Historically, multi-lateral efforts to coordinate the international tax system have principally focused on avoiding double taxation. However, many taxpayers currently exploit gaps in the international tax system to either make otherwise taxable income disappear or to shift income to jurisdictions with low tax rates with the intent of reducing worldwide tax liability. This trend is known as base erosion and profit shifting (“BEPS”) and many claim that it has been significantly reducing many countries’ tax revenues.
The Organisation for Economic Co-operation and Development (“OECD”), an international organization of 34 countries founded to stimulate international economic activity, is currently developing plans to address BEPS. Specifically, on July 19th, 2013, the OECD published the BEPS Action Plan (the “Plan”), which includes 15 action items that member countries will implement to prevent taxpayers from exploiting the global tax system. G20 Finance Ministers and G20 leaders have endorsed the Plan.
Participating countries intend to complete the action items by the end of 2015. The first action item involves identifying rules that address problems created by the digital economy. For example, many companies have a significant digital presence in the economy of a country but avoid paying tax to that country due to their view that they lack a nexus with the country. The second action item is neutralizing the effects of hybrid mismatch arrangements, which are arrangements that allow taxpayers to exploit country by country differences in the tax treatment of entities, instruments and transfers. Such exploitation allows taxpayers to deduct the same item of expense in different countries and to make income disappear across countries. Additional action items include modifying the permanent establishment threshold and developing rules to prevent profit shifting through transfer pricing.
The United States has voiced concerns about the Plan. For example, Robert Stack, Treasury Deputy Assistant Secretary of International Tax Affairs, recently stated that the U.S. opposes creating rules specific to the digital economy. However, Mr. Stack also stated that the U.S. does not necessarily oppose developing rules in a broader framework that acknowledge effects of the digital economy. For example, the U.S. would not necessarily oppose the recognition of permanent establishment on the basis of a company collecting electronic data in another country.
The United States is also concerned that the BEPS rules may in fact end up disadvantaging US companies. In fact, many U.S. companies have expressed concern over the Plan, including whether information contained in a newly created master file would remain confidential. The Plan requires the parent of a multi-national entity to prepare a master file that includes several sensitive items of information: organizational structure, written descriptions of drivers of business success, country by country breakdown of the enterprise’s economic activity and tax payments, and many other items.
Finally, although practitioners and academics generally agree on the need to tackle base erosion and profit shifting, many of these individuals question assumptions underlying the OECD Plan as well as the Plan’s timeline. For example, some argue that it is unclear that tax revenue has actually decreased due to base erosion and profit shifting. Additionally, many argue that some countries may intend their tax laws to cause direct or indirect harm to other countries’ revenues and therefore developing a plan to combat this occurrence will not succeed. The U.S. may have this concern. Lastly, many tax professionals view the Plan’s two year timeline as far too short to accomplish all of the action items.
James Murphy is the Director of Tax Controversy Services at alliantgroup. Mr. Murphy has successfully defended tax credits and deductions for a diverse client base before state and federal taxing authorities. Prior to joining alliantgroup, Mr. Murphy practiced commercial litigation in Houston, TX. He is licensed in Texas, Arkansas and the U.S. Tax Court.
John Portnow is a Project Associate in the Tax Research department at alliantgroup. He holds an LLM in Taxation and routinely advises in-house personnel and clients on a variety of complex tax law topics.