Tax avoidance by large businesses is a topic that continues to attract attention, with governments keen to state that they are tough on those that abuse the rules. As the Organisation for Economic Cooperation and Development (OECD) comes to the end of its ambitious two-and-a-half-year BEPS project to design a new framework for international tax, has it found a better and more internationally coherent approach?
What’s the problem?
The OECD issued its final package of measures on 5 October 2015 and has, for the first time, made a statement about the quantum of tax that is being lost by so-called Based Erosion and Profit Shifting (BEPS) from which the project name derives; the estimate is US$100bn - $240bn annually. Clearly, there is an issue to be addressed.
Is this just about major multinationals?
One very important point is that although to a large extent the project was aimed at addressing the tax mitigation techniques used by the major multinationals, potentially any business that has international aspects will be affected. In addition, despite what politicians may say, the OECD is more concerned with being balanced and fair than penalising taxpayers, and in the long-term, international groups may find that some of the ideas proposed by the OECD lead to a more consistent experience.
Although the BEPS proposals are not legally binding on any country, some countries have started to implement in certain areas, and many territories have indicated that they expect to follow the project recommendations. We will need to watch closely for more details on specific new rules as they come into effect, a process that could take several years. The recommendations fall into three broad categories: coherence, substance, and transparency.
The lack of coherence across territories is one reason for the gaps and imbalances. Examples of
BEPS recommendations that address this are:
- Interest deductibility – the OECD’s new approach is to limit tax deductibility based various factors. The general concern is that it is too easy to use financing costs to erode tax base.
- Harmful tax practices, specifically tax regimes for intellectually property – many countries have special low tax rates for income from intellectual property. The OECD believes that many of the current regimes are open to abuse and will need to be redesigned so that the benefits are closely aligned with significant economic activity.
The BEPS proposals have a relatively simple principle at their heart – to match the taxable profits in a territory with the value that has been created there. One key change in this area is to the definition of permanent establishment. This is a longstanding international tax concept, under which a company resident in one country can fall within the charge to tax, based on activities undertaken, in another country. There is a general view that the current rules on what does and what does not constitute a permanent establishment have been exploited, and so must be changed. One common situation is where a company tax resident in one country has a sales team overseas and that team plays the principal role leading to the conclusion of customer contracts. This is a good example of where many smaller businesses could be affected by the BEPS project.
The key here is the introduction of country-by-country reporting, whereby tax authorities in each country in which a group of companies does business will have access to key facts and figures about the tax paid by that group around the world. This alone is considered to have the potential to reduce aggressive tax planning as tax authorities will now have a clear picture.
Tax rules developed over time have simply not kept pace with modern business. These changes are expected to have a major impact over the years to come.