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By Herman B. Bouma, Esq.
Buchanan Ingersoll & Rooney PC, Washington, D.C.
With all due respect, the OECD's BEPS project was a fiasco, accomplishing little of any positive value and opening up a Pandora's box with its focus on "value creation" in the context of transfer pricing. Despite all the "happy talk" coming out of the OECD and all the talk of a revolution in the global international tax system,1 there is nothing revolutionary in the BEPS project. One can't help but be reminded of a line from Shakespeare: it is "full of sound and fury, signifying nothing."2
The OECD's BEPS project issued final reports on 15 Action items on October 5, 2015, and these were approved by the G20 in Antalya, Turkey, on November 16, 2015. The following is a review of what was accomplished by these final reports:
1. Action 1 (Address the tax challenges of the digital economy) — accomplished nothing, at least as far as income tax is concerned.3
2. Action 2 (Neutralise the effects of hybrid mismatch arrangements) – accomplished little.4
3. Action 3 (Strengthen CFC rules) — accomplished nothing.5
4. Action 4 (Limit base erosion via interest deductions and other financial payments) — accomplished little.6
5. Action 5 (Counter harmful tax practices more effectively, taking into account transparency and substance) — accomplished nothing other than to set some standards for "patent boxes" and the exchange of rulings.7
6. Action 6 (Prevent treaty abuse) — accomplished nothing.8
7. Action 7 (Prevent the artificial avoidance of PE status) — actually accomplished something.9
8-10. Actions 8-10 (Assure that transfer pricing outcomes are in line with value creation: intangibles, risks and capital, and other high-risk transactions) — made things worse by muddying the waters and basically allowing every tax authority to go off on its own aligning transfer pricing outcomes with "value creation" (whatever that means).10
11. Action 11 (Establish methodologies to collect and analyze data on BEPS and the actions to address it) — accomplished nothing.11
12. Action 12 (Require taxpayers to disclose their aggressive tax planning arrangements) — accomplished little.12
13. Action 13 (Re-examine transfer pricing documentation) — made things worse by requiring a country-by-country template which has no relevance to transfer pricing.13
14. Action 14 (Make dispute resolution mechanisms more effective) — accomplished nothing.14
15. Action 15 (Develop a multilateral instrument) — accomplished nothing.15
How did the project end up being such a huge waste of time for tax authorities, taxpayers, and tax advisors? Three factors appear to have been involved.
No Clear Focus
First of all, the project was off to a bad start when, in the fall of 2012, the OECD failed to zero in on exactly what the G20 was concerned about. Instead, once the G20 expressed some concern and asked the OECD to come up with an Action Plan, the OECD took off running. Apparently in an effort to impress the world (and perhaps keep the UN Committee of Experts on International Cooperation in Tax Matters at bay16), the OECD came up with a huge list of items, throwing in everything except the kitchen sink.17 Thus, the project never had a clear focus.
The OECD should have first sought to understand the principal G20 concerns, based on statements of leaders at G20 meetings and also statements of political leaders in their own national contexts, e.g., in the United Kingdom, France, and Germany. Concerns also could have been deduced from the hearings conducted by Senator Carl Levin's Permanent Subcommittee on Investigations, which hearings appear to have been a principal impetus for the G20 concerns.18 Based on this context, one could ascertain that there were four real concerns: the digital economy, royalty deductions when the associated royalty income is subject to low or no taxation,19 PE avoidance, and improper transfer pricing.
The OECD should have focused on these four concerns, identified problems in the global international tax system that give rise to these concerns, and then come up with solutions to these problems. Once it identified the solutions, it should have then come up with an Action Plan for countries, not for the OECD.
Instead, the Action Plan that the OECD developed for itself was a jumbled assortment of different items with different purposes and no clear focus.20
BEPS Is anEmpty Term
A second major factor leading to the failure of the BEPS project is that the term "BEPS" is empty. What does it really mean? I always draw a complete blank when I hear the term. It stands for "base erosion and profit shifting" and we're told by the OECD that profit shifting is a type of base erosion.21 Thus, we're left with the term "base erosion." But what does this mean? Beaches erode, not tax bases. Tax bases are reduced. Thus, we're talking about base reduction. But much base reduction is clearly legitimate. In fact, everyone agreed, including the OECD, that what the lambasted multinationals were doing was perfectly legal. Thus, base reduction can be perfectly innocuous. As stated by Judge Learned Hand, "Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes."22
Thus, if BEPS really means base reduction, what actually is the problem? Clearly, the OECD BEPS project was upset about certain types of base reduction but not others. But how do you distinguish between the two? The OECD BEPS project talked about "BEPS risks," "BEPS issues," "BEPS concerns," "BEPS channels," etc., but what exactly were these? If the project had defined "BEPS" as involving certain specific types of base reduction, then the term would have had some meaning. However, the OECD never did this; it simply referred to BEPS as some type of generic category of base reduction and thus it was never clear what exactly it was referring to. If someone asks you what is "BEPS," what do you say?
Too Much Verbiage
A third reason the OECD BEPS project wasted the time of so many is simply because it produced so much verbiage. The final reports number in excess of 1,900 pages. Moreover, the OECD often uses vague verbiage and undefined jargon instead of using precise terms clearly connected to reality.23 In addition, ideas are often repeated at least three or four times. If the reports were much more precise and concise, it is likely they would be of more interest to tax administrations, particularly tax administrations whose native language is not English.24
I must confess that when reading an OECD report I often feel I am reading a passage from "Jabberwocky," e.g., "`Twas brillig, and the slithy toves did gyre and gimble in the wabe." I'm also reminded of a statement by Judge Learned Hand about the U.S. income tax:
In my own case the words of such an act as the Income Tax, for example, merely dance before my eyes in a meaningless procession … couched in abstract terms that offer no handle to seize hold of … [A]t times I cannot help recalling a saying of William James about certain passages of Hegel: that they were no doubt written with a passion of rationality; but that one cannot help wondering whether to the reader they have significance save that the words are strung together with syntactical correctness.25
For an organization that has so many tax experts, one would expect much more precise and tightly written reports.26 The OECD should be clarifying the tax waters, not muddying them.
In conclusion, the emperor has no clothes.
The problem with the global international tax system is that many of the basic rules of taxation used by most countries make no sense, e.g., sourcing rules and determining the "residence" of a corporation based on place of incorporation.27 In addition, the arm's-length principle is totally unworkable and a huge waste of time. If the OECD really wants to revolutionize international taxation, it should focus on these issues. The sole redeeming value of the BEPS project is that its emphasis on "value creation" and the use of country-by-country reports might ultimately result in the general use of worldwide formulary apportionment.28
This commentary also appears in the January 2016 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Isenbergh, 900 T.M., Foundations of U.S. International Taxation, Cole, Kawano, and Schlaman, 940 T.M., Income Tax Treaties -- Administrative and Competent Authority Aspectsand in Tax Practice Series, see ¶7110, U.S. International Taxation: General Principles, ¶7160, U.S. Income Tax Treaties.
1 "According to the OECD, the Oct. 5 final BEPS reports lay the foundation for a modern international tax framework under which profits are taxed where economic activity and value creation occur." Bell, JCT Warns BEPS Measures May Increase Foreign Taxes, 230 Daily Tax Rep. G-1 (Dec. 1, 2015); "The OECD has released its final package of measures to tackle base erosion and profit shifting (BEPS), representing the most ambitious effort in history to harmonize tax laws across national boundaries." Bell, Mitchell, and Parker, Now It's Up to the Nations: OECD Delivers Global Tax Plan, 193 Daily Tax Rep. GG-1 (Oct. 6, 2015).
3 The OECD basically punted on the issue, leaving France with nothing on its most important concern. The final report states that the digital economy cannot be "ring-fenced" (whatever that means) and is increasingly "the economy itself." The latter would be a bit of a surprise to my dentist who still operates his practice without a computer.
4 Countries concerned about this issue could have dealt with it a long time ago. The final report sets forth several hundred pages of discussion with ideas that countries could have already implemented if they were really concerned about the issue. It's also not clear if this was really an issue that the G20 was concerned about; it appears to be a "bonus" item thrown in by the OECD at no extra charge.
The OECD overview of the final report on Action 2 begins with the following language: "A common approach which will facilitate the convergence of national practices through domestic and treaty rules to neutralise such arrangements." This is not a sentence — it contains a subject but no verb. There seems to be an intent to lead the reader to think that the final report actually came up with a common approach.
5 No country other than the United States cared about this. Again, there is no indication the G20 had any concern about this; it appears to be another "bonus" item thrown in by the OECD at no extra charge.
6 As with Action 2, countries concerned about this issue could have dealt with it a long time ago (and many did). The final report focused on interest deductions and completely ignored royalty deductions, which appeared to be a major concern of the G20. Moreover, the final report provides no coordination to ensure that the payee's interest income is reduced if the payor's interest deduction is reduced.
The OECD overview of the final report on Action 4 begins with the following language: "A common approach to facilitate the convergence of national rules in the area of interest deductibility." This is not a sentence — it contains a subject but no verb. As with Action 2, there seems to be an intent to lead the reader to think that the final report actually came up with a common approach.
7 With this Action item, the OECD resuscitated an ongoing project it already had on "harmful tax practices" and aligned it with the concerns of certain EU countries with patent boxes. Although the final report may result in increased "spontaneous exchange" of private rulings, it is unlikely this will accomplish much and will simply be a huge administrative burden on tax authorities, both the sending tax authority (which must cull through many rulings and determine which ones should be sent) and the recipient tax authority (which will feel an obligation to actually read what they're sent).
8 As with Action 2, countries concerned about this issue could have dealt with it a long time ago (and many did). This also does not appear to have been a concern of the G20; it appears to be another "bonus" item thrown in by the OECD at no extra charge.
9 It is clear that certain members of the G20 were concerned with the way in which a foreign-parented multinational group could generate sales in a country through a local subsidiary acting as an agent/distributor without generating much income taxable by that country. This is because the local subsidiary would be considered entitled to a minimal return and the foreign affiliate selling through or to the agent/distributor would not be considered to have a PE in that country. The final report indicates that the OECD Model Convention on Income and on Capital (OECD Model) will be modified so that there will be more situations in which the foreign affiliate is considered to have a PE in the country.
10 We seemed to have now entered an era where every tax authority can do what is right in its own eyes. "In those days there was no king in Israel; every man did what was right in his own eyes." Judges 21:25 (RSV). The U.S. position is that the final report on transfer pricing does not deviate from U.S. guidance on the arm's-length principle contained in the regulations under §482. The problem, however, is that the BEPS project has placed such a great emphasis on "value creation" that many tax authorities no doubt will take off and run with that phrase and won't really care too much what the final report on transfer pricing actually says.
11 This is something the OECD should have done before it even developed its Action Plan. It's a little bizarre to have an Action Plan to address BEPS but then one of the Action items is to determine how big a problem BEPS is. The OECD overview of the Action 11 final report states that it concludes that "significant limitations severely constrain economic analyses of the scale and economic impact of BEPS."
13 Most transfer pricing experts agree that the country-by-country template has virtually no relevance to the conduct of transfer pricing audits by tax authorities. It appears that its value, from the perspective of the OECD, is that it will shame corporations into not earning income in low- or no-tax countries even though such might be fully legal. Have we now moved from the rule of law to the rule of shaming?
14 This Action item is not focused on a G20 concern, but rather on the concern that the BEPS project will likely increase tax disputes between countries. The OECD Forum on Tax Administration and its Multilateral Strategic Plan on Mutual Agreement Procedures has already been at work on improving dispute resolution procedures. Nothing new was accomplished by the OECD BEPS project. It is true that a group of 20 countries has agreed to mandatory binding arbitration but this likely would have happened even without the BEPS project.
16 The OECD seems to be slightly paranoid that the United Nations might take over its tax function. It is unlikely that would happen anytime soon since the budget of the UN Committee of Experts on International Cooperation in Tax Matters is extremely small compared to that of the OECD's Centre for Tax Policy and Administration.
20 Because the Action Plan had so many diverse components, the vague term "deliverables" had to be used to cover the wide range of possible outcomes. If the OECD had simply focused on problems, then it could have simply referred to "solutions."
21 "While there are many ways in which domestic tax bases can be eroded, a significant source of base erosion is profit shifting." OECD Report, Addressing Base Erosion and Profit Shifting (released Feb. 12, 2013), p. 5.
23 Take, for example, the phrase "income shifting." Income is a value and you don't shift it; you may rearrange operations so that income is earned in different places but you don't "shift" income. Similarly for the term "deductible payment." In general, in a contractual situation, payments aren't deductible — the value of the payment may be equal to an amount that is deductible but the payment itself is not deductible.
24 One has to wonder how many tax administrations around the world are actually going to read the reports and, if they're not, what's the point? There's the age-old question, if a tree falls in the forest and no one is around, does it make a noise? Similarly, one might ask, if the OECD writes a report and no one reads it, does it have any significance?
26 I've been told that it's much harder for the OECD to reach consensus if countries know exactly what's being said. But what good is a consensus if it's built on mushy, vague language that a country can twist to its own desires? Such appears to be the basis for the consensus reached on Actions 8-10 dealing with transfer pricing.
27 One of the mysteries of the universe is why so many intelligent international tax practitioners don't see the absurdity of continuing to assign residency to a corporation. Once tax policymakers and tax technicians realize there is no logical way to assign residency to a corporation, they should dispense with corporate residency and go on to ask, "OK, what do we do now?" Once they move on to that question, chances for a rational international tax system will significantly improve.
28 See Durst, Analysis of a Formulary System, Part VIII: Suggested Statutory, Regulatory Language for Implementing Formulary Apportionment, 23 Tax Mgmt. Transfer Pricing Rep. 70 (May 1, 2014); Durst, 6938 T.M. (Bloomberg BNA Tax & Accounting), A Formulary System for Dividing Income Among Taxing Jurisdictions. See also Bouma, 12 Major Deficiencies of the Code Which Should Be Rectified as Part of Tax Reform, 42 Tax Mgmt. Int'l J. 426 (July 12, 2013).
The OECD could aid in the implementation of worldwide formulary apportionment by developing a Model Apportionment Formula. The existing OECD/Council of Europe Multilateral Convention on Mutual Administrative Assistance in Tax Matters (which, despite its name, is open to all countries) could be used to resolve inconsistent applications to a particular taxpayer.
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