Base Erosion & Profit Shifting – A Global ChallengeAtul Khurana
Base Erosion & Profit Shifting – A Global Challenge
“Recently more and more enterprises organised abroad by American firms have arranged their corporate structures aided by artificial arrangements between parent and subsidiary regarding intercompany pricing, the transfer of patent licensing rights, the shifting of management fees, and similar practices in order to reduce sharply or eliminate completely their tax liabilities both at home and abroad.”
So, Base erosion and profit shifting (BEPS) refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations. Under the inclusive framework, over 100 countries and jurisdictions are collaborating to implement the BEPS measures and tackle BEPS.
Background of the BEPS Project:
The Organization for Economic Co-operation and Development (OECD) has agreed a new framework that will allow all interested countries and jurisdictions to work jointly for the implementation of the package of measures against BEPS. This framework will bring together all interested countries and jurisdictions as Associates on an equal footing with OECD and G20 countries in the OECD’s Committee on Fiscal Affairs to develop international standards related to BEPS and to review and monitor the implementation of the whole BEPS package.
The proposal for broadening participation in the OECD/G20 BEPS Project was endorsed by the G20 Finance Ministers at their meeting in Shanghai, China and was welcomed by the G20 Finance Ministers and Central Bank Governors at their meeting on 14-15 April 2016 in Washington D.C.
What causes BEPS?
Corporate tax is levied at a domestic level. When activities cross border, 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.
Global Actions under this project:
Developed in the context of the OECD Project, the 15 actions set out below equip governments with domestic and international instruments to address tax avoidance, ensuring that profits are taxed where economic activities generating the profits are performed and where value is created:
ACTION 1: DIGITAL ECONOMY
ADDRESSING THE TAX CHALLENGES OF THE DIGITAL ECONOMY
Action 1 addresses the tax challenges of the digital economy and identifies the main difficulties that the digital economy poses for the application of existing international tax rules. The Report outlines options to address these difficulties, taking a holistic approach and considering both direct and indirect taxation.
ACTION 2: HYBRIDS
NEUTRALISING THE EFFECTS OF HYBRID MISMATCH ARRANGEMENTS
Action 2 develops model treaty provisions and recommendations regarding the design of domestic rules to neutralise the effects of hybrid instruments and entities (e.g. double non-taxation, double deduction, long-term deferral).
ACTION 3: CFC RULES
DESIGNING EFFECTIVE CONTROLLED FOREIGN COMPANY (CFC) RULES
Action 3 sets out recommendations to strengthen the rules for the taxation of controlled foreign corporations (CFC).
ACTION 4: INTEREST DEDUCTIONS
LIMITING BASE EROSION INVOLVING INTEREST DEDUCTIONS AND OTHER FINANCIAL PAYMENTS
Action 4 outlines a common approach based on best practices for preventing 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.
ACTION 5: HARMFUL TAX PRACTICES
COUNTERING HARMFUL TAX PRACTICES MORE EFFECTIVELY, TAKING INTO ACCOUNT TRANSPARENCY AND SUBSTANCE
Action 5 revamps the work on harmful tax practices with a focus on improving transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, and on requiring substantial activity for preferential regimes, such as IP regimes.
ACTION 6: TREATY ABUSE
PREVENTING THE GRANTING OF TREATY BENEFITS INAPPROPRIATE CIRCUMSTANCES
Action 6 develops model treaty provisions and recommendations regarding the design of domestic rules to prevent treaty abuse.
ACTION 7: PERMANENT ESTABLISHMENT STATUS
PREVENTING THE ARTIFICIAL AVOIDANCE OF PERMANENT ESTABLISHMENT STATUS
Action 7 contains changes to the definition of permanent establishment to prevent its artificial circonvention, e.g. via the use of commissionaire structures and the likes
ACTIONS 8-10: TRANSFER PRICING (Intangibles, Risks & Capital, High-Risk Transactions)
ALIGNING TRANSFER PRICING OUTCOMES WITH VALUE CREATION
Actions 8 – 10 contain transfer pricing guidance to assure that transfer pricing outcomes are in line with value creation in relation to intangibles, including hard-to-value ones, to risks and capital, and to other high-risk transactions.
ACTION 11: BEPS DATA ANALYSIS
MEASURING AND MONITORING BEPS
Action 11 establishes methodologies to collect and analyse data on BEPS and the actions to address it, develops recommendations regarding indicators of the scale and economic impact of BEPS and ensure that tools are available to monitor and evaluates the effectiveness and economic impact of the actions taken to address BEPS on an ongoing basis.
ACTION 12: DISCLOSURE OF AGGRESSIVE TAX PLANNING
MANDATORY DISCLOSURE RULES
Action 12 contains recommendations regarding the design of mandatory disclosure rules for aggressive tax planning schemes, taking into consideration the administrative costs for tax administrations and business and drawing on experiences of the increasing number of countries that have such rules.
ACTION 13: TRANSFER PRICING DOCUMENTATION
TRANSFER PRICING DOCUMENTATION AND COUNTRY-BY-COUNTRY REPORTING
Action 13 contains revised guidance on transfer pricing documentation, including the template for country-by-country reporting, to enhance transparency while taking into consideration compliance costs.
ACTION 14: DISPUTE RESOLUTION
MAKING DISPUTE RESOLUTION MECHANISMS MORE EFFECTIVE
Action 14 develops solutions to address obstacles that prevent countries from solving treaty-related disputes under MAP, via a minimum standard in this area as well as a number of best practices. It also includes arbitration as an option for willing countries.
ACTION 15: MULTILATERAL INSTRUMENT
MULTILATERAL CONVENTION TO IMPLEMENT TAX TREATY RELATED MEASURES TO PREVENT BEPS
Action 15 provides an analysis of the legal issues related to the development of a multilateral instrument to enable countries to streamline the implementation of the BEPS treaty measures. On 7 June 2017, over 70 Ministers and other high-level representatives participated in the signing ceremony of the Multilateral Instrument.
Global Challenges in this project:
The first step was to carry out an in-depth analysis of BEPS issues to identify what the problems are and the different factors that have determined them. For years the OECD has promoted dialogue and co-operation between governments on tax matters. There is the Model Tax Convention on Income and on Capital which forms the basis for negotiation of the more than 3,000 existing bilateral tax treaties in the world. There are the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, which embody the international standard to allocate profits among different parts of an MNE group. Several studies have been carried out on aggressive tax planning to help governments respond more quickly to tax risks. The Forum on Harmful Tax Practices has built support for fair competition and minimised tax-induced distortions, with more than 40 regimes identified over time as potentially harmful, all of which have been abolished or modified. And, of course, the work on tax policy and statistics, which has dealt with the effects of taxation on foreign direct investment and how to implement sensible corporate tax reforms.
Challenges of Digital Economy
These challenges relate to the allocation of taxing rights among countries – principally to when a non-resident should be taxed in a country on its business profits and the value of data, and how to allocate it for tax purposes.
The options include alternatives to the existing threshold for taxing non-residents (a “significant economic presence” test); the imposition of a withholding tax on certain types of digital transactions; and the introduction of an “equalisation levy.” At this stage, none of the options were adopted as internationally agreed standards. These conclusions may evolve as the digital economy continues to develop – in particular regarding robotics, the Internet of Things, 3D printing and the Sharing Economy – and will depend on the actual impact of other measures on BEPS issues. Countries therefore decided to continue monitoring developments in the digital economy and to take related decisions over time.
Next challenge: Inclusiveness, consistent implementation and monitoring impact :
Now that there is widespread agreement among countries on the measures to tackle BEPS, implementation becomes key. Work will be carried out to support interested countries, particularly those for which capacity building is an important issue, in implementing the rules and applying them in a consistent manner.
Some of the measures may be immediately applicable, such as the revised guidance on transfer pricing, while others require changes in domestic laws and in bilateral tax treaties. Action 15 provides for the development of a multilateral instrument to enable jurisdictions to implement the treaty measures agreed upon in the course of the BEPS Project and amend their networks of bilateral tax treaties. To date, about 90 countries have joined the Group as members, and 5 regional tax organisations have joined as observers.
Monitoring implementation and the impact of the different BEPS measures is another key element of the BEPS implementation phase. Following the G20 and OECD call for even increased inclusiveness, a new framework for monitoring BEPS will be conceived and put in place, with all interested countries participating on an equal footing. Monitoring the impact of the BEPS measures will likely include assessing the implementation of the minimum standards agreed in the areas of treaty abuse, dispute resolution, country-by-country reporting and harmful tax practices, as well as of the other BEPS measures, together with the monitoring of their overall impact and effectiveness.
Tax Evasion has proved to be the biggest reason behind the poor economical status of the countries. The governments at their domestic levels always tried to control this problem but the evasions’ has reached the international level now and affecting the world at large. This BEPS project of OECD is a need of time and if the BEPS project is implemented successfully will be a great reform which will help the nations in boosting up their economies.
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