08 October 2015
BEPS Reports Published
By John Watson
Monday saw the publication of the OECD reports on Base Erosion and Profit Shifting. What gobbledegook, you may think; but then, after all, it is all about tax. In particular it is about stopping multinationals from reducing their tax liabilities by various forms of financial trickery.
The figures are quite startling. It is estimated that between 4% and 10% of the tax which would be paid on global corporate profits is being avoided – a total of between US$100 billion and US$240 billion annually. That is bad news for developing countries, dependent on tax revenues to create new infrastructure, bad news for companies which do not avoid tax and who find themselves uncompetitive and bad news for individuals who will have to pay more income tax to make up the balance. What it isn’t, however, is fraud or indeed primarily the fault of the multinationals themselves. It is simply that the rules have got badly out of date and that management, concerned to limit tax like any other cost, have tried to use the gaps between them. Anyway, one way or another, everyone agrees that it has to stop and in 2013 the OECD began work on an “action plan” at the behest of the OECD and G20 Governments.
Like the leaky roof of an old house, the international tax system had a number of different holes and the actions set out in the OECD reports are designed to block them up. Since the object is to ensure that the right tax is paid in each jurisdiction, it is no surprise that the most important proposals fall into two categories. First, proposals to ensure that revenue streams which belong in a particular jurisdiction are brought into account in working out the taxable profit. Second, proposals to prevent those profits being depressed by too many deductions.
There are other strands, however. For example, an attack on arrangements under which payments are tax deductible in one jurisdiction but are not taxed when they arrive in another. Perhaps one tax system regards them as deductible interest whilst the other treats them as exempt dividends. If that happens, a corresponding proportion of the multinational’s profits will have done a fiscal disappearing trick by “slipping down the middle”. Anyway, that form of avoidance, together with other wheezes which depend on different treatments being available in different places, is to be countered by anti-hybrid rules.
The reports are a goody-bag of anti-avoidance measure. Tax treaties are to be changed so that it will no longer be possible to do significant business in a country without having a taxable presence there. Tax deductions for the payment of interest to other group entities will be limited to a fixed proportion of profit, or possibly by reference to overall group borrowing. Much more information, including information relating to tax strategies, will have to be provided to tax authorities. Harmful tax regimes designed to take business away from other countries (including the UK patent box) will have to be removed or amended.
Tax treaties will no longer be able to be used for tax avoidance purposes. A regime has been designed for taxing the profits of subsidiaries situated in tax havens.
It is all heady stuff, but by far the most interesting question is how profits are to be allocated between subsidiaries. Here the general rule that profits should be computed as if the companies were dealing at arm’s-length prices will be retained, but the guidance as to how those arm’s-length prices are to be calculated will be revised. In particular a dose of realism will be injected by looking past the contractual arrangements between the parties to their conduct, by avoiding the allocation of profits to locations where no real contribution is made and by disregarding arrangements which are uncommercial.
None of that is very surprising, but then one comes to a bit about rewards for taking risk being allocated to the company having control of the risk rather than the company actually exposed. A somewhat similar approach is taken to the taxation of income from intangibles and the income of overseas money box companies. Each time it becomes less clear exactly how the rules will work in practice and how they are consistent with the arm’s-length approach. No doubt they are necessary to combat current avoidance strategies but you wonder if they could be used against as well as by the authorities.
Most of the anti-avoidance measures suggested by the OECD are already in place in the UK. We already have arrangements under which tax schemes have to be disclosed. We already have a regime for taxing the profits of subsidiaries situated in tax havens. There is already a limit on how much interest can be deducted by a UK subsidiary of a multinational group, an anti-hybrid rule to prevent use being made of disparity of treatment. In fact in some places we go further than the OECD. The latest Finance Bill brings profits which have been diverted from the UK for tax avoidance reasons back into the UK tax net. Here the main job has been done and the focus will be on a few specific items (the Patent Box regime will need to be narrowed, for example) but if any politicians tell you that there is more money to be saved by changing the rules further to curb tax avoidance they are probably wrong.
Of more relevance to the UK are the proposed disclosure arrangements. In future, a multinational will have to provide a country-by-country report identifying its profits and the tax paid on them in each jurisdiction in which it does business. Those reports will be shared between tax authorities under automatic exchange of information provisions so that those operating in each jurisdiction in which a multinational trades will have this information. There are two risks here. One is that certain jurisdictions, hungry for tax, will target profits taxable elsewhere. The other is that confidential information on profit margins will be leaked to local competitors. The first can perhaps be dealt with by improving dispute resolution mechanisms. The second seems to be entirely inevitable.
