There is a growing perception that governments lose substantial corporate tax revenue because of planning aimed at shifting profits in ways that erode the taxable base to locations where they are subject to a more favourable tax treatment. Recent news stories show increased attention mainstream media has been paying to corporate tax affairs. Civil society and non-governmental organisations (NGOs) have also been vocal in this respect, sometimes addressing very complex tax issues in a simplistic manner and pointing fingers at transfer pricing rules based on the arm’s length principle as the cause of these problems. In this article, an attempt has been made to explain the background of a very ambitious and important BEPS Project undertaken by OECD. In addition, brief description of the task and issues of all the 15 Action Plans alongwith the time line and present status has been given for an understanding of the same.
1. Background on BEPS
Base erosion and profit shifting (BEPS) is a global problem which requires global solution. BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid. BEPS is of major significance for developing countries due to their heavy reliance on corporate income tax, particularly from multinational enterprises (MNEs).
In an increasingly interconnected world, national tax laws have not always kept pace with tax planning by global corporations, fluid movement of capital, and the rise of the digital economy, leaving gaps that can be exploited to generate double non-taxation. This undermines the fairness and integrity of tax systems.
This increased attention and the inherent challenge of dealing comprehensively with such a complex subject has encouraged a perception that the domestic and international rules on the taxation of cross-border profits are now broken and that taxes are only paid by the naive. Multinational enterprises (MNEs) are being accused of dodging taxes worldwide, and in particular in developing countries, where tax revenue is critical to foster long term development.
Business leaders often argue that they have a responsibility towards their shareholders to legally reduce the taxes their companies pay. Some of them might consider most of the accusations unjustified, in some cases deeming governments responsible for incoherent tax policies and for designing tax systems that provide incentives for Base Erosion and Profit Shifting (BEPS). They also point out that MNEs are still sometimes faced with double taxation on their profits from cross-border activities, with mutual agreement procedures sometimes unable to resolve disputes among governments in a timely manner or at all.
The debate over BEPS has also reached the political level and has become an issue on the agenda of several OECD and non-OECD countries. The G20 leaders meeting in Mexico on 18-19 June 2012 explicitly referred to “the need to prevent base erosion and profit shifting” in their final Declaration. This message was reiterated at the G20 finance ministers meeting of 5-6 November 2012, in the final communiqué.
The European Commission presented an Action Plan on 17-06-2015 to fundamentally reform corporate taxation in the EU. The Action Plan sets out a series of initiatives to tackle tax avoidance, secure sustainable revenues and strengthen the Single Market for businesses. The measures to be developed complement the work carried out in the OECD/G20 BEPS Project, whose outputs are expected to be presented to the G20 in October 2015.
1.1 Legality and issues relating to BEPS
Corporate tax is levied at a domestic level. When MNEs undertake activities across borders, the interaction of domestic tax systems means that an item of income can be taxed by more than one jurisdiction, thus resulting in double taxation. The interaction can also leave gaps, which result in income not being taxed anywhere. BEPS strategies take advantage of these gaps between tax systems in order to achieve double non-taxation or very low taxation.
Although some schemes used are illegal, most are not. Largely they just take advantage of current rules that are still grounded in a bricks and mortar economic environment rather than today’s environment of global players which is characterised by the increasing importance of digital economy, e-commerce, intangibles and risk management.
A question arises for consideration: if the BEPS strategies/ schemes are considered to be legal, then why should anyone worry about BEPS. There are three important factors in this regard. First, because it distorts competition: businesses that operate cross-border may profit from BEPS opportunities, giving them a competitive advantage over enterprises that operate at the domestic level. Second, it may lead to inefficient allocation of resources by distorting investment decisions towards activities that have lower pre-tax rates of return, but higher after-tax returns. Finally, it is an issue of fairness: when taxpayers (including ordinary individuals) see multinational corporations legally avoiding income tax, it undermines voluntary compliance by all taxpayers.
1.2 Importance of BEPS Project now and OECD’s role in addressing BEPS
The OECD has been providing solutions to tackle aggressive tax planning over the years. The debate and concern over BEPS has now reached the highest political levels in many OECD and non-OECD countries. The OECD does not see BEPS as a problem created by one or more specific companies. Apart from some cases of very bad and easily noticed abuses, the issue lies with the tax rules themselves. Business cannot be faulted for making use of the rules that governments have put in place. It is therefore governments’ responsibility to revise the rules or introduce new rules.
Many BEPS strategies take advantage of the interaction between the tax rules of different countries, which means that unilateral action by individual countries will not fully address the problem. In addition, unilateral and uncoordinated actions by governments responding in isolation could result in double – and possibly multiple – taxation for business. This would have a negative impact on flow of capital and technology, investment, growth and employment globally. There is therefore a need to provide an internationally coordinated approach which will facilitate and reinforce domestic actions to protect tax bases and provide comprehensive international solutions to respond to the issue. The BEPS Action Plan provides a consensus-based plan to address these issues and is part of the OECD’s ongoing efforts to ensure that the global tax architecture is equitable and fair.
1.3 BEPS Action Plans
It sets forth 15 actions to address BEPS in a comprehensive and coordinated way. These actions will result in fundamental changes to the international tax standards and are based on three core principles: coherence, substance, and transparency. The Action Plan also calls for further work to address the challenges posed by the digital economy. Looking toward innovative approaches to deliver change quickly, the Action Plan calls for a multilateral instrument that countries can use to implement the measures developed in the course of the work. While the OECD steps up its efforts to address double nontaxation, it will also continue work to eliminate double taxation, including through increased efficiency of mutual agreement procedures and arbitration provisions.
In July 2013, the Action Plan on Base Erosion and Profit Shifting directed the OECD to commence work on 15 actions designed to ensure the coherence of corporate income taxation at the international level. The first seven of these actions were presented to G20 Leaders at the Brisbane Summit in November 2014.
1.4 Actions plans being carried out in the context of BEPS
Domestic tax systems are coherent – tax deductible payments by one person results in income inclusions by the recipient. We need international coherence in corporate income taxation to complement the standards that prevent double taxation with a new set of standards designed to avoid double non-taxation. Four actions in the BEPS Action Plan (Actions 2, 3, 4, and 5) focus on establishing this coherence.
Current rules work well in many cases, but must be modified to prevent instances of BEPS. The involvement of third countries in the bilateral framework established by treaty partners puts a strain on the existing rules, in particular when done via shell companies that have little or no economic substance: e.g. office space, tangible assets, business operations and employees. In the area of transfer pricing, rather than replacing the current system, the best course is to fix the flaws in it, in particular with respect to returns related to over-capitalisation, risk and intangible assets. Nevertheless, special rules, either within or beyond the arm’s length principle, may be required with respect to these flaws. Five actions in the BEPS Action Plan focus on aligning taxing rights with substance (Actions 6, 7, 8, 9, and 10).
Because preventing BEPS requires greater transparency at many levels, the Action Plan calls for: improved data collection and analysis regarding the impact of BEPS; taxpayers’ disclosure about their tax planning strategies; and less burdensome and more targeted transfer pricing documentation. Four actions in the BEPS Action Plan focus on improving transparency (actions 11, 12, 13, and 14).
The brief description, timeline and present status of the Action plans are given in para 2 below.
1.5 Implementation of the BEPS actions
The BEPS Action Plan calls for the development of tools that countries can use to shape fair, effective and efficient tax systems. Because BEPS strategies often rely on the interaction of countries’ different systems, these tools will have to address the gaps and frictions that arise from the interaction of these systems. Some actions, for example, work on the OECD Transfer Pricing Guidelines and the Commentary to the OECD Model Tax Convention, will result in changes that are directly effective. Others will be implemented by countries through their domestic law, bilateral treaties, or a multilateral instrument.
1.6 Time frame for action plans
Addressing BEPS is critical for most countries and must be done in a timely manner so that concrete actions can be delivered quickly before the existing consensus-based framework unravels. At the same time, governments need time to complete the necessary technical work and achieve widespread consensus. Against this background, it is expected that the Action Plan will largely be completed within 2 years of its adoption. Indeed, the first set of measures and reports was released in September 2014, just 12 months after the launch of the BEPS project. Work on the reports to be delivered in 2015 has already started, and this work will continue at a fast pace to ensure the rapid development of concrete measures that countries can use to end double non-taxation and base erosion due to artificial shifting of profits.
1.7 Role of the G20 in BEPS project
Since its launch by the OECD, the work on BEPS received strong and consistent support by the G20 and it is a key item on the Finance Ministers’ and Leaders’ agendas.
Furthermore, all G20 countries have participated as equal partners in the development of the work. Their continued participation and endorsement at the highest levels of government have been critical to guarantee a level playing field and prevent inconsistent standards.
The delivery of the 2014 BEPS outputs is concrete evidence of how OECD and G20 members working together can achieve consensus on important tax reforms with a worldwide impact. Non-OECD G20 countries are Associates in the BEPS Project and participate on an equal footing in the decision making process, at the level of both the OECD Committee on Fiscal Affairs and of its subsidiary bodies carrying out the technical work. In addition, other countries and stakeholders have engaged in regular and fruitful dialogues throughout this process.
1.8 BEPS action plan and Tax competition Taxation is at the core of countries’ sovereignty, and each country is free to set up its corporate tax system as it chooses, including by charging the rate it chooses. The work is not aimed at restricting the sovereignty of countries over their own taxes; instead, it is aimed at restoring and strengthening sovereign taxing rights by ensuring that countries can protect their tax bases. It does so by addressing regimes that apply to mobile activities and that unfairly erode the tax bases of other countries, potentially distorting the location of capital and services.
1.9 Risk of not addressing harmful Tax Practices
The dangers of not addressing harmful tax practices can be felt both by governments and business. Firstly, harmful tax competition can introduce distortions and an unlevel playing field between businesses operating at domestic level and those that operate globally and have access to preferential tax regimes. Secondly, countries have long recognised that a “race to the bottom” would ultimately drive applicable tax rates on certain sources of income to zero for all countries, whether or not this is the tax policy a country wishes to pursue.
1.10 BEPS action plan & “Tax Havens”
The BEPS Action Plan aims to end the use of shell companies used to stash profits offshore or unduly claim tax treaty protection and neutralise all schemes that artificially shift profits offshore. Though the BEPS Action Plan is not about dictating whether countries should have a specific corporate income tax rate, it will have an impact on regimes that seek to attract foreign investors without requiring any economic substance.
1.11 Is BEPS effectively a tax increase on multinationals?
The BEPS project is not about increasing corporate taxes. Non- or low-taxation is not itself the concern, but it becomes so when it is achieved through practices that artificially separate taxable income from the activities that generate it. These strategies may increase tax disputes as countries fight against tax strategies that defy common sense. Implementation of the recommendations coming out of the BEPS project will reduce those disputes, giving business greater certainty, and reinforcing the fairness and consistency of international tax system.
1.12 Involvement of businesses and civil society in BEPS project
During the course of the work so far, stakeholders have been consulted at length. Discussion drafts released during the course of the work so far have generated more than 3,500 pages of comments, and have attracted a large number of participants at various public consultations. The OECD’s public webcasts of these consultations and updates on the project have attracted more than 10,000 viewers. This transparent and inclusive consultation process will continue throughout the course of the work.
1.13 BEPS action plan and offshore Tax Evasion
The work on BEPS focusses largely on legal tax planning techniques rather than offshore tax evasion, which is illegal. However, other work being carried out by the OECD and the OECD Global Forum on Transparency and the Exchange of Information is focused on combatting offshore tax evasion. More information about this work can be found on line at www.oecd.org/tax/exchange-of-tax¬information.
2. Brief description, timeline and present status of the BEPS action plans
2.1 Action 1 – Address the tax challenge of the digital economy
a) Anticipated result: Report identifying issues raised by the digital economy and possible actions to address them
b) initial deadline: September 2014
c) Present status: Final Report Issued.
d) Description of tasks and issues:
Identify the main difficulties that the digital economy poses for the application of existing international tax rules and develop detailed options to address these difficulties, taking a holistic approach and considering both direct and indirect taxation.
Issues to be examined include, but are not limited to, the ability of a company to have a significant digital presence in the economy of another country without being liable to taxation due to the lack of nexus under current international rules, the attribution of value created from the generation of marketable location relevant data through the use of digital products and services, the characterisation of income derived from new business models, the application of related source rules, and how to ensure the effective collection of VAT/GST with respect to the cross- border supply of digital goods and services. Such work will require a thorough analysis of the various business models in this sector.
2.2 Action 2 – Neutralise the effects of hybrid mismatch arrangements
a) Anticipated result: Changes to the Model Tax Convention Recommendations regarding the design of domestic rules.
b) initial deadline: September 2014
c) Present status: Comments on discussion draft received and published.
d) Description of tasks and issues:
Develop model treaty provisions and recommendations regarding the design of domestic rules to neutralise the effect (e.g. double non-taxation, double deduction, long- term deferral) of hybrid instruments and entities.
This may include: (i) changes to the OECD Model Tax Convention to ensure that hybrid instruments and entities (as well as dual resident entities) are not used to obtain the benefits of treaties unduly; (ii) domestic law provisions that prevent exemption or non-recognition for payments that are deductible by the payer; (iii) domestic law provisions that deny a deduction for a payment that is not includible in income by the recipient (and is not subject to taxation under controlled foreign company (CFC) or similar rules); (iv) domestic law provisions that deny a deduction for a payment that is also deductible in another jurisdiction; and (v) where necessary, guidance on coordination or tie-breaker rules if more than one country seeks to apply such rules to a transaction or structure. Special attention should be given to the interaction between possible changes to domestic law and the provisions of the OECD Model Tax Convention. This work will be co-ordinated with the work on interest expense deduction limitations, the work on CFC rules, and the work on treaty shopping.
2.3 Action 3 –Strengthen CFC rules
a) Anticipated result: Recommendations regarding the design of domestic rules.
b) initial deadline: September 2015
c) Present status: Comments on discussion draft received and published.
d) Description of tasks and issues:
Develop recommendations regarding the design of controlled foreign company rules. This work will be coordinated with other work as necessary.
2.4 Action 4 – Limit base erosion via interest deductions and other financial payments
a) Anticipated result: (i) Recommendations regarding the design of domestic rules.
(ii) Changes to the Transfer Pricing Guidelines
b) initial deadline: (i) September 2015 and (ii) December 2015, respectively.
c) Present status: Comments on discussion draft received and published.
d) Description of tasks and issues:
Develop recommendations regarding best practices in the design of rules to prevent base erosion through the use of interest expense, for example through the use of related- party and third-party debt to achieve excessive interest deductions or to finance the production of exempt or deferred income, and other financial payments that are economically equivalent to interest payments.
The work will evaluate the effectiveness of different types of limitations. In connection with and in support of the foregoing work, transfer pricing guidance will also be developed regarding the pricing of related party financial transactions, including financial and performance guarantees, derivatives (including internal derivatives used in intra-bank dealings), and captive and other insurance arrangements. The work will be coordinated with the work on hybrids and CFC rules.
2.5 Action 5 – Counter harmful tax practices more effectively, taking into account transparency and substance
a) Anticipated result: (i) Finalise review of member country regimes; (ii) Strategy to expand participation to non OECD members; and (iii) Revision of existing criteria.
b) initial deadline: (i) September 2014; (ii) September 2015; and (iii) December 2015, respectively.
c) Present status: Interim report issued; deadline for second output September 2015 (engaging with other non-OECD member countries on the basis of the existing framework).
d) Description of tasks and issues:
Revamp the work on harmful tax practices with a priority on improving transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, and on requiring substantial activity for any preferential regime. It will take a holistic approach to evaluate preferential tax regimes in the BEPS context. It will engage with non-OECD members on the basis of the existing framework and consider revisions or additions to the existing framework.
2.6 Action 6 – Prevent treaty abuse
a) Anticipated result: (i) Changes to the Model Tax Convention; and (ii) Recommendations regarding the design of domestic rules.
b) initial deadline: For both (i) & (ii) September 2014.
a) Present status: First Discussion draft released on 21-11-2014. Based on the Comments received, a new discussion draft released on 22- 5-2015, for Public Comments by 17-06- 2015. Comments on the revised discussion draft have been received and published on 18-06-2015.
c) Description of tasks and issues:
Develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances. Work will also be done to clarify that tax treaties are not intended to be used to generate double non-taxation and to identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country. The work will be coordinated with the work on hybrids.
2.7 Action 7 – Prevent the artificial avoidance of PE status
b) Anticipated result: Changes to the Model Tax Convention.
c) initial deadline: September 2015
d) Present status: First Discussion draft released on 31-10-2014. Based on the Comments received, a new discussion draft released on 15- 05-2015, for Public Comments by 12-06- 2015. Comments have been received and published on 15-06-2015.
e) Description of tasks and issues:
Develop changes to the definition of PE to prevent the artificial avoidance of PE status in relation to BEPS, including through the use of commissionaire arrangements and the specific activity exemptions.
Work on these issues will also address related profit attribution issues.
2.8 Action 8 – Assure that transfer pricing outcomes are in line with value creation: intangibles
a) Anticipated result: (i) Changes to the Transfer Pricing Guidelines and possibly to the Model Tax Convention; and (ii) Changes to the Transfer Pricing Guidelines and possibly to the Model Tax Convention.
b) initial deadline: (i) September 2014; and (ii) September 2015, respectively.
c) Present status: Discussion draft released. Comments received and published on discussion draft on Actions 8, 9 and 10. Detailed discussion draft on Cost Contribution Arrangements also released. Comments on discussion draft on Cost Contribution Arrangements have been received and published on 01-06-2015. Comments on discussion draft on Action 8 (Hard-to-value intangibles) have been received and published. Public consultation on discussion draft will be held on 6-7 July 2015.
d) Description of tasks and issues:
Develop rules to prevent BEPS by moving intangibles among group members. Phase:
I. (i) adopting a broad and clearly delineated definition of intangibles;
(ii) ensuring that profits associated with the transfer and use of intangibles are appropriately allocated in accordance with (rather than divorced from) value creation;
II. (iii) developing transfer pricing rules or special measures for transfers of hard-to-value intangibles; and
(iv) updating the guidance on cost contribution arrangements.
2.9 Action 9 – Assure that transfer pricing outcomes are in line with value creation: risks and capital
a) Anticipated result: Changes to the Transfer Pricing Guideline and possibly to the Model Tax Convention.
b) initial deadline: September 2015.
c) Present status: Discussion draft released. Comments received and published on discussion draft on Actions 8, 9 and 10.
d) Description of tasks and issues: Develop rules to prevent BEPS by transferring risks among, or allocating excessive capital to, group members. This will involve adopting transfer pricing rules or special measures to ensure that inappropriate returns will not accrue to an entity solely because it has contractually assumed risks or has provided capital. The rules to be developed will also require alignment of returns with value creation. This work will be coordinated with the work on interest expense deductions and other financial payments.
2.10 Action 10 – Assure that transfer pricing outcomes are in line with value creation: other high-risk transactions
a) Anticipated result: Changes to the Transfer Pricing Guideline and possibly to the Model Tax Convention.
b) initial deadline: September 2015.
c) Present status: Discussion drafts released. Comments received and published on discussion draft on Actions 8, 9 and 10. Comments also received and published on Action 10: low-value adding services, Cross-border commodity transactions and Use of profit Splits in the context of the global value chains.
d) Description of tasks and issues:
Develop rules to prevent BEPS by engaging in transactions which would not, or would only very rarely, occur between third parties. This will involve adopting transfer pricing rules or special measures to:
(i) clarify the circumstances in which transactions can be recharacterised;
(ii) clarify the application of transfer pricing methods, in particular profit splits, in the context of global value chains; and
(iii) provide protection against common types of base eroding payments, such as management fees and head office expenses.
2.11 Action 11 – Establish methodologies to collect and analyse data on bEPS and the actions to address it
a) Anticipated result: Recommendations regarding data to be collected and methodologies to analyse them.
b) initial deadline: September 2015.
c) Present status: Discussion draft released. Comments on discussion draft received and published.
d) Description of tasks and issues:
Develop recommendations regarding indicators of the scale and economic impact of BEPS and ensure that tools are available to monitor and evaluate the effectiveness and economic impact of the actions taken to address BEPS on an ongoing basis. This will involve developing an economic analysis of the scale and impact of BEPS (including spillover effects across countries) and actions to address it.
The work will also involve assessing a range of existing data sources, identifying new types of data that should be collected, and developing methodologies based on both aggregate (e.g. FDI and balance of payments data) and micro- level data (e.g. from financial statements and tax returns), taking into consideration the need to respect taxpayer confidentiality and the administrative costs for tax administrations and businesses.
2.12 Action 12 – require taxpayers to disclose their aggressive tax planning arrangements
a) Anticipated result: Recommendations regarding the design of domestic rules
b) initial deadline: September 2015
c) Present status: Discussion draft released. Comments on discussion draft received and published.
d) Description of tasks and issues:
Develop recommendations regarding the design of mandatory disclosure rules for aggressive or abusive transactions, arrangements, or structures, taking into consideration the administrative costs for tax administrations and businesses and drawing on experiences of the increasing number of countries that have such rules. The work will use a modular design allowing for maximum consistency but allowing for country specific needs and risks. One focus will be international tax schemes, where the work will explore using a wide definition of “tax benefit” in order to capture such transactions. The work will be coordinated with the work on co-operative compliance. It will also involve designing and putting in place enhanced models of information sharing for international tax schemes between tax administrations.
2.13 Action 13 – Re-Examine transfer pricing documentation
a) Anticipated result: Changes to Transfer Pricing Guidelines and recommendations regarding the design of domestic rules.
b) initial deadline: September 2014
c) Present status: Discussion draft released. Comments on discussion draft received and published. A Country-by-Country Reporting Implementation package developed under the OECD/G20 BEPS Project has been released on 08-06-2015.
d) Description of tasks and issues:
Develop rules regarding transfer pricing documentation to enhance transparency for tax administration, taking into consideration the compliance costs for business. The rules to be developed will include a requirement that MNE’s provide all relevant governments with needed information on their global allocation of the income, economic activity and taxes paid among countries according to a common template.
2.14 Action 14 – Make Dispute resolution mechanisms more effective
a) Anticipated Result: Changes to the Model Tax Convention
b) Initial Deadline: September 2015
c) Present Status: Discussion draft released. Comments on discussion draft received and published.
d) Description of tasks and issues:
Develop solutions to address obstacles that prevent countries from solving treaty-related disputes under MAP, including the absence of arbitration provisions in most treaties and the fact that access to MAP and arbitration may be denied in certain cases.
2.15 Action 15 – Develop a multilateral instrument
a) Anticipated Result: (i) Report identifying relevant public international law and tax issues; and (ii) Develop a multilateral instrument.
b) Initial Deadline: (i) September 2014; and (ii) December 2015, respectively.
c) Present Status: (i) Final Report issued.
d) Description of tasks and issues:
Analyse the tax and public international law issues related to the development of a multilateral instrument to enable jurisdictions that wish to do so to implement measures developed in the course of the work on BEPS and amend bilateral tax treaties.
On the basis of this analysis, interested Parties will develop a multilateral instrument designed to provide an innovative approach to international tax matters, reflecting the rapidly evolving nature of the global economy and the need to adapt quickly to this evolution.
In the next part(s), we would discuss the various other aspects relating to BEPS Project including engagement with developing countries and impact on Non-G 20 or Non- OECD countries.
