By Craig A. Sharon, Esq.
Former Director of the IRS's Advance Pricing Agreement Program, Washington, DC
Much has already been said, and more will surely be written, about the report on Base Erosion and Profit Shifting (BEPS) issued by the Organisation for Economic Co-Operation and Development (OECD) in February 2013.1 Given the low profile and fast pace of the BEPS project, most of the early commentary has come from the OECD participants and tax authority representatives involved in drafting the report. Although their public comments (and the report itself) reflect a pro-government tilt, such comments also signal (more than the report does) a caution and a balance seemingly intended to tamp down the political heat, while heading off a panicked reaction within the business community that could cause short- or long-term damage to the global economy. Taxpayers, governments, and others would be well advised to follow the OECD's tempered lead as the BEPS project proceeds in the months and years ahead.
In the spirit of the foregoing, I offer a few other observations about the OECD project and the BEPS report:
- The BEPS issues are old hat, but the OECD's "holistic" (i.e., "comprehensive") approach and sense of urgency in dealing with the issues are new. The OECD report identifies seven "pressure points" requiring further study and analysis: Transparency regarding effective tax rates;
- Transfer pricing;
- Hybrid mismatches;
- Application of treaty concepts to the digital economy;
- Tax treatment of intra-group financial transactions;
- Effectiveness of anti-avoidance measures;
- Availability of harmful preferential tax regimes.
All of these issues have been studied if not once, then multiple times over the years, either in isolation or as part of broader OECD projects. Search the OECD website (www.oecd.org) and you'll find any number of past and current OECD projects related to BEPS:
- Information exchange and tax transparency;
- Permanent establishment (PE) definitions, limitation on benefits, tax treaty aspects of e-commerce, and other treaty issues;
- IP transfers, safe harbor provisions, restructurings, attribution of profits to PEs, and other transfer pricing issues;
- Aggressive tax planning and harmful tax practices;
- Tax policy analysis and statistics;
- Dealing effectively with transfer pricing and other tax administration issues.2
If you look at individual countries, you'll see that many have already taken steps to address BEPS (e.g., IRC §901(m) and the dual consolidated loss rules in the United States, limiting deductions in Denmark for payments on debt treated as equity in the recipient's country and in the Netherlands where the lender is subject to a low rate of tax in the lender's country, and the adoption in various countries of stricter thin capitalization rules and/or anti-abuse rules).
What's new and anxiety-producing for taxpayers about the current BEPS work is the political environment. Because of austerity policies adopted by many governments that impose higher taxes on individuals and on consumption, multinational companies that pay limited income tax in the places where they operate are now in the crosshairs of elected and other public officials, including heads of government. For multinationals, which represent an easy political target, such a position is an unpredictable, uncertain, risky, and possibly punitive place to be. Cool heads and a calm approach are required of all affected constituencies - business, tax authorities, elected officials, and the public at large.
- Although the fiscal crisis may be motivating public officials to demand fast and comprehensive action on BEPS, the project was in some sense inevitable as an evolutionary response to globalization. Just as globalization (coupled with advances in information and communication technologies) has produced entirely new business models and legal structures, which in turn have led businesses to adopt new tax strategies, globalization has forced tax authorities to continually update their enforcement strategies, such as expanding taxpayer information sharing, embracing new forms of tax authority collaboration, and taking other joint and collective actions to "match up" better with taxpayers' changing business models. While these administrative efforts have been underway for years, if not decades, it is hardly surprising that the underlying domestic rules and international standards would lag behind and, at some point, would need to be updated to keep up with the changing economic landscape. Viewed in this light, the BEPS project doesn't seem so revolutionary or forced, notwithstanding the surrounding political rhetoric.
- While taxpayers are understandably anxious about the direction of the BEPS project, the high-level political attention insures that the project is not going away any time soon. In that case, constructive participation by business will lead to more favorable results than a rearguard action intended to maintain the status quo. First of all, the status quo, although familiar and mostly manageable, is hardly ideal. Second, the trends aren't promising, judging by the increasing volume of administrative controversy and litigation, the growing influence of the BRICS (Brazil, Russia, India, China, and South Africa), the rising need for multilateral solutions, and the mounting uncertainty and potential for double taxation that exists. Third, knee-jerk opposition will only isolate the business community, render it irrelevant, and lead to more problematic outcomes. Doing nothing is not an option, so thoughtful participation is the only viable alternative.
- Objectivity is equally important for the OECD and governments. On that score, the public comments to date have been more balanced and less critical of taxpayers than the BEPS report, which seems to attribute most of the BEPS problem - based primarily on anecdote, rather than data - to over-aggressive, "loophole-hunting" taxpayers. By pointing the finger at taxpayers, the report underplays the extent to which governments, acting in their own self-interest, have contributed to the perceived problem. Ironically, as noted in my last Commentary, some of the more "moralizing" governments have engaged in their own form of tax competition to attract private investment and spur economic growth. Until the substantive rules are changed, governments should not publicly condemn multinationals for applying rules that the governments themselves create and control, and certainly should not coerce them into paying additional (i.e., voluntary) tax. To that end, I'm puzzled by the assertion in the report that taxpayers have adopted structures that are only "technically legal."3 Is that an unacceptable form of compliance generally, or only if an anti-abuse rule applies?
- The critical tone about taxpayers in the BEPS report contrasts with the friendlier tenor of OECD and tax authority statements encouraging taxpayers to adopt a more cooperative, less confrontational approach to international tax compliance as part of wide-ranging administrative reforms that many tax authorities have been adopting and implementing over the past few years. In this context, tax authorities have been emphasizing the potential benefits to taxpayers from embracing a compliance mindset that promises to reward greater taxpayer transparency, cooperation, and less aggressive behavior with better case selection, earlier decision-making, increased certainty, and minimal double taxation - a reasonable quid pro quo. In comparison, the BEPS report reflects much greater skepticism about taxpayer motives and relies primarily on the threat of double taxation chaos if the project fails. It remains to be seen whether or not the IRS and other tax authorities will deliver on their promises to low-risk taxpayers in the administrative context, but a more moderate tone and a better balance of "carrot and stick" reforms would surely help the BEPS process. The OECD's rejection of formulary apportionment is appreciated, but other potential "carrots" that the OECD could offer taxpayers include genuine commitments to:
- standardize global transfer pricing documentation requirements;
- develop a global consensus on headquarters allocations;
- push harder for the adoption and use of safe harbors for routine transactions;
- promote regular use of treaty arbitration when the deadlines have passed;
- reaffirm the importance of comparable uncontrolled transactions as the threshold benchmark for assessing arm's-length behavior;
- forge an understanding with the BRICS about the arm's-length standard and a definition of PE that comports with established international standards, reduces the number of disputes, and minimizes the potential for double taxation;
- discourage governments from coercing taxpayers into paying additional, extra-legal tax by putting taxpayer reputations at risk.
The foregoing suggestions relate almost exclusively to transfer pricing, but similar taxpayer-friendly ideas exist with respect to the other six pressure points (e.g., more objective and easier-to-apply limitation on benefit (LOB) provisions in treaties and a consistent thin capitalization standard). Personally, I'd like to see a more robust discussion about the ins and outs of "double non-taxation." The BEPS report unequivocally condemns it, and while the term connotes inequity, the OECD analysis seems oversimplified in concept and practice.
- Obviously, it is far too early to predict the outcome of the OECD project. The initial BEPS report only explains the context of the project, lays out a framework for analysis, and outlines the expected next steps (i.e., development of an "Action Plan" to be approved by the OECD's Committee on Fiscal Affairs (CFA) in June 2013). If transfer pricing is the tax world's window on globalization, then the BEPS project represents the tax world's window on high-level, government-to-government, multilateral negotiations. Given the political attention, the process and possibly the outcome of the project will differ from the technical tax discussions that typically occur within the CFA and between and among tax authorities. This difference introduces new uncertainty, creates a more dynamic environment, and will require a subsequent implementation phase to flesh out the details (including transition rules) - all of which will inevitably extend the project's timetable, which seems unrealistically tight in any event. Given the importance and scope of the project, some delay would be welcome and also seems to be inevitable.
- The Action Plan will clarify the timetable and scope of the project, but whatever the Plan, it will likely take a year or more for the OECD to produce a comprehensive follow-up report and years more for governments to implement the recommendations. The United States has been discussing corporate tax reform for years now, without much progress. The challenges of agreeing to and implementing a comprehensive BEPS reform plan on a global basis - the stated goal of the project - can hardly be overstated. The needed action items will require far-reaching domestic, bilateral, and possibly multilateral negotiations, agreements, and implementation. In the meantime, the environment will change (including the possible enactment of U.S. tax reform) and new data may become available that will require adjustment to the process or refinement of the Plan's substantive recommendations. For better or worse, many of us are likely to be dealing with this project for the rest of our professional careers.
Given the circumstances, business input will be critical to the success of the BEPS project. Success will turn on the development of solutions that increase certainty and reduce the potential for double taxation, and thereby encourage increased investment, economic growth, and job creation for the benefit of taxpayers, governments, and the public. The good news is that the OECD represents by far the best forum for undertaking the BEPS project, and it is openly encouraging active business participation. Business should take advantage of the offer - respectfully, of course.
This commentary also will appear in the June 2013 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Daher and Aceves, 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 T.M., 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 Treaties.
1 OECD (2013), Addressing Base Erosion and Profit Shifting (OECD Publishing). .