Friday, July 19, 2013
Some businesses that are worth billions may pay practically no tax in the places where they operate and make profits. Not because they’re defrauding the system, but because tax systems simply haven’t kept up with how firms in the digital economy in particular add value and make profits, on intangible assets such as design and licensing for example, or even by exploiting your personal data.
Other firms also avoid paying what most citizens would consider “fair” taxes through “(tax) base erosion and profit shifting” or BEPS as the OECD calls it. As we discussed in this article, BEPS schemes themselves can be extremely complicated, but the basic idea is simple: shift profits across borders to take advantage of tax rates that are lower than in the country where the profit is made. Three popular mechanisms for doing this are hybrid mismatches, special purpose entities (SPE), and transfer pricing.
Hybrids try to have the same money or transaction treated differently (as debt or equity for instance) by different countries to avoid paying tax, and often feature dual residence – companies that are residents of two countries for tax purposes. An SPE is an entity with no or few employees, little or no physical presence in the host economy and whose assets and liabilities represent investments in or from other countries and whose core business consists of group financing or holding activities.
Transfer prices are the prices various parts of a company pay each other for goods or services. They are used to calculate how profits should be allocated among the different parts of the company in different countries, and are used to decide how much tax the MNE pays and to which tax administration. There is no simple method for calculating a transfer price and the lack of good “comparables” (similar operations carried out at market prices by unrelated entities) often results in profits being artificially shifted to no- or low-tax jurisdictions.
International tax rules are generally efficient in ensuring that companies are not subject to double taxation, but BEPS takes advantage of gaps in the rules to avoid paying tax completely, so-called “double non taxation” or to pay a sum across two or more countries that is less than what they would pay in a single country.
Opportunities for MNEs to pay less tax harm everybody. Governments lose revenue and may have to cut public services and increase taxes on everybody else. But businesses suffer too. Small businesses, businesses working mainly in one national market and new firms can’t compete with MNEs who shift profits across borders to avoid or reduce tax. And an MNE that doesn’t shift profits is at a disadvantage compared to its BEPSing rivals.
What can be done? Today, the OECD launched a 15-point Action Plan that will give governments the domestic and international arms they need to combat BEPS. The Plan recognises that greater transparency and improved data are needed to evaluate and stop the growing disconnect between where money and investments are made and where MNEs report profits for tax purposes.
The Action Plan will for example stop the abuse of transfer pricing by ensuring that taxable profits can’t be artificially shifted through the transfer of patents, copyright or other intangibles away from countries where the value is created, and it will oblige taxpayers to report their aggressive tax planning arrangements.
When we wrote about BEPS in February, we mentioned the sense of urgency surrounding the OECD work, with the proposal that a workable plan be agreed on within six months. The next steps will take a bit longer of course, but not that much longer. The actions outlined in the Plan will be delivered over the next 18 to 24 months by the joint OECD/G20 BEPS Project, regrouping all OECD members and G20 countries on an equal footing. To ensure that the actions can be implemented quickly, a multilateral instrument will also be developed for countries that want to amend their existing networks of bilateral tax treaties.
Some may protest and try to get the plan neutralised, but would they really prefer the alternative if the no action is taken to address the weaknesses that put the present consensus-based multilateral framework at risk and countries apply: “unilateral measures, which could lead to global tax chaos marked by massive re-emergence of double taxation”?
- OECD, Press Release
- Accounting Today, Governments to Pursue Action Plan to Address Multinational Tax Avoidance
- BBC News, OECD Launches Plan to Stop Firms 'Abusing' Tax Rules
- Bloomberg, OECD Proposes Plan for Crackdown on Companies’ Tax Avoidance
- CNN, OECD Unveils Global Crackdown on Tax Arbitrage by Multinationals
- The Economist, A Call to Action
- Financial Times, OECD Unveils Global Crackdown on Tax Arbitrage by Multinationals
- The Guardian, Amazon Told: Time Is Up for Tax Avoidance
- The Guardian, OECD Tax Proposals Offer G20 'Once in a Century' Chance to Fix Creaking System
- New York Times, G-20 Backs Plan to Curb Tax Evasion by Large Corporations
- Reuters, G20 Backs Fundamental Reform of Corporate Taxation
- The Telegraph, OECD Unveils Plan to End 'Golden Era' of Tax Avoidance
- Wall Street Journal, G-20 to Back Corporate Tax Reform
- Washington Post, G20 to Target Global Tax Loopholes
(Hat Tip: Omri Marian.)