The OECD BEPS Report: The story of the Elephant, the 800-pound Gorilla and the Tiger

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

Monique van Herksen, Ernst & Young in The Netherlands

Monique van Herksen is a partner

On February 12, 2013, the OECD released a report addressing Base Erosion and Profit Shifting (hereinafter “BEPS”) that concludes that a comprehensive action plan should be developed quickly and that a global action plan is needed to address the issue of BEPS.1 Reading the report, a sense of urgency is apparent. The need is expressed to  

“halt base erosion, which constitutes a serious risk to tax revenues, tax sovereignty and tax fairness for OECD member countries and non-members alike.”2




According to the Report,  

“a number of indicators show that the tax practices of some multinational companies have become more aggressive over time, raising serious compliance and fairness issues.”  


Furthermore, the Report identifies that  

“current international tax standards may not have kept pace with changes in global business practices, in particular in the area of intangibles and the development of the digital economy. For example, today it is possible to be heavily involved in the economic life of another country, e.g. by doing business with customers located in that country via the internet, without having a taxable presence there or in another country that levies tax on profits.”




In an era where non-resident taxpayers can derive substantial profits from transacting with customers located in another country, questions are being raised about whether the current rules properly address these developments. Finally, the Report references that as business increasingly integrates across borders and tax rules often remain unco-ordinated, there are a number of structures, technically legal, which take advantage of asymmetries in domestic and international tax rules. In this respect, hybrid mismatch arrangements are mentioned.

What has happened to make the OECD come forward with this Report? Base erosion is nothing new. The OECD on its website quotes a statement by US President Kennedy saying:  

“Recently more and more enterprises organised abroad by American firms have arranged their corporate structures aided by artificial arrangements between parent and subsidiary regarding intercompany pricing, the transfer of patent licensing rights, the shifting of management fees, and similar practices[…] in order to reduce sharply or eliminate completely their tax liabilities both at home and abroad.”3




John F. Kennedy was president of the United States from 1961 to 1963. Considering this statement and the time when it was made, 'artificial’ arrangements, however defined, appear to be nothing new in tax. Base erosion practices may be addressed by transfer pricing rules and enforcement thereof, plus that we have seen a lot of activity around the issuance of general anti avoidance rules (hereinafter: GAAR) by several countries lately. The issue of how to deal with intangibles is the subject of a separate study being conducted by Working Party 6 of the OECD, namely the project to update Chapter VI of the OECD Transfer Pricing Guidelines For Multinational Enterprises and Tax Administrations (hereinafter: OECD Transfer Pricing Guidelines) which commenced in 2010 with the issuance of a scoping paper, and is ongoing.4 Furthermore, the practice of hybrid mismatches was the subject of a separate OECD study that culminated in the issuance of a report as recent as last year, named “Hybrid mismatch arrangements: Tax Policy and Compliance issues”.5 Double non taxation is being scrutinised and has been the topic of a study by the European Union, reference its 2012 consultation paper and July 5, 2012, summary report. The OECD similarly is looking at this, witness a May 2012 meeting organised by the Canadian Revenue Authorities for OECD member countries. This issue is linked with hybrid mismatches, addressed in the above mentioned OECD report, issued in spring of 2012.

So what is the BEPS Report and its progeny to add considering these developments? The BEPS Report continues to provide that  

“more fundamentally, a holistic approach is necessary to properly address the issue of BEPS” and that “the integrity of the corporate income tax is at stake.”




Some of the issues referenced in this respect are  

“the balance between source and residence taxation, the tax treatment of intra-group financial transactions, the implementation of anti-abuse provisions, including CFC legislation as well as transfer pricing rules.”




How to interpret this apparent cry for comprehensive global action by the OECD? And more than that, if such a comprehensive action plan is to be developed, what can we expect and should taxpayers plan or brace for? It seems as if the OECD, through its call for action, is trying to address and co-ordinate a couple of major issues or sensitivities in tax practice and tax policy that are surfacing globally. Not only have the G20 asked the OECD to co-ordinate this, they have asked the OECD to do so rapidly, and propose an action plan by July 2013. However, there are some issues underlying the Report that, if ignored, can have a major impact on the outcome of the BEPS efforts that the OECD plans to undertake. They are the respective Elephant, Gorilla and Tiger in the room, so to say. First and foremost, enter the Elephant: the longstanding issue of addressing jurisdiction to tax based on source and residence-based taxation. Second, enter the 800-pound Gorilla: the fairness notion of taxation that has been in the news prominently and thirdly, enter the Tiger: access to avoidance of double taxation for taxpayers globally. Transfer pricing, intra-group financial transactions, anti-abuse provisions could all be seen as components that are subject to the behavioural pattern of these three animals that seem to rule the global tax habitat and related discussions recently. Following, the three animals identified above are independently looked at and the challenge to have them live together in harmony.

l. The Elephant

International tax law governs the taxing rights of sovereign nations. Whereas the OECD BEPS project will underscore that its task is to find solutions within the current internationally agreed global tax framework, one issue at the base of the reasons for the BEPS Report has to be: who has fiscal jurisdiction to tax income? This issue is potentially far more sensitive than first meets the eye. This issue at its core is larger than a discussion on whether or not the taxable corporate income tax base can be eroded by cross-border deductible payments.

Professor Roy Rohatgi describes the jurisdiction to tax issue most succinctly as follows:  

“There are two schools of thought on fiscal jurisdiction based on differing perceptions of State sovereignty. The first believes that there is no restriction on a State's right to tax, and that it may be exercised without regard to other States. It is therefore not necessary to have a legal connection or link with a jurisdiction, provided there is a valid nexus with that State. The other school maintains that the sovereign right to tax is confined to a territory having a 'legally relevant connection’ between the State and the taxpayer. Although the issue is still unsettled, both views accept that 'connecting factors' give a State the right to tax. These connecting factors link the taxpayer personally to a particular tax jurisdiction. They include personal links with the home State by virtue of residence, domicile or citizenship for natural persons, and the place of incorporation or location of a registered office, or management and control for legal persons. An economic activity is also connected with the host state, which exercises its taxing rights due to the territorial link. The domestic laws in countries normally apply the following international tax principle based on connecting factors:

• Residence rule: unlimited taxation rights are granted to the country of residence, due to its 'personal attachment’ of persons. The country of residence (or nationality) may impose its taxes on the worldwide income of individuals or corporations due to the protection it offers to the tax subject.

• Source rule: Limited taxation rights are granted to the country of source due to the economic attachment’ of persons. The country of source reserves the right to tax the income that is derived from the economic activities within its territory.”6




The treaties for the avoidance of double taxation that were developed after World War II as a result of the work conducted by the League of Nations (the later United Nations), in general pursued a residence based taxation system, in which income would be taxed mainly in the State of residence, and the residual would be allocated to the State of Source. To be specific, as reported in detail by C. John Taylor, the League of Nations established a Committee of Academic Experts which produced a Report in which it was maintained that competence to tax should correspond with a person's economic allegiance. The most important determinants of which were the origin of wealth and domicile of the consumer of wealth.7 The Experts framed the issue as a conflict of interest between debtor (capital importing) and creditor (capital exporting) countries. Members of the Expert group argued in favour of residency-based taxation. In the end, the source (or at that time generally Colony) country was allocated the right to impose “impersonal taxes” (i.e. withholding taxes) on various classes of local income, with the country of residence (at that time generally Imperial Country) providing a foreign tax credit for such taxes.8 The impact of this recommendation was to exempt from source country taxation all profits derived by a foreign enterprise through independent agents. Furthermore, a source country would have no right to tax business profits from industrial and commercial activities on a net basis (unless the foreign parent had a permanent establishment in the source country).9

Anyone engaged in the tax profession has been able to observe the rapid development of transfer pricing rules the past years. Because of the arm's length requirement, remuneration levels of associated enterprises have to reflect functions performed, risks assumed and assets used, and be comparable to those that independent enterprises earn. After these rules were put in place, multinational enterprises were audited as regards their compliance with the rules. What was perhaps unanticipated was that multinational enterprises seemed to have the flexibility to morph into the functional characteristics and a comparable of choice, so to say. With some careful planning, they could restructure themselves so that the functions performed, risks assumed and assets used by the respective associated enterprises match the functionality of a low risk entity or an entrepreneurial, high risk entity. Once this was developed, it did not take long until full-fledged distributing or manufacturing entities were seemingly surgically stripped into low risk distributors or contract manufacturers with marginal returns, and high value assets or high risk functions were centralised in associated enterprises that were established in jurisdictions that offered favourable corporate tax regimes. One can add to this the possibility to put in place intercompany financing arrangements that create tax deductible interest expenses and at the same time allow for non-taxed financing income earnings, and the broader use of holding companies or flow-through companies. Hybrid financing instruments that qualify as debt at the level of the debtor and capital at the level of the creditor may offer the result of creating deductible expenses on one end and non-taxed income on the other end of the transaction. The rationale used to explain and justify this development is that tax is seen as a cost of doing business and managing cost is considered a necessary part of business. In fact, one can even say that tax directors of a multinational enterprise have as mandate to manage and minimize tax costs, for the benefit of their shareholders. All of this is done according to the applicable law and rules of play in force, of course, aided by the residence and source based taxation division and international rules of taxation, and where applicable, the double tax treaty provisions.

In following the above referenced mandate, some business restructurings observed were perhaps more synthetic than others. Early on, as long as risk and funding were assigned to a location and contracts reflected that assignment, less attention was paid to the substance of business transactions and day-to-day operations that make up a certain functionality. How many people are needed to manage a certain risk? What skill set is actually needed to perform certain risk management? The Business Restructuring chapter of the OECD Transfer Pricing Guidelines brought limits to this practice and clarified that unrestricted tax planning would not be condoned in this respect. The OECD will point out that there should not be an oversimplification of what is happening in the field of business restructuring. Segregating risk and intellectual property is just not that simple. Nevertheless, many of the new corporate supply chain structures however substantive and legally correct, are practically out of reach for small individual and independent enterprises, as are the (tax) cost savings they bring. It was probably never envisaged that, rather than a stick for multinationals to pay the right amount of tax, or a mere compliance exercise, transfer pricing would become a tool that could be legally used to effectuate interesting tax savings.

In addition to the above development, anyone keeping an eye on the economic developments of the past couple of years will note that the term “BRICS” is prominently represented in the press. The economic and increasingly so also political power of the BRICS is making a mark on international policy and developments. The economic crisis shows the weakness of the European and American consumer markets. It also shows the dependency of multinational enterprises on consumer demand in the former developing countries, including India and China, to recover. China is regularly identified in the news as the locomotive that pulls forward the European economy: when the Chinese imports are reported to go up, the European stock exchanges go up as well. So it should come as no surprise that the governments running the BRICS countries are becoming more powerful politically and that the taxing authorities of these countries are becoming more powerful politically as well. Like any country, China and India and the other BRICS need revenue to finance their industrial and technology development and growing populations. Where in the past they were considered dependent on international aid and foreign direct investment and had little capacity to monitor and manage the country's tax system, today their government representatives and business leaders are Harvard and MIT trained, have MBAs from London schools and are aware of the value of training and education.10

Multinational enterprises that are in the business of rendering services and making products want to make sure they tap into the rising local demand for consumer goods and services in the BRICS markets. New technology, like the internet and digital commerce, allow for a global market reach with relatively limited global investments.11 Multinational enterprises have organised themselves to reach large amounts of consumers in far-away markets. While doing so, many continue to use the established practice to determine taxable income at arm's length based on functions performed, risks assumed and assets used, while benefitting from the flexibility multinational structures offer. This practice seems to now encounter serious challenges. BRIC governments seem to believe that they have been dealt the short end of the straw as regards global taxable income distribution as a result of these developments. Many of them are the holder of rare and extremely valuable market commodities: Comparatively Low Cost Labour, Natural Resources and vast Consumer Demand. Nevertheless, they have a reduced opportunity to capitalise on the market value of these commodities, as they are often allocated taxing rights based only on source based-taxation. Multinational enterprises doing business in the BRICS may operate largely digitally, and often operate with relatively simple structures that include contract manufacturers, stripped distributors or licensees and service providers. The entrepreneurial functions that earn residual profit, are often centralised in tax favourable jurisdictions. This organisational structure is being experienced as unfair by some taxing authorities, regardless of the international income allocation or taxation rules in place. As a result, we are seeing tax positions taken by these taxing authorities that - in light of the existing and internationally accepted transfer pricing rules - may appear extreme and uncalled for. Reference can be made to examples such as demand for revenue corresponding to income earned from location savings and location advantages (as reflected in Chapter 10 of the UN Practical Manual on Transfer Pricing),12 very fluid definitions and increased sightings of permanent establishments (subject to taxation in the source country) and extra-territorial taxation of capital gains (i.e. the Indian Vodafone case).13 Leave alone the effective expansion of the authority to tax by the several domestic GAAR being issued. All of these developments could potentially be seen as a break with the traditional international tax rules by way of claiming exceptions to the rules. And as goes with exceptions, one can do, many defy the rule. In addition, the BRICS appear to be acting in a united fashion. Not only are they united at the United Nations, but more and more so they are taking the initiative to do business with each other and discuss major issues amongst themselves with the exclusion of non BRICS countries.14 As a result the alternative countries for multinational enterprises to go to are reduced. In addition, the siren call of Consumer Demand, Low Cost Labour and Natural Resources are proving so hard to resist that at least some multinational enterprises seem to prefer accepting the (fiscal) conditions put on them for doing business in the BRICS countries over not doing business there. By doing so, they are seen as indirectly endorsing the positions taken by the respective taxing authorities and the fiscal Diaspora that appears to be taking place.

If the above analysis of combined factors is correct, the OECD rightfully maintains in the BEPS report that a comprehensive solution cannot be developed without the contribution of all stakeholders. In that case, all interested member countries will indeed have to be involved in the development of the action plan and non-member countries, in particular G20 economies will have to contribute as well. The Elephant in the room is the demise of an internationally agreed and consistent system determining jurisdiction to tax, as a result of increasing exceptions to the rules and issues such as location savings and location advantages, new valuable intangibles and GAAR.

ll. The Gorilla

One of the underlying justifications of the right to tax by a government is the notion that taxes are the price we pay for a civilised society. Hand in hand with this justification goes the notion that taxes ought to be levied based on the ability to pay. These underlying principles are usually not expressed as such in the respective tax laws that are issued, however, but they do serve as universal and underlying justification for taxes. Their application may be deduced from a progressive tax system, i.e. one where a higher tax rate is applied to those taxpayers reporting a higher amount of taxable income. As regards income tax there is no direct rule that ties the (amount or value of) benefits of a civilised society, to the amount of tax to be paid. True, certain taxes are consumption based and some duties or levies are user-based (like a VAT or toll roads). In those situations, consumers and users pay these taxes, non-consumers and non-users do not. But income taxes do not follow that approach. One can question how and whether the rationale for an income tax is to be applied to corporate enterprises as well. There isn't one comprehensive and universal rationale why companies should pay tax in addition to private individuals. One can find academics repeating the “price for civilisation or benefits received” argument, the latter of which refers to the benefits of limited liability, and there is also reference to an efficiency argument, that companies can be seen as collection agents for taxes (by performing wage withholding and collecting social security premiums, sales taxes and VAT, dividend withholding taxes) but otherwise if one considers that all company costs including tax costs are passed on by companies to the end users of their products or services, the rationale for a corporate income tax may be relatively weak. Companies operate as flow-through organisms and pass on all of their costs one way or another.15 If you over simplify, you can say that all they are is a legal vehicle through which raw materials and labour are converted to cash flow with the help of strategy, management, logistics and capital. Their mandate is to serve their shareholders by creating share value or return on investment such as dividend. Managing tax costs contributes to this mandate.

Nevertheless, the notion that companies must contribute and pay (more) corporate tax and an emphasis on their perhaps “diabolical” features have been around for a while. The OECD BEPS report mentions that there is a growing perception that governments lose substantial corporate tax revenue because of planning aimed at shifting profits in ways that erode the taxable base to locations where they are subject to a more favourable tax treatment.16 Many studies by international organisations, including the European Union and the OECD, commence with a listing of how much tax revenue is lost as a result of behaviour by multinational enterprises. The European Commission's Commissioner for Taxation, Algirdas Semeta, speaks of around one trillion Euros being lost to tax evasion and avoidance every year in the EU alone.17 Movies have used companies as a favoured villain for years emphasising a focus on greed and profit, witness inter alia movies such as 1987's Wall Street, with Michael Douglas acting as tycoon Gordon Gecko, and 1993's The Firm with Tom Cruise acting as a novice associate in a law firm engaged in tax fraud and money laundering.18

The global economic crisis and resulting layoffs and pay cuts by governments and businesses have demanded a heavy toll. There is a great sense of injustice at the level of the public at large, in that the current economic crisis is seen as mainly the result of greed by some at the expense of many others. People, politicians and the press are all seeking someone to blame. Extensive articles appeared in the press on multinational enterprises using tax haven jurisdictions to evade corporate taxes.19 Politicians catering to their constituency and “determined that multinationals would not avoid tax” set up hearings to get to the bottom of it all, like the UK Public Accounts Committee asking companies (Amazon, Starbucks and Google) to appear before them on November 12, 2012. Somewhat similarly, questions are submitted with increasing regularity to the Ministry of Finance in the Netherlands by Parliament as regards the Netherlands being identified as a jurisdiction that is the domicile of financing and holding companies for many multinational enterprises identified in the press. This has required the Under Minister of Finance to put forward the position of the Netherlands authorities as regards the discussion on base erosion and use of Dutch holding and financing companies.20 Multinational enterprises are not the lone target of this scrutiny on tax contributions and the determination whether the amounts contributed are proportionally fair, however. The “Occupy” movement that commenced in Zuccotti Park New York, in the fall of 2011, emphasised income disparity and the difference between the “99 Percent” of the population who have nothing and the “1 Percent” who reportedly control 40 percent of the world's wealth. The Occupy movement spread around the world and demanded inter alia more proportional taxation. Those seen as potentially “aiding and abetting” the “1 Percent” and the multinational enterprises with evading taxes are under similar scrutiny. On January 31, 2013, the UK Public Accounts Committee made a spectacle out of a hearing directed at the Big 4 accounting firms and “their helping companies deprive the Treasury of taxes everyone else has to pay” 21 and the hearings are ongoing grilling individual companies

The public interest in fairness of taxation and the morality of (not) paying (sufficient) tax constitutes a 800-pound Gorilla in the room of tax policy. Multinational enterprises can in general structure their business -legally- more tax favourable than small independent business enterprises and individual entrepreneurs can. Whatever the OECD BEPS study comes out with as a solution to base erosion and profit shifting will have to not excite this animal too much to be successful. Although the OECD BEPS study will not go that far, what if it would conclude that one way to address base erosion would be the abolition of corporate tax in general (and a recommendation to switch to a global value added tax system)? Or that the solution would lie in introducing a global flat corporate tax rate of 15 percent for all countries, which would be a reduction in the currently applicable corporate tax rate of most countries, but also a broadening of the tax base? A recommendation along these lines, regardless of its projected positive economic effects may very well not be acceptable from a Gorilla perspective. To the Gorilla these solutions could seem to favour multinational enterprises rather than force them to contribute to society by paying more tax. The Gorilla is a social animal that is loyal to its troop or band, not to outsiders. The Gorilla wants to be the centre of attention. These characteristics may very well have the Gorilla prefer seeking domestic and unilateral legislative changes and in the end keep OECD member countries and non-member countries from being able to work together as constructively as they should to develop a viable action plan.

lll. The Tiger

Countries are taking vigorous action to raise revenue. They need to finance halting growth of their economies, finance growing populations and fund failing banks. To raise the necessary revenue, there are spending cuts made on one hand and more tax audits conducted on the other hand. More tax audits are leading to more tax adjustments and as a result, more tax disputes. Multinational enterprises are of course being audited in particular with respect to issues that are seen as contributing to base erosion and profit shifting. The OECD BEPS Report defines these as being:

i. international mismatches in entity and instrument characterisation (hybrid mismatch arrangements and arbitrage),

ii. digital goods and services and the application of treaty concepts to profits derived from the delivery and sale thereof,

iii. related-party financing, captive insurance and other intra group financial transactions,

iv. transfer pricing,

v. individual anti-avoidance mechanisms such as GAAR, CFC rules and thin cap rules, and

vi. the availability of harmful tax preferential regimes, i.e. local country tax incentives created by tax competition.22


Therefore, the action plan the OECD is likely to suggest will probably present measures to curb or manage the issues identified above, that tax authorities can use disallow these practices.

Multinational enterprises that are presented with an income adjustment will try to reduce the (tax) cost of that adjustment. Being taxed is one thing. Being taxed twice is once too many and also internationally seen as an unacceptable barrier to doing business. Furthermore, considering that companies are flow-through organisms in the world of tax and pass on all costs one way or another, double taxation in the end is passed on to consumers of goods and services just as other costs are. So to the extent that an (upward) income adjustment made by taxing authorities in one country affects an international transaction between these associated enterprises of a multinational enterprise, the upward (primary) adjustment on one side will require a downward (corresponding) adjustment on the other side of the transaction, to avoid double taxation.

There are several ways to obtain avoidance of double taxation. One way is to have the (primary) tax adjustment annulled or found to be incorrect by a (domestic) court of law. This route is one that generally is lengthy and can take several if not many years. A taxpayer will first have to object to the assessment, and if the objection is reviewed and rejected, appeal to a court of law. In the mean time, the taxpayer may very well not have gotten an extension of payment and is litigating to get a refund of the taxes it paid. If an extension of payment is granted, then the amount in dispute is accruing interest for the extension of the payment. So if the taxpayer loses in court, the assessment will have to be paid plus interest. Furthermore, if the taxpayer loses in court, he will still have to proceed and seek avoidance of double taxation elsewhere. A next way to avoid double taxation is to submit a request to the respective competent authorities of the States affected by the primary adjustment. Assuming there is a treaty for avoidance of double taxation in place between the States, and the procedural requirements are fulfilled to file such a request (usually this includes filing within 3 years of the first notification date of the adjustment), the adjustment and its resulting double taxation are reviewed by the competent authorities, which will endeavour to resolve the double taxation between the two of them. This avenue can take a while as well. Situations where cases took more than four years to resolve are not at all uncommon, although there has been great emphasis by the OECD and European Union to speed up the process. A Memorandum on Effective Mutual Agreement Procedures (MEMAP) was issued by the OECD in 2007 as part of a process to improve the functioning of international tax dispute procedures.23 Furthermore, the OECD has moved forward with issuing mutual agreement statistics on their website.24 The EU Commission, through its European Union Joint Transfer Pricing Forum issued two Codes of Conduct on the functioning of the EU Arbitration Convention, that serve to speed up the process as well.25 The Arbitration Convention is a multilateral treaty between the EU Member States that serves to avoid double taxation that arises from transfer pricing. A faster way to get to the mutual agreement procedure can be if there is accelerated competent authority access. That means that a taxpayer would already consult the respective competent authorities and put them on notice that he will seek avoidance of double taxation, at the time that the audit is still being conducted and the tax assessment is not yet issued in final. Some countries offer accelerated competent authority access.26 However, the competent authority process is seen as being non-transparent, as taxpayers cannot be party to the actual State-to-State discussions and the basis on which agreements are made are not disclosed. So although avoidance of double taxation is deemed very important, so much so that the new 2010 OECD Model Convention and the new 2012 UN Model Convention both allow for a possibility to use arbitration to resolve such double taxation cases, actually getting avoidance of double taxation can be a bit of an exasperating process. A third unofficial way is to apply some form of “self-help” and make a corresponding adjustment in the other State, either by filing an amended tax return for the corresponding year, or by making a corresponding adjustment in a later year, that would help justify the actual transfer of funds to the country where the primary adjustment is made. This last option of “self-help” requires a re-invoicing process and although fast, is usually not appreciated by the tax authorities of the State at whose detriment the corresponding adjustments is made, plus that it may have additional consequences in the area of VAT and customs duties. Claiming a hidden tax credit in the corresponding State for the additional tax to be paid in the country of the primary adjustment is usually also not welcomed by the taxing authorities of the corresponding State.

The past couple of years have seen constantly increasing tax disputes and tax adjustments for multinational enterprises, leading to double taxation. The traditional avenues to dispute resolution and avoidance of double taxation, litigation or the mutual agreement procedure, take time. This is due to complexity but also because the institutions responsible for these processes are understaffed. There is much more demand for avoidance of double taxation than supply of resources to render assistance. More and more, we see taxpayers presented with tax disputes resolve them by entering directly and unilaterally into settlement agreements. The consequence of these settlement agreements often is that no mutual agreement procedure access is available, because the settlement terms bar this, or because the competent authorities refuse to present the case to the other competent authority.27 Taxpayers not wanting to carry the double tax costs are looking for solutions, however. If the tax treaty process to avoidance of double taxation is not working, they will need to seek other avenues. One of which increasingly is looking at the use of bilateral investment treaties. Bilateral investment treaties aim to provide protection to investments made by nationals of the contracting States in their two countries. These bilateral investment treaties may offer investors fair and equitable treatment, protection against expropriation, and the treaty may have in place a most favoured nation principle, which means that investors will not be treated less favourable than investments of investors in third States. In case of disputes, the taxpayer may choose to initiate a dispute resolution procedure to protect its investment. These disputes are handled by arbitrators who are not government representatives or government employees. To the extent that double taxation cases are handled under bilateral investment treaties, they are outside of the scope of control of the competent authority and mutual agreement process. Double taxation in this story, personifies the Tiger. It is a solitary and territorial predator, that does not operate in groups. Double taxation is a cost of business and of governments alike, as the nature of multinational enterprises or any company for that matter, is to absorb and pass cost on to the end consumer of its services or products, or its shareholders.

lV. The zoo in our future

The OECD BEPS Report, although it identifies several specific technical items that need to be addressed (such as hybrid mismatch arrangements, transfer pricing rules producing undesirable results, the jurisdiction to tax in particular as regards digital goods and services, anti avoidance measures, intra-group financing arrangements and harmful regimes) may very well be, more than we think, driven by Elephants. Jurisdiction to tax and a general unhappiness with the legal environment that either dictates or accommodates the current allocation of income is an important underlying issue that needs to be successfully addressed to get to a more stable international fiscal world.

What may be coming our way? Initial thoughts lead to one, some or all of the following as ideas that might s potentially achieve a result that may appease the Elephant, but there are undoubtedly many more solutions, provided the G20 can actually collectively agree on the respective solutions:

i. explicit international matching rules (for example that hybrid instruments need to be characterised consistently and the same in all countries involved where they have tax effect, in order to have treaty benefits apply. One could consider additional mandatory exchange of information and documentation as regards the tax characterisation on instruments being put in place and reported for tax purposes);

ii. transfer pricing rules that weigh substance and the number of employees at least as heavy as legal risk allocation and financing of intangible property. This issue appears to already be considered by the OECD in its project on intangibles. But perhaps also, a mechanism that lessens the benefits of the centralisation of functions in low tax jurisdictions, such as a limit on deductibility of intercompany charges if the recipient of that income is not taxed or taxed below a certain tax rate;

iii. rules that more easily establish a service as being rendered and that grant a low threshold for the source jurisdiction to tax (the income allocable to) these services rendered within a jurisdiction (new services rules are currently being discussed by the UN Committee of Experts to be included in the future update of the UN Model tax Convention) are a possibility. Although the OECD is likely to prefer to not revisit the permanent establishment concept, a much lower permanent establishment threshold would technically address some of the raised concerns and could possibly also be used to address digital sales-based revenue;

iv. a universal GAAR proposal to handle anti-avoidance at least consistently globally and to halt the overflow of different unilaterally designed GAARs would come in useful, perhaps to include as a new treaty article denying treaty benefit access in those situations. These GAAR rules could also serve to limit the deduction of interest payments in related party financing arrangements or to apply withholding tax on interest payments;

v. definition and identification of harmful tax regimes, not much unlike the effort conducted by the EU when addressing harmful tax competition with a Code of Conduct for Business Taxation and exclusion of treaty benefits in case income is not subject to tax in the other country, for example by extending the limitation on benefits clause to low or no tax scenarios, or by granting a per se right to impose full withholding taxes in case the income is not subject to a certain threshold level of tax in the recipient country.28


However, whatever proposal the OECD and G20 countries come up with to address the identified issues, one thing that is sure is that it will be prey for the Tiger. The BEPS Report even acknowledges that as it explicitly mentions  

“that the OECD has developed standards to eliminate double taxation and should ensure that this goal is achieved while efforts are deployed to also prevent double non-taxation. In this respect, a comprehensive approach should also consider possible improvements to eliminate double taxation, such as increased efficiency of mutual agreement procedures and arbitration provisions.”




The solutions to the issues raised should not create additional double taxation. That alone will probably be more challenging than coming up with initiatives to address the issues raised. At the end of the day avoidance of double taxation means that one State cedes jurisdiction to tax, i.e. tax revenue, to another State. Although the mandate of the competent authority is primarily to resolve double taxation (and not to raise revenue), a likely if not natural allegiance with the home jurisdiction will probably exist. As long as the competent authority function to resolve double taxation is not outsourced to an independent professional body or international specialised institution or as long as arbitration is not universally accepted and included in the respective treaties for avoidance of double taxation, the Tiger will be a threat to the Elephant and certainly to its calf. Action by the respective governments along the lines of the BEPS proposals will likely lead to an increase in double taxation. To try to reduce double taxation, it is recommended that the OECD BEPS report outcome considers an effective date for the proposed action items. A dynamic interpretation, as used with the OECD Transfer Pricing Guidelines, will lead to uncertainty and exposure for multinational enterprises as regards positions taken in past years.

The Elephant and the Tiger, however large and courageous, will both need to reckon with the Gorilla. The Gorilla may not see any reason for making multinational enterprises that are engaged in tax disputes eligible for avoidance of double tax. The Gorilla may consider that strong shoulders should carry the heavier weight, ability to pay should be the norm, and multinational enterprises report enormous turnovers in their annual reports that would seem to justify a proportionally matching corporate tax liability. Similarly, the Gorilla will want to make sure that any actions taken regarding the Elephant are structured in favour of citizens and individuals. One can expect that the Gorilla will remain agitated and has power to influence the respective country politicians until the global economy is showing strong signs of recovery.

Life in general but also taxes are more transparent than they ever were before thanks to the internet and thanks to increasing and extensive government co-operation and co-ordination. This transparency makes the world (seem) much smaller and issues much bigger than they were before. To allow these three large animals to live in harmony and co-exist going forward, it is crucial that all of them get the proper amount of attention but also the proper amount of space to live and function adjacent to each other. For the success of the outcome of the study announced in the BEPS Report it will be important that the OECD does not act alone. Other organisations could be involved as well, like the UN, the World bank and the IMF. Furthermore, related working groups should ideally jointly establish a clear set of rules and procedures. As to the issues covered by the rules and procedures, as uniform as possible definitions and interpretations will benefit multinational enterprises so that they can continue to contribute to foreign direct investment but uniformity will also help to come to a consistent administration of the respective rules internationally. If anything, history shows that multinational enterprises can adapt. They have adapted to the increase in reporting requirements for tax and accounting purposes that have come their way the past couple of years and are likely to adapt to clear instructions on what is and what is not BEPS also. Multinational enterprises are legal structures through which - in simple terms - raw materials and labour are converted to cash flow and profit with the help of management, market strategy, logistics and capital. The individuals that invest in them, manage them and work for them are all likely to follow new applicable laws and rules, once those are decided upon, properly issued and well-administered. Only if the zoo in our future that houses these animals provides for clear borders and boundaries that can be observed by them, are they likely to be able to co-exist in some form of harmony.

Monique van Herksen is an international tax practitioner and partner with Ernst & Young in The Netherlands. This “animal story” reflects exclusively her own views, not those of Ernst & Young. She can be reached at:


1 OECD, Report Addressing Base Erosion and Profit Shifting issued February 12, 2013.

2 Id. at p.5


4 OECD, Transfer Pricing and Intangibles: Scope of the OECD Project, January 25, 2011.

5 OECD Report of May 3, 2012.

6 Roy Rohatgi, Basic International Taxation, Second Edition Volume I: Principles, p. 14-15.

7 C. John Taylor, Twilight of the Neanderthals, or are Bilateral Double Taxation Treaty Networks Sustainable ? Melbourne University Law Review Vol. 34, 2010.

8 C.H. Lowell & B. Wells, Tax Base Defence: History and Reality, 20 Intl. Transfer Pricing J. 2 (2013), Journals IBFD (accessed 28 Mar. 2013).

9 Id.

10 Justine Doody, Building a new power balance BRIC by BRIC, OECD Insights Blog, July 19, 2012.

11 One can easily predict that the developments of 3D printing may create another challenge as to where value is created and resulting income should be taxed.


13 Vodafone International Holdings B.V. v. Union of India & Anr., Civil Appeal No. 733 of 2012,

14 For example, the BRICs are reported to examine the possibility of setting up a new development bank for themselves and other developing countries according to declarations made after the BRICs summit in New Delhi in 2012. Co-operation among fiscal and financial authorities is a target result as well. See

15 See also: Richard M. Bird, Why Tax Corporations? Working paper 96-2 prepared for the technical committee on business taxation December 1996.

16 OECD, Report Addressing Base Erosion and Profit Shifting issued February 12, 2013 at p. 13.

17 Com (2012) 722. Clamping down on tax evasion and avoidance: Commission presents the way forward. Communication from the Commission to the European Parliament and the Council on an Action Plan to strengthen the fight against tax fraud and tax evasion. See

18 For a more extensive listing, see the cover story of the Wall Street Journal of October 14, 2011: Hollywood's Favorite Villain.

19 Examples include: Jesse Drucker, Inside Google's $1 Billion a year tax cutting strategy, Bloomberg, October 21, 2010; Tax Justice Network, How SAB Miller escapes tax in developing countries, published as: “Brewer accused of depriving poor countries of millions in revenue”, The Guardian, November 29, 2010; How GE reaps billions tax free , International Herald Tribune , March 26-27, 2011; For Starbucks in Britain, a skinny tax bill? Washington Post, December 7, 2012.

20 See inter alia the letter of January 17,2013, IFZ/2013/25 U from the Under Minister of Finance to Parliament.


22 OECD, Report Addressing Base Erosion and Profit Shifting issued February 12, 2013, at p. 47.



25 Code of Conduct of July 28, 2006, for the effective implementation of the Convention on the elimination of double taxation in connection with the adjustment of profits of associated enterprises (2006/C 176/02) and the Revised Code of Conduct of December 30, 2009, for the effective implementation of the Convention on the elimination of double taxation in connection with the adjustment of profits of associated enterprises (2009/C 322/01).

26 Dutch Decree of September 29, 2008, IFZ/2008 248M, paragraph 3.1.2 “vervroegde onderlinge overleprocedure” and US Rev Proc 2006-54, December 4, 2006, IRB 2006-49.

27 For example, Circular 21E of June 5, 2011 by the Italian Revenue Agency explicitly excludes settled cases from competent authority relief.

28 Here and there even the implementation of a minimum tax system is being mentioned, with the big question who would set the rate and how to make it uniformly applicable.

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