In the Eye of the (BEPS) Storm: The 'Big Questions'

By Craig A. Sharon, Esq.  

Ernst & Young LLP, Washington, DC


My previous two commentaries were about the OECD's base erosion
and profit shifting project (the BEPS project),2 so I
might as well make it a trilogy. That's not simply for the sake of
symmetry, but rather because, after months of non-stop development,
the project is entering a quiet phase - at least compared to the
remarkable pace of the past six months - as the OECD and the
countries participating in the project begin to flesh out the 15
items set forth in the BEPS Action Plan. That's not to say that the
BEPS debate will go silent. Far from it. There's far too much to
talk about:

  •  What's driving the project? Is it politics from on high?
    Or is the OECD trying to stay in control of a potential runaway
    train? Or is it exactly what the OECD has been asserting since the
    BEPS project started, i.e., that the international tax rules simply
    need modernizing?
  •  What's the most reasonable interpretation of the OECD
    reports issued since February (i.e., the BEPS Report, the BEPS
    Action Plan, the revised Intangibles Report, and the White Paper on
    documentation)? As lengthy as the reports are, they remain vague,
    ambiguous, and inchoate in many important respects.
  •   Where is the OECD heading? We have a sense of the
    direction, but the final destination is anyone's guess. If the
    participating countries end up in different destinations, we're all
    in trouble … .

That leads to the first big open question:

In the end, is the BEPS project likely to lead to
more or less consensus than the status quo?

I'm increasingly pessimistic. First, the status quo, while not
perfect, is mostly manageable. Although the BRICS and other
developing countries pose special challenges and Europe continues
to struggle with the after-effects of the global financial crisis,
tax authorities are generally able to resolve their differences
with limited double taxation. Even the OECD concedes that the
current rules work well in the vast majority of cases.

It's hard to see the current direction of the BEPS project
producing a broader consensus, providing more certainty, and
generating less controversy than the status quo. The principal
transfer pricing changes, i.e., a revised application of the
arm's-length standard based on people functions, more liberal
recharacterization rules for the typical hard-to-value cases, and
yet-to-be-defined special measures "within and beyond" the
arm's-length standard:

1. are untested, imprecise, and more subjective than the current
rules, which generally respect upfront legal structures and
intercompany agreements;

2. are likely to embolden those tax authorities that have more
fundamental concerns about the current international tax system
than the narrow stated focus of the BEPS project (i.e., limiting
double non-taxation and excessive income shifting to tax

3. may be too broad, unfavorable, and/or controversial for the
United States and other OECD countries to accept, creating a bigger
chasm between developed and developing countries than currently
exists today; and

4. may require, in order to generate any kind of consensus,
final recommendations and actions that are too vague, watered-down,
or manipulable to be implemented and enforced in a uniform or
consistent manner across countries.

The proposed changes to the permanent establishment (PE) rules,
the results-oriented focus on the digital economy, and the
formula-based country-by-country reporting regime also introduce
new layers of uncertainty and potential areas of controversy. Only
an eternal optimist would believe that the participating countries
will reach a broad consensus on the new concepts, adopt and
implement those concepts in standard ways, and then enforce the new
rules in a limited and predictable manner.

Consider the following as an example of the challenge. In June
2012, the OECD proposed the use of bilateral memoranda of
understanding (MOUs) for tax authorities to establish safe harbor
rules for the most common, low-value, low-risk, cross-border
transactions (i.e., routine distribution and manufacturing and
contract research and development). Nearly 18 months later, it
doesn't appear that any tax authority is seriously pursuing, let
alone on the verge of announcing, any such MOU. If no two tax
authorities can reach an agreement on these routine transfer
pricing transactions, imagine the likelihood of the global tax
community reaching a broad consensus on the far more complex and
contentious issues being addressed in the BEPS project.

My overall impression is that governments and taxpayers have so
far only been shadow boxing and sparring. At some point over the
next year or so, when the potential "winners" and "losers" become
clear, the fight will start in earnest.3 That raises the
second big question:

Will the United States be a net winner or loser in
the BEPS fight?

At the moment, the BEPS project and U.S. corporate tax reform
are on mostly separate tracks. Yes, there are a few common issues,
such as the use of the CFC rules as a "special measure" to backstop
the arm's-length standard, but there doesn't seem to be much
interest within the Obama Administration or in Congress to
coordinate the timing or the substance of the two processes.
Inevitably, though, the processes will collide, and it will be
interesting to see if the Treasury Department, which is leading the
U.S. participation in the BEPS project, and the Congress, which
remains uncertain about whether and how to proceed with U.S. tax
reform, will be on the same page when that happens. The dynamics of
the two processes are impossible to predict, but there are
undeniable United States vs. rest-of-the-world tensions, the most
obvious of which is the BEPS project's disproportionate (almost
exclusive) focus on the alleged improprieties of U.S. companies,
especially U.S. technology and internet companies. Indeed, it seems
like the principal purpose of the BEPS project is to increase the
foreign tax liabilities of U.S. multinationals. That focus is not
in the United States' fiscal and economic interests and ignores the
contributing behavior of foreign companies and effects of harmful
tax competition.

The broader policy arguments informing the BEPS project and U.S.
tax reform efforts are beyond the scope of this commentary, but the
current limited U.S. coordination is problematic, especially if you
extrapolate the need for such coordination within and among so many
countries. It is yet another reason to be skeptical that the
project will produce a new and improved international tax
system.  That raises the next big question:

As the BEPS project proceeds, what effect will it
have on current enforcement efforts?

The early signals are not favorable as certain governments
(e.g., Mexico, France, Norway, Australia and the EU) begin to take
unilateral steps to implement BEPS-related concepts in the form of
proposed legislation, establishing "working groups" to review
existing and formulate new frameworks, suspension of "BEPS"-related
APAs, etc.4 Even if
directionally consistent with the BEPS project, these early steps
threaten the coherence of the overall project and will be difficult
to change once adopted and/or implemented. It's wishful thinking
for the OECD to downplay these developments.5 They threaten the
entire project and will lead, if unchecked, to the global tax chaos
that the BEPS project is nominally intended to head off.

On the administrative side, it's inevitable that BEPS-related
concepts will filter into current enforcement efforts.6 That's especially true
for transfer pricing as tax authorities refocus their attention on
the substance required to align profit with so-called
value-creating activities. What was considered adequate substance a
few years ago, especially relating to allocations of risk and
ownership of intellectual property, is now subject to challenge in
hindsight based on the OECD's evolving views. Not even the
substance requirements in Chapter IX of the OECD Transfer Pricing
Guidelines, recently adopted to deal with restructurings, would
seem to pass muster under the revised Intangibles Report (e.g.,
it's possible to subcontract important functions under Chapter IX,
but seemingly not under revised Chapter VI). A similar problem
exists for commissionaire arrangements and other limited-risk
business models, which only a year ago were not considered to
create PEs under longstanding OECD views.7 The
BEPS Action Plan contemplates reversing this position in an effort
to overturn recent unfavorable litigation results in various
European courts (e.g., in Norway, France, and Italy).

The extent to which the BEPS project is introducing new rules or
clarifying existing rules is important. The former will presumably
have only prospective effect. The latter will only cause additional
controversy. The OECD needs to pay greater attention to the
transition rules that will be needed to avoid new results-oriented
interpretations, inconsistent application of current standards, and
the inevitable controversy that will flow from the use of
retroactive analyses.

That leads to the final big question:

In the midst of the current uncertainty, what could
or should multinational companies be doing?

There are three simple answers: cooperate, engage, and assess.
Cooperation is key. The BEPS project isn't going away.  The
political attention is too high. So the real question is how it
will end. Having started the project, it's now incumbent on the
OECD, tax authorities, and the international business community to
finish it by developing as much consensus as possible. If the fear
of global tax chaos engendered the project, such chaos will surely
ensue if the project falls apart and individual countries go their
own way, now armed with the BEPS Action Plan. For example, going
forward, what will stop a tax authority from taking the position
that a transfer pricing analysis that generally disregards legal
arrangements in favor of people functions complies with the OECD's
evolving view of the arm's-length standard?

To help shape the final BEPS work product, taxpayers will need
to engage with the OECD and their respective tax authorities. That
can be done directly or through business organizations, such as
BIAC, the ICC, and/or the USCIB. Although the business community's
involvement in the BEPS project is less formal than in recent OECD
projects, the OECD is soliciting the views of the business
community.8  Even if the
OECD's initial reactions have shown little flexibility (e.g.,
limited revisions to the original Intangibles Report, insistence on
country-by-country reporting, lowering the PE threshold, etc.), the
business community's continued involvement is essential as more
detail emerges about the Action items and the hard negotiations

In the meantime, taxpayers need to assess their current
situations. The transfer pricing documentation rules are likely to
be implemented first, with the new substance rules likely to
infiltrate current audits. Taxpayers should begin to prepare for at
least those two developments. The better informed and more engaged
taxpayers will be in the best position to respond as other issues
arise, as they're surely bound to do over the coming months as the
more-threatening back side of the BEPS storm hits.

This commentary also will appear in the December 2013 issue
of the
 Tax Management International Journal.
 For more information, in the Tax Management Portfolios,
see Daher, 536 T.M.
, Interest Expense Deductions, Maruca
and Warner, 886 T.M.
, Transfer Pricing: The Code, the
Regulations, and Selected Case Law, Nauheim and Scott, 938
, U.S. Income Tax Treaties - Income Not Attributable to a
Permanent Establishment, and in Tax Practice Series, see ¶2330,
Interest Expense, ¶3600, Section 482 - Allocations of Income and
Deductions Between Related Taxpayers, and ¶7160, U.S. Income Tax

Copyright©2013 by The Bureau of
National Affairs, Inc.

  1 The views expressed herein are those of the
author and do not necessarily reflect those of Ernst & Young
LLP or any other member of Ernst & Young Global Limited.

  2 See "Initial Observations on the OECD BEPS
Project," 42 Tax Mgmt. Int'l J. 363 (6/14/13), and
"Questions and Concerns about the OECD's Changing View of the
Arm's-Length Standard," 42 Tax Mgmt. Int'l J. 628

  3 See "[EU] Commission: U.K. `Patent Box' Violates
Tax Code of Conduct, Should Be Eliminated," 201 Daily Tax
, I-3 (10/17/13).

  4 See "Unilateral BEPS Actions Could Lead to Double
Taxation, Practitioners Tell OECD"Daily Tax Rpt., I-1
(10/8/13); "EU Targets Digital Companies' Tax Evasion, Seeks Modern
Framework to Protect Base," 195 Daily Tax Rpt., I-1

  5 Id.

  6 See, e.g., "Practitioner Sees Chinese Tax
Authorities Looking to `Self Adjustments' for Revenue," 22 Tax
Mgmt. Transfer Pricing Rpt.
, 752 (10/17/13).

  7 See OECD's revised Discussion Draft
on the definition of "permanent establishment" (Article 5 of the
OECD Model Tax Convention) (10/19/12).

  8 See "Officials Call on Businesses for
Suggestions to Address BEPS," Tax Notes