When the Group of 20 governments teamed up with the Organisation for Economic Co-operation and Development (OECD) to curtail base erosion and profit shifting (BEPS), they sought to reform global taxation using an orderly and cohesive process.
World leaders wanted to boost tax collection and at the same time narrow the gaps between national-level systems.
That collective desire, however, has not yet translated into collective action.
“There is a sense that there are little pots of gold out there in tax ha-vens…governments want to get their hands on them.“
Alf Capito, EY Asia-Pacific Tax Policy Leader
Even before the OECD BEPS project formally issued recommendations in 2015, countries including the United Kingdom, France, China and Australia were forging ahead with their own implementation of key concepts.
While all agree the global tax environment has shifted, the unified and phased implementation approach sought by the G20 and OECD has proven elusive.
‘Their own interpretations’
The fundamental tension between sovereignty and unity is largely responsible.
States determine how they tax economic activity, and unlike with trade pacts or regional integration, this has shown to be an area where they are loath to surrender control.
“Each country is implementing BEPS pursuant to their own interpretations of various action items and how readily they apply in their respective countries and economies,” says Curt Kinsky, EY Asia-Pacific Transfer Pricing Leader.
With BEPS implementation into its second year, the countries that have emerged as the keenest to adopt the BEPS reforms or even go beyond its mandate include Australia and European countries, who are in some cases pushed by directives from the European Commission in Brussels.
But the global environment could see an additional shift once elections are completed in the US, which has struck a more cautious posture on the BEPS project.
If the new President and Congress sworn in next January pursue comprehensive tax reform, a pressing issue in Washington for more than a decade, “this could be the big game changer in terms of global corporate income tax standards,” says Valère Moutarlier, director of the European Commission’s Directorate General for Taxation and Customs.
The roots of reform
The focus on BEPS is frequently considered an outcome of the 2007–08 global financial crisis, which left governments starving for revenue and triggered public awareness of the ways multinational corporations are able to reduce their tax obligations.
But the groundwork was actually laid “in the mid-1990s, when Europe opened its borders to really implement the vision of a single market,” says Jean-Pierre Lieb, EY EMEIA Tax Policy and Controversy Leader, based in Paris. “That was the beginning of the erosion of corporate tax in Europe.”
The change forced smaller EU members to find new ways to be competitive, including competing for foreign investment using tax incentives.
The European Commission in 1997 aimed to avoid what it deemed harmful tax cooperation with its Code of Conduct for Business Taxation.
That has resulted in more than 100 cases of tax rules or laws being adjusted at the national level.
The Commission has also launched high-profile investigations into whether countries including Ireland, the Netherlands and Luxembourg violated state aid rules by offering tax incentives to companies in specific circumstances.
Countries that wanted to compete on tax were then left with the option of lowering overall rates and promoting loopholes they had discovered in their own tax treaties, Lieb says.
Departing from the implementation script as written by the OECD is a matter of both speed and process.
Individual countries, such as France, have moved without waiting for final guidelines.
The UK has introduced new incentives to push research and development through its Patent Box regime.
It also introduced a Diverted Profits Tax in 2015, seen as a way to tax multinationals that aim to pay less by avoiding having a formal permanent establishment (PE) in the country.
At the regional level, some bodies are pursuing a transparency agenda that goes beyond the scope of the BEPS project.
Action 13 of the OECD recommendations would require companies to share with tax inspectors, in each of the jurisdictions in which they operate, a complete global picture of sales, operations, employees, profits and other key figures using a country-by-country (CbC) report.
The rule would apply to any entity with annual revenue exceeding €750 million operating in the Eurozone, and the first of these reports are to be filed at the end of this year.
The reports were envisioned by the OECD only for the use of tax inspectors, but the European Parliament has proposed requiring companies doing business in its member countries to disclose some of that information to the public.
Regardless of the extent of dissemination, however, this now means a better idea for tax inspectors of what their taxpayers do beyond national borders and a reason to be in closer contact with their peers in other countries.
Cooperative links have already been forged: France’s Direction générale des finances publiques is conducting technical assistance missions with counterparts in African countries, for example.
National authorities have also expanded their use of a body within the OECD, the Joint International Tax Shelter Information and Collaboration Network, says Alf Capito, EY Asia-Pacific Tax Policy Leader based in Sydney.
Through this body they can compare notes on multinationals and share in the process of auditing them.
Pots of gold
While tax policy in Europe is evolving fast, across the Atlantic there has been more debate than change.
“From the outset, I have questioned the benefits to the US Government, businesses, and workers from providing sensitive information in the country-by-country reports,” says US Senator Orrin Hatch, Chairman of the US Senate Finance Committee.
“The risks would be significant if this information were ever leaked to the public sphere. To date, there remain many aspects regarding implementation that have to be worked through, including ways to guarantee the confidentiality of sensitive taxpayer information. This will require work by tax administrators and stakeholders, alike and I hope we will be able to find a safe and viable path forward.”
The US tax code features the highest headline corporate income tax rate among OECD countries, at 35%, but with scores of credits, deductions and exemptions that significantly lower the actual rates paid.
US law also creates an incentive for American corporations to hold their retained earnings outside the country, as income is not taxed unless it is repatriated. This unique policy has left others keen to tax that stateless income.
“There is a sense that there are little pots of gold out there in tax havens,” Capito says. “Governments want to get their hands on them.”
A wary eye from the US
Also, because US-based multinationals are most often the objects of scrutiny, skepticism about the BEPS project is mounting in Washington, DC.
“We cannot allow American taxpayers to foot the bill for increased tax collections in Europe and elsewhere,” said Kevin Brady, the House of Representatives Ways and Means Committee Chairman, during a speech at the Tax Council Policy Institute in February.
If tax reform is indeed on the cards after the 2016 election, Brady’s committee would be one of several starting points for debate.
While G20 and OECD members are committed to the process, those outside the two bodies are also welcome to participate.
“As BEPS matures, there will be a more sophisticated and higher common denomina-tor of tax rules across the globe.“
Curt Kinsky, EY Asia-Pacific Transfer Pricing Leader
However, tax administrators in developing countries could struggle to digest and act on the new information and tools BEPS provides, says Lieb, with the exception of the larger ones such as Brazil, Russia, India and China.
India, for example, has had participant status at the OECD since 2006, and sent representatives to attend working groups on the BEPS project.
In one example of national-level divergence on BEPS implementation, India is among 20 countries in either the G20 or OECD that have declined to support a mandatory arbitration process.
With varied attitudes across the globe, one region in particular displays a cross section of approaches and attitudes perhaps representative of the whole: Asia-Pacific countries.
The region ranges from Japan south to New Zealand, and countries are members of both, one or neither of the G20 and OECD.
The geography is vast, as are these countries’ developmental stages, from highly developed Japan, long a key player in the global economy, to the frontier market of Papua New Guinea.
“Australia and China are moving full steam ahead, and the rest of Asia-Pacific is listening and learning as those two prominent players proceed,” Kinsky says.
In China, an update to its rules on transfer pricing is largely consistent with BEPS Action 13.
A key divergence, however, revolves around an argument that it can impose an additional tax for allowing access to its market.
The Chinese authorities’ view is that because the country’s market is unique in its size and scope, offering a huge mass of consumers as well as low-cost workers, corporations should pay a premium to operate in it.
‘Believes it contributes more’
At the heart of this argument, Kinsky says, is the idea that China is more than just a manufacturing hub, where ideas and processes that were developed elsewhere are used to assemble products.
“China believes it contributes more to the value chain than others want to attribute to it,” Kinsky says.
“Because of its volume and growth trajectory, China views its market as an intangible asset that must be properly rewarded.”
According to Kinsky, “The SAT in China is already involved in many tax controversy cases based on the China market as an intangible; and this will likely grow as country by country reporting over the next few years reveals the importance of the Chinese market for many inbound global companies.
“Conversely, after Chinese outbound global companies submit their reports in late 2017 (for fiscal year 2016), they will undoubtedly be queried by tax authorities across the globe about their value chains and how profit is allocated. Relatively new global players from China are going to have to grow up fast in this new era of tax transparency.”
Chinese firms with revenue above CNY5 billion had to submit documents in line with Action 13, including their CbC reports, by 31 May 2016, ahead of the BEPS recommendation of 31 December.
Australia has emerged as one of the world’s most aggressive adopters of the BEPS project and its principles.
Like in Europe, public pressure plays a role, but not just from people and advocacy groups.
Domestic businesses are also complaining to the Australian Tax Office (ATO), Capito says.
Local advertising firms are telling the Government about their frustration over losing sales to online competitors, for example.
Domestic banks do not have the tax strategies available to multinationals but must compete with global money-transfer platforms.
In response to criticism about settling disputes with companies, the ATO hired a former federal judge to review the process.
“The ATO will not settle a dispute at any price,” Commissioner Chris Jordan said in February in testimony to parliamentarians.
The country has been grading its taxpayers according to how likely they are to use aggressive tax strategies and recently increased the number considered high-risk from one to six.
The country has also introduced new laws that go above and beyond BEPS, says Capito.
Permanent establishments in spotlight
An example of the measures introduced to counter multinational tax avoidance is the Multinational Anti-Avoidance Law and the Australian Diverted Profits Tax.
Together, these measures are similar to the UK’s Diverted Profits Tax, but operate more stringently and impose greater sanctions.
Although aimed at enabling the ATO to target multinationals with tax strategies designed to avoid paying tax in Australia by not having a PE in the country, these measures can lead to more tax imposed over that scenario.
The explanatory material for these measures acknowledges that this problem was addressed through the BEPS process, but it cited the need for faster action within Australia rather than moving at the pace set by the OECD for the adoption of the BEPS reforms.
The BEPS project addresses PEs in Action 7, which is also important for countries rich with natural resources, including in Asia-Pacific.
In Indonesia, the Government has long sought to capture more revenue from resource extraction, be it through taxation or moves such as the 2009 ban on exporting unprocessed ore. (The ban has not been fully implemented, although efforts to do so increased in 2014.)
Multinationals have avoided setting up PEs in Indonesia and elsewhere in the past by using commissionaire arrangements, for example, and by chopping up contracting into smaller deals.
However, resource producers may argue that signing many smaller agreements for goods and services is not a tax strategy but a necessity driven by the nature of their options.
In many countries, local-content mandates result in smaller domestic companies participating, for example.
And across the industry, the specialists necessary in particular for technologically advanced extraction processes mandate narrowly defined contracts with a large number of entities.
Why the difference?
One factor explaining a diversity of approaches in Asia-Pacific is that economies vary, as do relationships with multinationals.
Japan has a relatively large group of multinationals investing outside the country, and therefore impacts may be different from in Thailand, where foreign direct investment (FDI) is mostly inward and not outward.
In fact, Thai FDI is dominated by Japanese multinationals in the manufacturing estates outside Bangkok.
In China, sources of investment are more diversified.
South Korea is a source of FDI rather than a destination, typically clustered in heavy industry and electronics.
Its Government has yet to fully commit to BEPS (e.g., it has not yet adopted country-by-country reporting) and is further studying the impacts it would have on its economy, Kinsky says.
Generally, however, what hasn’t changed in Asia-Pacific or the wider world is that countries are ultimately faced with a choice between maximizing tax revenue and attracting investment.
The enduring challenge of finding the sweet spot between those outcomes is an indication that, just like before BEPS, the global tax landscape is not a smooth one.
The basic principles could converge, but variance will remain, and for corporations this is both an opportunity and a burden.
“As BEPS matures, there will be a more sophisticated and higher common denominator of tax rules across the globe. However, there will be variances,” Kinsky says. It will be up to taxpayers to recognize and manage any differences.”
Key action points
- Understand that profound changes in global taxation require a substantially evolved mission for the tax department — business as usual is unacceptable
- Revise the structure of the tax function to improve its ability to collaborate with all dimensions of the organization, including global processes spanning human resources, supply chain, financial planning, R&D, M&A, treasury, legal and operations
- Prepare for BEPS, digitization and finance transformation
- Review the current skill set of staff and develop an action plan for acquiring or developing the needed talent