International Tax Reform– Mitigating Corporation Tax Avoidance Schemes– BEPS: Bring Transparency to Global Tax Systems…

Tackling corporate tax avoidance schemes in the global economy is a high international priority: Tax evasion and tax avoidance reduce government revenues, which has a significant detrimental effect on the provision for infrastructures, public services, public utilities… Almost half of all global commerce passes through tax havens in spite of the fact that they account for about 3% of global GDP…

According to J.G. Gravelle; multinational enterprises are shifting profits from jurisdictions with high-tax rates to jurisdictions with low-tax, and shifting debt from low tax rates to high tax jurisdictions… there are other creative schemes used by multinational enterprises to avoid paying a ‘fair’ share of taxes…

The Organization of Economic Development and Cooperation (OECD) estimates about $US100 billion to $US240 billion annually is lost due to array of tax avoidance schemes devised by multinational enterprises… The OECD, acting at the request of the G20, released an action plan to address concerns over ability of multinational enterprises to minimize taxation through sophisticated tax planning schemes and thus reduce tax revenues in affected jurisdictions…

The diminution of a nation’s tax base through tax  avoidance schemes is known as ‘base erosion’. Broadly, ‘base erosion’ occurs when multinationals locate profits in low-tax jurisdictions. The legal practice, known as ‘profit shifting’, diminishes tax base of corporations and thus tax receipts of nations that might otherwise claim taxes on corporations’ profitable activity…

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As a counter measure to these tax avoidance schemes, the OECD initiated an ‘action plan’ known as ‘Base Erosion and Profit Shifting’ (BEPS). This ‘action plan’ or BEPS project, sets forth a number of areas of concern and corresponding approaches to reduce ‘double non-taxation’, and ‘double taxation’ of corporate and individual income…

The OECD’s recent report identified the following 6 elements as key drivers of BEPS:

(1) hybrids and mismatches which generate arbitrage opportunities– differences in the tax treatment or transfers between two or more countries;

(2) residence-source tax balance, in context of the digital economy;

(3) intra-group financing, with companies in high-tax countries being loaded with debt;

(4) transfer pricing issues such as treatment of group synergies, location -specific savings;

(5) effectiveness of anti-avoidance rules, which are often watered down because of heavy lobbying and competitive pressure;

(6) existence of preferential regimes.

According to Ian Shane; in theory this mean that multinational enterprises operating cross-borders must make changes in their operations, but don’t get too excited just yet… Each country that sign-up to the BEPS rules (90 nations have signed-up) must enact legislation to bring the rules into effect and amend their individual tax treaties with other countries…

And the exact form in which the new rules are to be enacted is up to each country… and at present time many countries have only agreed to apply a minimum standard to some parts of the proposed new BEPS regime. Also, participating countries are not obliged to implement certain parts of the BEPS plan, such as; curbs on tax deductibility of interest payments… At least for the present, there is no need for cross-border business to do anything, but watch this space; however, change is coming and it means tighter international tax rules…

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In the article What is the Purpose of BEPS? by Patrick Love writes: Some multinational enterprises that are worth billions pay practically no taxes in countries where they operate and make profits… Not because they are defrauding the system, but because tax systems simply have not kept-up with innovations in the digital economy, e.g.; added value, profits on intangible assets, licensing, even exploiting personal data… Multinationals avoid paying– what most citizens would consider– ‘fair’ taxes through; ‘tax base erosion and profit shifting’ or BEPS, as OECD calls it. BEPS schemes can be extremely complicated, but the basic idea is simple; shift profits across borders to take advantage of tax rates that are lower than in the country where the profit is made. Three popular schemes include:

  • Hybrid Mismatches is when multinational enterprises try to have the same money or transaction treated differently– e.g.;  as debt or equity– by different countries so as to avoid paying taxes, and often they feature dual residency– companies that are residents of two countries for tax purposes…
  • Special Purpose Entities (SPE) is when multinational enterprises have– no or few employees, little or no physical presence in a host country, and the assets and liabilities represent investments-in or from other countries… and the core business consists of group financing or holding activities…
  • Transfer Prices is when multinational enterprises’ various parts of the enterprise pays each other for goods or services received. Through transfer prices profits are allocated among the different parts of the enterprise in different countries… also they are used to determine the amount of tax the multinational pays, and to which tax administration. There is not a simple method for calculating a transfer price and the lack of good ‘comparables’ often results in profits being artificially shifted to ‘no- or low-tax’ jurisdictions…

International tax rules are generally efficient in ensuring that multinational enterprises are not subject to double-taxation, but some multinationals takes advantage of gaps in the rules to avoid paying tax completely, so-called ‘double non-taxation’… In this scenario multinational pay a sum across two or more countries that is less than what they would pay in a single country. Multinationals tax avoidance harms everybody: Governments lose revenue and may have to cut public services and increase taxes on everybody else…

And, business suffer too, e.g.; small and new businesses working mainly in one national market cannot compete with  multinationals  that are continually shifting profits across borders to avoid or reduce tax… Hence, purpose of BEPS is to provide greater transparency to mitigate the growing disconnect between where money and investments are made, and where  multinationals report profits for tax purposes…

In the article Why BEPS is Game Changer by Nieuwsbericht writes: BEPS is game changer for two main reasons: First, BEPS is the first substantial move ‘in almost a century’ to align the international tax standards with the globalization of international business. One may argue that governments will always lag the speed and creativity with which multinational enterprises adjust to changing regulation. However, this misses the point; BEPS signals that governments around the world are beginning to work together to adapt to new realities… And even more importantly, governments expect multinational enterprise to demonstrate responsible business conduct, even when it comes to taxation.

Second, BEPS is an unprecedented process in which OECD and G20 countries are working together on creating a new international tax standards and all participating countries are engaged on an equal footing… dealing with highly complicated, controversial topics. Even though the initial drive came from the G20, technical work is being shared by an extended OECD Committee, which includes; both emerging and developing countries participating equally… Hence, this new found– co-operative, co-ownership, equality-based initiative between countries may very well provide an excellent best-practice model for other complicated policy issues outside the tax area…

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In the article BEPS Tax Storm Is Coming by Joe Harpaz writes: BEPS is a set of reforms currently on the way to becoming one of multinationals’ biggest challenges… but few people outside of the geekiest recesses of tax policy are even aware of its existence… At its root, BEPS lays-out a series of actions designed to realign tax policies with the realities of the global economy…

The most significant of these suggests is that multinationals must file detailed tax reports in every country where they do business; they have never had to do that before… Previously, multinationals had to show only the transaction flow from one country to another. Now, the full details of each multinational tax payments to each country will be available globally in a standardized, shareable template. Beyond that, the new reporting guideline will require– financial, sales, personnel information… to help countries determine the value of the operations within their borders and how that should be reflected in taxes for that jurisdiction…

It’s important to note the unique nature of the OECD and the role it plays in the global marketplace: BEPS is just a series of suggestions made by a consortium of global government representatives, which has no real legislative authority… Although OECD does have a clear-cut agenda and detailed deadlines it hopes to meet with its BEPS ‘action plan’… the passage, enforcement of these guidelines are left to individual countries…

Hence, sensing this burgeoning tax issue will blossom into something bigger, some multinational enterprises are already adjusting policies, e.g.; Amazon announced it will change the way it accounts for revenue from retail sales in EU: Under new arrangement, Amazon will book all revenue from retail sales in each countries, rather than routing the profits through Luxembourg (as it has been doing), which has the lowest corporate tax rate in the EU…

It’s still too early to determine if other multinationals will follow, but one thing is clear: multinationals will have to provide unprecedented  level of tax transparency…

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Overall multinational enterprises have welcomed efforts to bring greater clarity to the international tax system. However, some are growing concerned about how the project is shaping-up: The International Chamber of Commerce (ICC) for instance has affirmed its ‘active engagement’ in the BEPS project, however, the ICC warns that it’s ‘crucial’ for both OECD member states and non-members to reach agreement on BEPS project’s outcomes to avoid inconsistencies and conflicts between the national tax regimes and to reduce double taxation… Whether or not the BEPS project succeeds in substantially reducing opportunities for ‘base erosion and profit shifting’ in the international tax system remains to be seen. However, it’s clear that unprecedented change is going to take place to the international tax landscape in months and years ahead and multinational enterprises must be alert to these developments…