BEPS: A multinational problem calling for a multinational solution

The public has always been familiar with the terms tax dodging, tax avoidance, and tax structuring. However, in today’s international tax parlance, terms have evolved into more creative and catchy phrases. One may have probably encountered the terms “Double Irish” and “Dutch Sandwich”, more often combined by tax lawyers as “Dutch Sandwiches washed down with a Double Irish”, as well as the so-called “Bermuda Triangle”.

As appealing as the terminologies may sound, tax authorities from around the world are going after multinational companies (MNCs) that employ these tax strategies. So what exactly did MNCs do earn the ire of tax authorities?

In the current economic environment, companies that operate on a multinational level no longer employ a straightforward structure with one entity per jurisdiction to take charge of its operations in such country. Gone are the days where operations and market consumption are the main motivating points in establishing foreign presence. International tax rules drawn some 80 years ago have not kept up with the fast-changing business environment. The host of driving forces has invariably changed: Instead, we now see tax-driven structures taking advantage of low-tax jurisdictions, favorable tax treaties, and country mismatches in taxation of entities, products and income streams. These are all considered base erosion and profit shifting schemes, or simply BEPS.

BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to make profits “disappear” for tax purposes or to shift profits to locations where there is little or no real activity but the taxes are low, resulting in little or no overall corporate tax being paid. Double Irish and Dutch Sandwich both make use of Ireland and the Netherlands as pass-through locations, and adding a tax haven into the combo makes up the Bermuda Triangle. Instead of planes and ships disappearing, profits disappear – at least from the eyes of the tax authorities.

The interplay of multiple domestic tax systems often lead to an overlap of rules, which may result in double taxation. However, the same scenario can also create loopholes which could lead to an income not being taxed anywhere, thus resulting in double non-taxation. This gives MNCs undue competitive advantage as compared to enterprises that operate on a domestic level. Numerous economic and tax publications reveal MNCs from a developed country selling products in another high-tax country actually route profits through a web of companies located in multiple low- or zero-tax jurisdictions, finally arriving at, more often than not, a tax haven. Hardest to attribute are revenues from intellectual property, like the patents and copyright, and digital products such as downloaded songs and applications.

The ultimate goal of the big corporate tax dodgers is what tax lawyer Edward D. Kleinbard calls “stateless income”- siphoning profits out of high-tax countries in Europe, Japan and North America and moving them around under various tax treaties until they are not subject to any tax because they are being reported in a nonexistent country called Nowhere. Thus, tax bases are eroded from jurisdictions where they were actually collected and shifted to low or zero-tax regimes. Overall, billions are saved through the shifting maneuvers.

Base erosion poses a serious risk to tax revenues, tax sovereignty and tax fairness for businesses. Opportunities for MNCs to pay less or no tax will harm everybody, corporations and individuals alike. Governments lose revenue and may have to cut public services, including education and healthcare, and increase taxes on everybody else – individuals, small businesses, domestic-level enterprises and new firms that cannot compete with MNCs that shift profits across borders to avoid or reduce tax.

Over the past years, giant companies have been slapped with tax bills for shifted profits. In response to this long-standing outcry, the Organization for Economic Cooperation and Development (OECD) has announced an international action plan, called “Project BEPS”, to target multinational businesses. The OECD is an international economic organization of 34 countries, founded in 1961 to stimulate economic progress and world trade. Approved by the G20 (Group of 20, which is an international forum for governments and central bank governors from 20 major economies) in July 2013, this plan aims to counter BEPS and eventually eliminate double non-taxation. While there are no easy solutions to address BEPS issues, the OECD is in an ideal position to support countries’ collective efforts towards drawing up effective and fair tax rules and at the same time provide a more or less level playing field for businesses, whether domestic or multinational.

The OECD launched an action plan that would give governments the necessary tool they need to counter the BEPS issue. There are 15 BEPS actions being considered and worked on by the OECD. For each of the actions, there are factors to consider such as the timing and impact. For years, the OECD has promoted dialogue and cooperation between governments on tax matters.

Among its focus are the challenges brought by the digital economy. While it cannot be ring-fenced for special tax treatment, its framework should ensure profits are taxed where economic activities occur and where value is created.

Another focus is the neutralization of the effects of hybrid mismatch arrangements. These are cross-border arrangements that take advantage of differences in the tax treatment of financial instruments, asset transfers and entities to achieve “double non-taxation”. A common example of a hybrid financial instrument is one that is considered a debt in one country and an equity in another country. The intent is to set out recommendations for hybrid mismatch rules and model treaty provisions which will put an end to multiple deductions for a single expense and deductions in one country without corresponding taxation in another.

The action plan also rejects treaty-shopping practices through anti-abuse rules. Treaty shopping refers to arrangements through which a person who is not a resident of one of the two states that concluded a tax treaty may attempt to obtain benefits the treaty grants to residents of these states.

A country-by-country report information is also envisioned to provide tax administrations with useful information to assess risks, make determinations about where audit resources can most effectively be deployed, and create priority action plans.

Other focus areas include the design and strengthening of controlled foreign company (CFC) rules, base erosion via interest deductions and other financial payments, artificial avoidance of Permanent Establishment (“PE”) status, transfer pricing, rules on taxation of intangibles, and development of multilateral instruments to amend bilateral tax treaties.

As the OECD/G20 BEPS Project is being completed, big economies around the globe have initiated their own unilateral actions against these conduit-type structures. Effective April 1 this year, the United Kingdom started imposing a “diverted profits tax” at the rate of 25%. Australia is likewise considering to follow suit and levy tax on companies that artificially divert profits generated to lower tax locations. The “Double Irish” is being shut down by the Irish government, although companies that are currently utilizing the structure will have a five-year transition period before the new law eliminates the tax structure completely.

Today’s global economy is rapidly expanding, and business operations spanning multiple jurisdictions is now the norm rather than the exception. Indeed, cooperation between and among governments are necessary to align their tax policies to prevent profit shifting. Considering our growing economy and being one of Asia’s investment hotspots, our own Government is behooved to participate vigorously with international efforts to remove the practice of BEPS. Failure to do so will mean that the Philippines will lose out on increased tax collections that could in turn be used to fund the delivery of basic services. –Christy Irene D. Enrile (The Philippine Star)