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The tenacious struggle of the states against corporate tax avoidance

Tax_Evasion_WEEDThe long struggle of governments to combat tax evasion and avoidance by multinational enterprises continues unabated. However, if the most recent developments in negotiations around the OECD’s anti-BEPS project and discussions concerning the upcoming G20 summit in Australia in November are any indication, it does not look as if any significant progress will be made to turn the tide of tax abuse – at least not in the near future. Indeed, more entrenched problems, such as tax competition among countries (leading to ever lower taxation rates) and the disadvantages faced by developing countries under the current international tax regime are yet to be addressed. In his article below, WEED’s Markus Henn discusses these issues and provides a critical overview of the anti-BEPS actions that have been proposed by the OECD so far.

October 17, 2014 | SOMO

The tenacious struggle of the states against tax avoidance of companies

In November 2013 the G20 supported an action plan of the OECD against the ‘[tax] base erosion and profit shifting’ (BEPS), i.e. tax avoidance by multinational companies (for background see: WEED December 2013 Newsletter). This plan is now being elaborated by the members of the OECD and the G20 – a total of 44 states – and is due to be completed by the end of 2015. During this process the OECD has made efforts to encourage the participation of developing countries, however, this has been limited to regional consultations. What is more, the action plan itself was, from the outset, rather more focused on the problems of richer states. It does not give any serious thought as to how corporate profits – and thus taxes – can be distributed more equitably between the less and more developed countries where corporations operate. This is not surprising, since previous OECD tax standards have been tailored to their members, especially the model for tax treaties. For that reason, the United Nations has now developed its own standards for tax treaties and for taxing multinational corporations, taking into account the interests of the poorer states. However, the United Nations has been sidelined again by the G20 and the OECD in recent negotiations, thus perpetuating the UN’s marginal role in the BEPS process.

Interim Results of OECD Action Plan on BEPS

In September 2014, the OECD published its interim results for the first half of the Action Plan, namely proposals regarding the following action points:

•          Mismatch arrangements (Action 2): This action point attempts to deal with differences between national tax rules. Companies can exploit these differences so that the same cost factor reduces the tax base in two states or is not taxed. The most common case is the different treatment of a transaction by one state as equity and by another as credit. This enables the company to deduct interest from income in one country and have a tax-free dividend in another country. Against such structures, the OECD recommends eliminating tax benefits for a transaction if another state also provides an advantage for the same transaction. If a state fails to cooperate, the other state should act unilaterally. In the EU and Germany, rules have recently been adopted in this sense.

•          Harmful tax practices (Action 5): This action point proposes to assess whether national tax rules are granting tax benefits (e.g. exemptions from tax payments) beyond what is justified by economic substance. What ‘substance’ means here is hard to explain, as it is already part of the problem: Some countries, for example, would like to allow for benefits that are related to research on a patent. The OECD began screening such benefits 15 years ago, but so far has virtually not intervened in any structure they found. The only additional proposal now made is a vague call for more transparency and a complex proposal for testing the substance, but this is not yet the consensus. The OECD therefore openly admits that they could not agree on one of the most harmful practices, namely, when revenue from patents or licenses is not taxed at all, or if so, only very little. The United Kingdom, Luxembourg, the Netherlands and Spain are said to have been opposed to it.

•          Abuse of tax treaties (Action 6): So far, as their main purpose, tax treaties only act to avoid double taxation, but are known in practice to also facilitate tax avoidance and non-taxation. Since tax treaties are often not designed in the interests of developing countries, because they are based on the OECD tax treaty model, developing countries identified this issue as one of their BEPS priorities in a special report by the OECD. In its interim proposals, the OECD proposes adding the prevention of non-taxation as a general aim of their tax treaty model, and recommends having certain clauses against non-taxation in any tax agreement as a minimum standard. This is useful, but not entirely new, since many bilateral agreements already contain such clauses.

•          Transfer pricing of intangibles (Action 8): Transfer prices are used for avoiding tax payments during trans-border transactions within a company. To put a stop to complete arbitrariness of the company on which prices goods or services should be taxed as well as unlimited shifting of where the income to be taxed is based, the OECD so far has relied on the so-called arm's length principle. It means that an intra-company cross-border transaction must be calculated at the same price as an external one. This approach very often reaches its limits, because it is very difficult to make a comparison of internal and external prices. This is particularly difficult for intangible goods such as patents and licenses, as these goods are by definition unique. The OECD has already been aware of the problem for decades. Nevertheless, its proposals continue to rely on the arm’s length principle for taxing intangibles. Proposals that go somewhat beyond this were also raised, but were postponed for a decision in 2015.

•          Country-by-country documentation (Action 13): Transparency concerning the business operations of a company is a prerequisite for the recognition of tax avoidance. The OECD is now proposing to make important country-by-country information of a company’s operations accessible to the authorities. This means that the country-by-country reports will not be public, as has long been demanded by civil society. As a result, authorities will lack the complementary critical examination of the public and academics to detect tax evasion and public pressure on avoiding taxes will be lacking.

•          Digital Economy (Action 1): The OECD considers that using modern communication and means of production and the digitalization of the entire economy does not create entirely new problems concerning taxation, but worsens existing ones, e.g. with regard to the tax allocation of assets and economic activities. Thus the OECD proposes measures that mainly take digitalization into account for other actions of the action plan.

•          Multilateral agreement (Action 15): So far, international tax law is characterized by bilateral tax treaties that are only moderately similar, based on the above-mentioned models of the OECD and the United Nations. Tax treaties have often resulted in no tax payments. However, it is difficult to change and adjust thousands of tax treaties. Thus the OECD has examined the need for a multilateral agreement on cross-border taxation – superseding existing treaties – and its feasibility. It has come to the conclusion that this is both desirable and possible. However, whether the states will become involved in this system overhaul is unclear. Although the agreement will be open to all countries later, they would have no say in the design.

Further Work

The OECD is now trying to address the outstanding aspects of the above actions; however its main priority over the coming year will be fleshing out the remaining action points of the plan. These include actions concerning the taxation of intra-company financial services and risk transfers (Actions 4, 9 and 10), which have been identified by developing countries as a priority in the special OECD report. The item ‘artificial avoidance of permanent establishment status’ (Action 7) is also significant for developing countries. Indeed, under current rules, taxes are only collected from permanent establishments, which imply firms with economic activity of some importance. The issue herein is that the OECD seems not to be addressing aspects of the permanent establishment definition that are especially important for developing countries. Furthermore, measures against shell/mailbox companies will be developed (Action 3), which are expected to be met with similar resistance to that triggered by the action against harmful tax practices. To increase transparency, the OECD will consider methodologies to collect BEPS data for the authorities (Action 11), and to obligate companies to disclose their tax avoidance strategies (Action 12). Finally, OECD discussions will cover the strengthening of dispute settlement mechanisms (Action 14).

In conclusion, it does not look as if the efforts of the G20 and the OECD will strongly push back tax avoidance. Wider problems such as tax competition among countries to attract (foreign) investment that lead to ever lower taxation rates, and important disadvantages for developing countries, have not yet even been addressed.

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