BEPS in Trouble—Gloves Off at the OECD Conference

The verities of international tax law are no more. The days of strong residence-based rules of corporate taxation are numbered. The age of the Permanent Establishment (“PE”) as the central concept of international tax is drawing to a close. That seems to be the message from the OECD International Tax Conference, held June 10-11 in Washington.

The conference witnessed an extraordinary spat between the U.S. and other countries, including the U.K., over the direction being taken by the BEPS project. In essence, the U.S. is fed up with the BEPS project while other countries are fed up with the U.S. for being fed up.

Pornography Test

It all started with the opening address by Bob Stack, U.S. Treasury Deputy Assistant Secretary for International Tax Affairs. The U.S., he said bluntly, was “extremely disappointed in the output [of the BEPS project], and our collective failure . . . to do more, and to do better work than we have done.” Rather than producing administrable rules, the BEPS negotiators seemed to be opting instead for giving wide discretion to tax officials. This brought into question the whole international tax system. “Do the international tax rules even matter anymore?” he asked. “Do we really need a standard setter to say, ‘Tax administrators can use the pornography test to catch tax avoidance. We know it when we see it. And we will get you if we want to’?”

Other delegates seemed taken aback by Stack's remarks.  The U.S. seemed “quite frustrated with dealing with other countries,” noted Mike Williams, U.K. Treasury Director of Business and International Tax, at a later panel discussion. The South African delegate, Sunita Manik, group executive with the South Africa Revenue Service’s large business service, was more colourful in her language. “I was reminded of a movie I once watched and the man said he thought the marriage was fine until his wife asked for a divorce. The last two days, for me, have brought to the fold that maybe the marriage doesn’t seem to be working that well, and maybe some counselling is needed.”

U.K. and Australian Measures

In his address, Stack was particularly critical of two recent unilateral measures to combat BEPS—the U.K.'s Diverted Profits Tax (“DPT”), implemented in April, and Australia’s proposed Tax Integrity Multinational Anti-avoidance Law. The key element of the DPT, targeted at multinationals that avoid having a tax presence in the U.K., is a charge of 25% (5% more than the U.K.'s corporate tax rate) on “diverted” profits relating to activity in the U.K. by a person (the “avoided PE”) in connection with supplies of goods and services by a nonresident company to customers in the U.K.. The charge, which does not apply to small or medium-sized enterprises, bites if: 

  • it is reasonable to assume that any of the activity of the avoided PE or the nonresident company is designed to ensure that the company is not carrying on a trade in the U.K. through a PE by reason of the avoided PE’s activity; and
  • it is also reasonable to assume that either:
    • arrangements are in place between the nonresident company and a related party which achieve an “effective tax mismatch outcome” with “insufficient economic substance”; or
    • there are arrangements whose main purpose, or one of whose main purposes, is the avoidance of U.K. corporation tax.

The proposed Australian legislation applies to multinationals which have global income in excess of A$1 billion (approximately $777 million) and are, or have a related entity that is, subject to no or low corporate tax. It targets a situation where:

  • such a multinational derives income from supplying goods or services to an Australian customer;
  • activities in connection with the supply are undertaken in Australia by an associated or commercially-dependent Australian entity; but
  • in order to gain a tax benefit, the transaction is arranged in a way that avoids attributing the profits to an Australian PE.

In such circumstances, the Australian tax authorities would have the power to look through the transaction, and tax the supply as if it had been made through an Australian PE. There would also be a penalty of 100% of the tax owed.

Political Forces

The U.K. and Australian measures, Stack complained, turned the PE concept on its head by holding that “a taxpayer who follows the very specific PE provisions in a treaty can also somehow be acting in contravention of the objective and purposes of the treaty.” As such, they took “us further down the road in which a taxpayer is at the mercy of whatever a tax auditor decides is the right amount to pay.” What made this particularly perturbing was that these measures emanated not from the usual suspects such as India, China, Brazil and South Africa, but from “strong traditional residence countries” that happened to be “two of our closest friends.”

While berating the U.K. and Australian measures for taking the BEPS project in a “disturbing direction,” Stack acknowledged that powerful political forces were at work. “Regular folks in those countries, squeezed during a time of austerity, deeply resented reports that multinationals—largely reported as U.S. multinationals—could achieve very low rates of tax.” In that regard, Stack added, the U.K. and Australian measures had shone “a spotlight on the degree to which political pressure can trump policy”. Both countries thought they were entitled “to more than the income from the assets, functions and risks actually in their jurisdiction.”  As a result, they had opted for legislation that focused not on what happened within their jurisdictions, but outside them. It was difficult to believe, he added, that tax experts in the British and Australian governments did not recognise the technical weaknesses of the legislation.

The Australian delegate, Rob Heferen, Deputy Secretary of the Australian Treasury’s Revenue Group, freely acknowledged that public opinion was driving his country’s proposed legislation. “In a taxi, you don’t talk about the weather,” he said. “You talk about whether a multinational corporation is paying its fair share of tax . . . hence the need for the Australian government to act in the way it did.”

Righteous Indignation

The U.K.'s Mike Williams was less willing to acknowledge the impact of politics. U.K. tax policy, he coolly stated, “is determined by the U.K. government and Parliament, consistent with our international obligations.” Instead, he criticised America's approach to the BEPS project. The U.S. remained committed to “detailed,” “descriptive” rules, but such rules would simply not work. “If you do go for detailed rules, how do you make them work in the very different circumstances of many different countries? If the rules are very detailed, and they do have to take into account circumstances in different countries, how do you keep them up to date?”

It was better, added Williams, to cooperate with the rest of the world rather than “fulminate against it.” Cooperation required respect for other countries’ views and practices, and the realisation that the rest of the world “isn’t going to buy into the U.S. rules.” The alternative would be more chaos and controversy “which will almost certainly lead to more double taxation.”

What Williams seems to be saying here is that the U.S. has a choice to make between principle and pragmatism. It can continue to insist on bright-line rules, and then go off to sulk in the tent of righteous indignation when its friends go down another route. Or it can accept the inevitable and help to shape the new world order that is even now being moulded by public opinion.

To judge from Bob Stack's comments, it seems that the U.S. has already made up its mind.

Dr Craig Rose, Technical Editor, Global Tax Guide