 governments supporting the BEPS Action plan will be willing to change their underlying tax laws to adopt changes they don’t support? In the United States, the House Ways and Means Committee and the Senate Finance Committee are considering reforming the US tax code. There are many political hurdles to tax reform, and it is unlikely that there will political agreement on tax reform in Congress in the next two years, before the 2014 elections. Chairman Dave Camp of the House Ways and Means Committee will be term limited out of the chairmanship at the end of 2014. Chairman Baucus of the Senate Finance Committee is retiring from the Senate at the end of 2014. There are great political differences between the Republican controlled House and the Democratic controlled Senate that will make the passage of tax reform very difficult. The Republicans would like to enact a revenue-neutral tax package. The Democrats would like to raise revenue to offset the current fiscal deficit. Neither side has shown any willingness to compromise on this revenue issue. The Obama Administration is very supportive of the BEPS project, but does not have tax reform as a high priority. Without a reform of the US tax system, many of the changes likely to result from the BEPS Action Plan will be difficult to enact in the United States. If changes are proposed through the adoption of an OECD multilateral tax treaty, there is no guarantee that the US Senate will be able to adopt that multilateral. There is an OECD multilateral convention on the exchange of information that is currently languishing in the US Senate, and any other multilateral will be difficult to adopt quickly. If the United States has political problems adopting the recommendations of the BEPS project, will the other OECD countries proceed without them? Many of the concerns of the OECD members involve US multinationals. Without changes in the US tax law, it will be hard to address the individual BEPS action items separately. Conclusion The media, governments and international organizations such as the OECD acknowledge that for the most part, multinational corporations are very concerned with respecting and conforming to the tax laws of the jurisdictions in which they operate. The OECD report on BEPS uses the example of how companies may operate in a jurisdiction without having a taxable presence in it, in order to demonstrate that today’s tax laws may not provide for a reasonable or fair allocation of taxing rights. The report reflects the position of several high-tax jurisdictions that some existing and accepted tax principles should be revised. Many countries deliberately create tax incentives in or to become more attractive to foreign investors. Multinational corporations are free to choose the territories in which they wish to establish. A lot of what is at the centre of the debate on corporate tax avoidance therefore comes down to companies responding to the tax incentives that have been introduced into the tax laws in the countries in which they operate. The BEPS project is in its early stages. Coming to consensus on the items included in the Action Plan could be difficult. It is hard to gauge how willing governments will be to change their tax rules to adopt any final BEPS recommendations if consensus is reached. How can the various governments be brought to a common understanding on tax rules, considering that in most countries, the tax regime in place reflects a policy designed to enhance that nation’s economic development? The answer remains elusive. The Obama Administration is very supportive of the BEPS project, but does not have tax reform as a high priority