International tax rules, many of which were first designed over a century ago, have failed to keep up with globalisation and technological change. Today, they have begun to reveal weaknesses that legally allow companies to record profits, and consequently their taxes, in lower tax jurisdictions where their businesses are present. This profit shifting has eroded sovereign tax bases, and weakened the hand of already struggling public authorities. Businesses have an obligation to maximise profits for their shareholders, so the burden of action falls on governments to fix their tax systems and work together to forge a global approach that reflects today’s financial world. At the request of G20 finance ministers, the OECD has produced its 15-point Action Plan on Base Erosion and Profit Shifting (BEPS) that will help ensure that multinationals pay their fair share of taxes.
The following points present a summary of these. For the full text issued in July 2013, visit www.oecd.org/ctp/beps.htm
ACTION 1: Address the tax challenges of the digital economy. A dedicated task force will identify the issues raised by the digital economy and possible actions to address them. Work will focus on a thorough analysis of the different business models, the ever-changing business landscape and a better understanding of the generation of value in this sector, including from an indirect tax point of view.
ACTION 2: Neutralise the effects of hybrid mismatch arrangements. Mismatches in the way countries’ tax laws treat entities and instruments can allow companies to claim multiple deductions for the same economic expense or cause taxable income to disappear. This action will result in treaty and domestic law provisions to neutralise these schemes.
ACTION 3: Strengthen controlled foreign companies (CFC) rules. One of the sources of BEPS concerns is the possibility of creating offshore entities and routing income through them to escape taxation in the country of the shareholder. Strong CFC rules can address this issue by including the income of these offshore entities in the shareholder’s income on a current basis.
ACTION 4: Limit base erosion via interest deductions and other financial payments. Some companies use excessive interest deductions to erode their taxable profits, or use debt (which generates interest expense deductions) to finance the production of tax-exempt income. This action will result in rules to prevent BEPS through the use of interest expense and other financial payments.
ACTION 5: Counter harmful tax practices more effectively. Countries have long recognised that a “race to the bottom” would ultimately drive applicable tax rates on certain mobile sources of income to zero for all countries, whether or not this was the tax policy a country wished to pursue. This action will result in revamping the work on harmful tax practices, with a focus on the transparency of the regimes and the economic substance required to benefit from them.
Aligning taxation and substance
ACTION 6: Prevent treaty abuse. While tax treaties are designed to prevent double taxation, in some cases they are used to create double non-taxation, in particular through the use of conduit companies set up in a third country (i.e., not the country of the investor or that of the investment). This action will result in provisions that prevent the granting of treaty benefits in inappropriate circumstances.
ACTION 7: Prevent the artificial avoidance of permanent establishment (PE) status. Under the international standard, a country may not tax the business profits of a foreign company unless the company has a PE in that country. If the company is not taxed on those profits in its jurisdiction of residence, double non-taxation results. This action will result in changes to the definition of PE to prevent the artificial avoidance of PE status in relation to BEPS.
ACTIONS 8, 9 and 10: Ensure that transfer pricing outcomes are in line with value creation in respect of: intangibles; risks and capital; and other high-risk transactions. Transfer pricing rules serve to allocate income earned by a multinational enterprise (MNE) among the countries in which the MNE does business. In some cases, MNEs have been able to use and/or misapply the existing rules to separate income from the economic activities that produce that income. This most often involves transfers of intangibles or other mobile assets, over-capitalisation of group companies, and contractual allocations of risk. These actions will result in rules to prevent BEPS through transfers of intangibles, through transfers of risk or excessive allocations of capital, or through transactions which would not, or would only very rarely, occur between third parties. Ensuring transparency while improving certainty
ACTION 11: Establish methodologies to collect and analyse data on BEPS and the actions taken to address it. This action will identify tools to monitor and evaluate the effectiveness and economic impact of the actions taken to address BEPS, including its spill-over effects.
ACTION 12: Require taxpayers to disclose their aggressive tax planning arrangements. Improved disclosure measures can help tax administrations and tax policymakers to identify emerging risk areas, and also serve as a deterrent to those companies wishing to engage in aggressive planning. This action will result in mandatory disclosure rules targeting these kinds of arrangements.
ACTION 13: Re-examine transfer pricing documentation. While taxpayers are often required to produce voluminous documents regarding their transfer pricing arrangements, in many situations the information does not help tax administrators develop a “big picture” of a taxpayer’s global arrangements. This action will result in rules regarding transfer pricing documentation that enhance transparency for tax administrations while taking into account compliance costs for business, and will include a requirement that MNEs provide all relevant governments with needed information on their global allocation of income, economic activity, and taxes paid on a country-by- country basis.
ACTION 14: Make dispute resolution mechanisms more effective. The actions to counter BEPS must be complemented with actions to ensure the certainty and predictability needed to promote investment in today’s environment. This action will ensure such certainty by developing solutions to address obstacles that prevent countries from solving treaty-related disputes.
ACTION 15: Develop a multilateral instrument. Changes to the OECD Model Tax Convention are not directly effective without amendments to bilateral tax treaties. A multilateral instrument to amend bilateral treaties is a promising way forward and work has started on the development of such an instrument, in order to be ready for swiftly incorporating changes.
For more information on the OECD Action Plan on BEPS, contact Raffaele Russo at the OECD
See also OECD (2013) Taxing Multinational Enterprises: Base Erosion and Profit Shifting (BEPS),
© OECD Observer No 295 Q2 2013