In the midst of the recent focus on domestic tax reform, a global initiative is quietly reshaping the very foundations of international tax rules through treaties and other measures. The initiative in question is the Organization for Economic Cooperation and Development (OECD) Base Erosion and Profit Shifting (BEPS) project, a monumental effort involving over 100 countries and jurisdictions to combat the widespread issue of base erosion and profit shifting on a global scale.
The OECD, consisting of 35 Member countries, including economic powerhouses like the United States and Japan, as well as emerging players such as Mexico, Chile, and Turkey, leads this unprecedented global tax reform initiative. The primary objective is to address tax planning strategies that exploit gaps and mismatches in tax rules, artificially shifting profits to low or no-tax locations where minimal economic activity occurs.
The BEPS Action Plan and Its Objectives
The BEPS Action Plan, unveiled in the summer of 2013, serves as the blueprint for this comprehensive global tax reform initiative. It identifies 15 key focus areas, spanning topics such as the digital economy, hybrid mismatch arrangements, treaty abuse, and transfer pricing. The overarching goal is to overhaul the international tax framework, ensuring that profits are reported in the jurisdictions where the economic activities generating them take place, rather than being relegated to locations on paper.
The magnitude of the BEPS issue is evident in the current estimate provided by the OECD, stating that the overall tax loss due to BEPS ranges between 4% and 10% of global corporate income tax revenues. This equates to a staggering annual sum of at least $100 to $240 billion USD.
Unpacking the Impact of BEPS
A report from the Joint Committee on Taxation sheds light on the decline in the average tax rate for U.S. Controlled Foreign Corporations, plummeting from 26.0 percent in 1998 to 10.6 percent in 2012. This decline is attributed to several factors, including the global decrease in statutory corporate tax rates and a substantial portion of earnings being reported in low-tax jurisdictions. While this trend could stem from general market growth, it also underscores the potential influence of BEPS.
Recognizing the limitations of existing data sources in analyzing BEPS, especially due to the lack of non-tax return information, the OECD has called for the collection of new data in a globally consistent format. The organization has identified six indicators to assess the impact of BEPS over time:
- Concentration of foreign direct investment
- High profit rates of low-taxed affiliates of Multinational Enterprises (MNEs)
- High profit rates of MNE affiliates in lower-tax locations
- Effective tax rates of large MNE affiliates relative to similar non-MNE entities
- Concentration of royalty receipts relative to research and development spending
- Interest expense to income ratios of MNE affiliates in countries with above-average tax rates
U.S. Response to the BEPS Project
Over the past few years, both the U.S. Congress and the Treasury Department have introduced proposals aligned with the goals of the OECD BEPS project. In 2016, the Treasury Department published a new Model Tax Treaty that incorporates various recommendations from the BEPS project. Notable features of this model include a more robust base erosion test for qualifying for treaty benefits and rules to guard against contract splitting abuses tied to the 12-month permanent establishment threshold.
Additionally, the model treaty introduces a 12-month ownership requirement for the 5% withholding rate on direct dividends. These policy changes underscore the commitment of the United States to curbing base erosion and profit shifting, emphasizing that the focus on fundamental changes to international tax rules will extend far beyond the scope of domestic tax reform measures.
The Road Ahead
As the OECD BEPS project continues to unfold, its impact on the global tax landscape is undeniable. With over 100 participating countries, this initiative marks the most extensive collaboration in history to address the challenges posed by base erosion and profit shifting. The ongoing commitment of nations, including the United States, highlights the significance of international cooperation in creating a fair and equitable tax environment that transcends national borders. As policymakers navigate this intricate terrain, adapting to the evolving norms set by the BEPS project remains a priority for governments, businesses, and tax professionals worldwide.