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Base Erosion and Profit Shifting

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Marianne Ojo D Delaney (PhD)

This document discusses base erosion and profit shifting (BEPS), which refers to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no tax locations. While not all schemes are illegal, BEPS undermines tax system fairness. The document outlines why BEPS poses risks to tax revenues, sovereignty, and fairness. It argues that international tax rules have not kept up with changing business environments like global value chains. A holistic and coordinated global approach is needed to comprehensively address BEPS through improved transparency, consistency in entity and instrument characterization, transfer pricing rules, and anti-avoidance measures.

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BASE EROSION AND PROFIT SHIFTING FUNDAMENTAL AND SUBSTANTIVE ISSUES PROF MARIANNE OJO
DEFINITION ? ¡°BASE EROSION AND PROFIT SHIFTING (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. ALTHOUGH SOME OF THE SCHEMES USED ARE ILLEGAL, MOST ARE NOT. THIS UNDERMINES THE FAIRNESS AND INTEGRITY OF TAX SYSTEMS BECAUSE BUSINESSES THAT OPERATE ACROSS BORDERS CAN USE BEPS TO GAIN COMPETITIVE ADVANTAGE OVER ENTERPRISES THAT OPERATE AT A DOMESTIC LEVEL. ¡° (OECD)
INTRODUCTION ? WHILST MANY WAYS EXIST WHEREBY DOMESTIC TAX BASES ARE SUBJECT TO BEING ERODED, A PRINCIPAL SOURCE OF BASE EROSION IS PROFIT SHIFTING. ? BASE EROSION PRESENTS A VITAL AND IMPORTANT ISSUE FOR THE FOLLOWING REASONS: ? ITS THREAT AS A SERIOUS RISK TO : ? TAX REVENUES, ? TAX SOVEREIGNTY AND: ? TAX FAIRNESS
FUNDAMENTAL POLICY ISSUE ? - THE INTERNATIONAL COMMON PRINCIPLES DRAWN FROM NATIONAL EXPERIENCES TO SHARE TAX JURISDICTION MAY NOT HAVE KEPT PACE WITH THE CHANGING BUSINESS ENVIRONMENT. ? - DOMESTIC RULES FOR INTERNATIONAL TAXATION AND INTERNATIONALLY AGREED STANDARDS ARE STILL GROUNDED IN AN ECONOMIC ENVIRONMENT CHARACTERIZED BY A LOWER DEGREE OF ECONOMIC INTEGRATION ACROSS BORDERS ¨C RATHER THAN TODAY¡¯S ENVIRONMENT OF GLOBAL TAXPAYERS, CHARACTERIZED BY THE INCREASING IMPORTANCE OF INTELLECTUAL PROPERTY AS A VALUE DRIVER, AND BY CONSTANT DEVELOPMENTS OF INFORMATION AND COMMUNICATION DEVELOPMENT.
SOME SELECTED MAJOR AREAS FOR CONSIDERATION AND FOCUS: ADDRESSING BEPS ? NEED FOR INCREASED TRANSPARENCY IN RESPECT OF TAX RATES OF MULTINATIONAL ENTERPRISES ? GREATER FOCUS ON INTERNATIONAL MISMATCHES IN ENTITY AND INSTRUMENT CHARACTERIZATION (HYBRID MISMATCH ARRANGEMENTS AND ARBITRAGE) ? TRANSFER PRICING ? IMPROVING TAX COMPLIANCE ON-SHORE AND OFF-SHORE ? TAX TREATMENT OF RELATED PARTY DEBT FINANCING ? EFFECTIVENESS OF ANTI AVOIDANCE MEASURES AND RULES TO PREVENT TREATY TAX ABUSE
NEED FOR HOLISTIC AND COORDINATED APPROACH ? - HOLISTIC APPROACH URGENTLY AND PRINCIPALLY REQUIRED TO ADDRESS THE ISSUE OF BEPS. GOVERNMENT ACTIONS SHOULD BE COMPREHENSIVE AND ROBUST IN DEALING WITH DIFFERENT ASPECTS OF THE ISSUE ¨C FOR EXAMPLE, THE BALANCE BETWEEN SOURCE AND RESIDENCE TAXATION, TAX TREATMENT OF INTRA GROUP FINANCIAL TRANSACTIONS, THE IMPLEMENTATION OF ANTI ABUSE PROVISIONS (INCLUDING CFC LEGISLATION) AS WELL AS TRANSFER PRICING RULES. ? - NEED FOR COORDINATED APPROACH SINCE MANY BEPS STRATEGIES TAKE ADVANTAGE OF THE INTERFACE BETWEEN TAX RULES OF DIFFERENT COUNTRIES, AND SINCE IT MAY BE DIFFICULT FOR A SINGLE INDIVIDUAL COUNTRY, ON ITS OWN, TO ADDRESS THE ISSUE IN ITS ENTIRETY. ? - COLLABORATION AND COORDINATION WOULD NOT ONLY FACILITATE AND REINFORCE DOMESTIC ACTIONS TO PROTECT TAX BASES, BUT WOULD ALSO BE CRUCIAL AND VITAL TO PROVIDING COMPREHENSIVE INTERNATIONAL SOLUTIONS THAT MAY RESPOND FAIRLY TO ADDRESS THE ISSUE.
THE RELEVANCE OF GLOBAL VALUE CHAINS (I) ? - RISE OF GLOBAL VALUE CHAINS (GVCS) HAS ALTERED THE LANDSCAPE OF WHAT ECONOMIES DO AND WHAT THEY PRODUCE OR GENERATE. ? - INCREASINGLY LESS RELEVANT TO TALK ABOUT GROSS GOODS OR SERVICES THAT ARE EXPORTED ? - MORE INCREASINGLY RELEVANT TO TALK ABOUT STAGES OF PRODUCTION
THE RELEVANCE OF GLOBAL VALUE CHAINS (II) ? - FROM AN ECONOMIC POINT OF VIEW, MOST OF THE VALUE OF A GOOD OR SERVICE IS TYPICALLY CREATED ALONG WITH UPSTREAM ACTIVITIES (WHERE PRODUCT DESIGN, R&D OR PRODUCTION OF CORE COMPONENTS OCCUR); ? OR FROM THE TAIL-END DOWN-STREAM ACTIVITIES (WHERE MARKETING OR BRANDING OCCURS) ? - KNOWLEDGE BASED ASSETS SUCH AS INTELLECTUAL PROPERTY, SOFTWARE AND ORGANIZATIONAL SKILLS HAVE BECOME INCREASINGLY IMPORTANT FOR PURPOSES OF COMPETITIVENESS, ECONOMIC GROWTH AND EMPLOYMENT
REFERENCES ? OECD (2013), ADDRESSING BASE EROSION AND PROFIT SHIFTING, OECD PUBLISHING ? HTTP://DX.DOI.ORG/10.1787/9789264192744-EN
SUGGESTED READING ? AULT, H. J., SCHON, W. & SHAY, S. E. (2014). BASE EROSION AND PROFIT SHIFTING: A ROAD MAP FOR REFORM ? GARBARINO, C. (2014). THE USE OF CROSS BORDER CORPORATE PROFITS AND LOSSES AND ¡°GLOBAL CORPORATE TAX INFORMATION¡±: A GAM THEORY APPROACH ? KEIGHTLEY, M. P. & STUPAK, J. M. (2015). CORPORATE TAX BASE EROSION AND PROFIT SHIFTING (BEPS): AN EXAMINATION OF THE DATA

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Base Erosion and Profit Shifting

  • 1. BASE EROSION AND PROFIT SHIFTING FUNDAMENTAL AND SUBSTANTIVE ISSUES PROF MARIANNE OJO
  • 2. DEFINITION ? ¡°BASE EROSION AND PROFIT SHIFTING (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. ALTHOUGH SOME OF THE SCHEMES USED ARE ILLEGAL, MOST ARE NOT. THIS UNDERMINES THE FAIRNESS AND INTEGRITY OF TAX SYSTEMS BECAUSE BUSINESSES THAT OPERATE ACROSS BORDERS CAN USE BEPS TO GAIN COMPETITIVE ADVANTAGE OVER ENTERPRISES THAT OPERATE AT A DOMESTIC LEVEL. ¡° (OECD)
  • 3. INTRODUCTION ? WHILST MANY WAYS EXIST WHEREBY DOMESTIC TAX BASES ARE SUBJECT TO BEING ERODED, A PRINCIPAL SOURCE OF BASE EROSION IS PROFIT SHIFTING. ? BASE EROSION PRESENTS A VITAL AND IMPORTANT ISSUE FOR THE FOLLOWING REASONS: ? ITS THREAT AS A SERIOUS RISK TO : ? TAX REVENUES, ? TAX SOVEREIGNTY AND: ? TAX FAIRNESS
  • 4. FUNDAMENTAL POLICY ISSUE ? - THE INTERNATIONAL COMMON PRINCIPLES DRAWN FROM NATIONAL EXPERIENCES TO SHARE TAX JURISDICTION MAY NOT HAVE KEPT PACE WITH THE CHANGING BUSINESS ENVIRONMENT. ? - DOMESTIC RULES FOR INTERNATIONAL TAXATION AND INTERNATIONALLY AGREED STANDARDS ARE STILL GROUNDED IN AN ECONOMIC ENVIRONMENT CHARACTERIZED BY A LOWER DEGREE OF ECONOMIC INTEGRATION ACROSS BORDERS ¨C RATHER THAN TODAY¡¯S ENVIRONMENT OF GLOBAL TAXPAYERS, CHARACTERIZED BY THE INCREASING IMPORTANCE OF INTELLECTUAL PROPERTY AS A VALUE DRIVER, AND BY CONSTANT DEVELOPMENTS OF INFORMATION AND COMMUNICATION DEVELOPMENT.
  • 5. SOME SELECTED MAJOR AREAS FOR CONSIDERATION AND FOCUS: ADDRESSING BEPS ? NEED FOR INCREASED TRANSPARENCY IN RESPECT OF TAX RATES OF MULTINATIONAL ENTERPRISES ? GREATER FOCUS ON INTERNATIONAL MISMATCHES IN ENTITY AND INSTRUMENT CHARACTERIZATION (HYBRID MISMATCH ARRANGEMENTS AND ARBITRAGE) ? TRANSFER PRICING ? IMPROVING TAX COMPLIANCE ON-SHORE AND OFF-SHORE ? TAX TREATMENT OF RELATED PARTY DEBT FINANCING ? EFFECTIVENESS OF ANTI AVOIDANCE MEASURES AND RULES TO PREVENT TREATY TAX ABUSE
  • 6. NEED FOR HOLISTIC AND COORDINATED APPROACH ? - HOLISTIC APPROACH URGENTLY AND PRINCIPALLY REQUIRED TO ADDRESS THE ISSUE OF BEPS. GOVERNMENT ACTIONS SHOULD BE COMPREHENSIVE AND ROBUST IN DEALING WITH DIFFERENT ASPECTS OF THE ISSUE ¨C FOR EXAMPLE, THE BALANCE BETWEEN SOURCE AND RESIDENCE TAXATION, TAX TREATMENT OF INTRA GROUP FINANCIAL TRANSACTIONS, THE IMPLEMENTATION OF ANTI ABUSE PROVISIONS (INCLUDING CFC LEGISLATION) AS WELL AS TRANSFER PRICING RULES. ? - NEED FOR COORDINATED APPROACH SINCE MANY BEPS STRATEGIES TAKE ADVANTAGE OF THE INTERFACE BETWEEN TAX RULES OF DIFFERENT COUNTRIES, AND SINCE IT MAY BE DIFFICULT FOR A SINGLE INDIVIDUAL COUNTRY, ON ITS OWN, TO ADDRESS THE ISSUE IN ITS ENTIRETY. ? - COLLABORATION AND COORDINATION WOULD NOT ONLY FACILITATE AND REINFORCE DOMESTIC ACTIONS TO PROTECT TAX BASES, BUT WOULD ALSO BE CRUCIAL AND VITAL TO PROVIDING COMPREHENSIVE INTERNATIONAL SOLUTIONS THAT MAY RESPOND FAIRLY TO ADDRESS THE ISSUE.
  • 7. THE RELEVANCE OF GLOBAL VALUE CHAINS (I) ? - RISE OF GLOBAL VALUE CHAINS (GVCS) HAS ALTERED THE LANDSCAPE OF WHAT ECONOMIES DO AND WHAT THEY PRODUCE OR GENERATE. ? - INCREASINGLY LESS RELEVANT TO TALK ABOUT GROSS GOODS OR SERVICES THAT ARE EXPORTED ? - MORE INCREASINGLY RELEVANT TO TALK ABOUT STAGES OF PRODUCTION
  • 8. THE RELEVANCE OF GLOBAL VALUE CHAINS (II) ? - FROM AN ECONOMIC POINT OF VIEW, MOST OF THE VALUE OF A GOOD OR SERVICE IS TYPICALLY CREATED ALONG WITH UPSTREAM ACTIVITIES (WHERE PRODUCT DESIGN, R&D OR PRODUCTION OF CORE COMPONENTS OCCUR); ? OR FROM THE TAIL-END DOWN-STREAM ACTIVITIES (WHERE MARKETING OR BRANDING OCCURS) ? - KNOWLEDGE BASED ASSETS SUCH AS INTELLECTUAL PROPERTY, SOFTWARE AND ORGANIZATIONAL SKILLS HAVE BECOME INCREASINGLY IMPORTANT FOR PURPOSES OF COMPETITIVENESS, ECONOMIC GROWTH AND EMPLOYMENT
  • 9. REFERENCES ? OECD (2013), ADDRESSING BASE EROSION AND PROFIT SHIFTING, OECD PUBLISHING ? HTTP://DX.DOI.ORG/10.1787/9789264192744-EN
  • 10. SUGGESTED READING ? AULT, H. J., SCHON, W. & SHAY, S. E. (2014). BASE EROSION AND PROFIT SHIFTING: A ROAD MAP FOR REFORM ? GARBARINO, C. (2014). THE USE OF CROSS BORDER CORPORATE PROFITS AND LOSSES AND ¡°GLOBAL CORPORATE TAX INFORMATION¡±: A GAM THEORY APPROACH ? KEIGHTLEY, M. P. & STUPAK, J. M. (2015). CORPORATE TAX BASE EROSION AND PROFIT SHIFTING (BEPS): AN EXAMINATION OF THE DATA