Base Erosion and Profit Shifting (BEPS) has emerged as one of the most important challenges for governments all over the world. The Liberalization, Privatization and Globalization (LPG) has resulted;
The digital economy has boosted trade and foreign investments in many countries, thereby supporting generation of employment, growth, innovation and removal of poverty. The LPG also helps in creation of multinational organisations all over the world.
There in past the fear of double taxation restricts multinational companies to spread outside their country. It was recognised that the interaction of the foreign companies with domestic tax system in host country might lead to double taxation, which might result in adverse impacts on growth and global prosperity.
The governments to eliminate double taxation started entering into Double Tax Avoiding Treaties. The bilateral treaties are effective in preventing double taxation, but they often fail to prevent double non-taxation that results from interactions among more than two countries. This led increased a number of sophisticated tax planners, who are expert in finding loopholes in these Double Tax Avoidance Agreements and helping MNCs to do aggressive treaty shopping and go for Base Erosion and Profit Shifting to reduce their Tax Burden.
Base erosion and profit shifting (BEPS) refers to corporate tax planning strategies used by multinationals to “shift” profits from higher–tax jurisdictions to lower–tax jurisdictions, thus “eroding” the “tax–base” of the higher–tax jurisdictions.
The Organization for Economic Co-operation and Development (OECD) define BEPS strategies as also: “exploiting gaps and mismatches in tax rules”;
The BEPS is a term used to described “ tax planning strategies” that rely on mismatches and gaps that exist between the tax rules of different jurisdictions , to minimise the corporation tax that is payable overall, by either making tax profits “ disappear” or shift profits to low tax operations where their little or no genuine activity.
BEPS generally refers to those instances, where gaps between different taxation regimes leads to tax avoidance and loss to the concerned governments. The MNCs by taking advantage of gaps in taxation rules and regulations of two countries, shift their profit from higher taxation state to lower taxation state, causing tax loss to former. The BEPS refers to;
In generally BEPS activities are not illegal because these MNCs are exploiting the taxation gaps between two countries to avoid payment of tax in higher taxation country to lower taxation country.
The base erosion constitutes a serious risk to tax sovereignty, tax fairness and tax revenues for both developed and developing countries alike.
The Double Taxation Avoidance Agreement between two countries will be made on assumption that the same transaction should not be taxed in both countries. But due to tax planning and gaps available the MNCs plan their transaction in such a way that their transaction does not taxed any where in two countries.
TO UNDERSTAND THE PROCESS LETS’ CONSIDER TWO CASES;
In January 2017 OECD report estimates that BEPS tools are responsible for tax losses of circa $100–240 billion per annum. In June 2018 report by tax academic Gabriel Zucman , estimated that the figure is closer to $200 billion per annum. The Tax Justice Network estimated that profits of $660 billion were “shifted” in 2015 (due to Apple’s Q1 2015 leprechaun economics restructuring, the largest individual BEPS transaction in history. The effect of BEPS tools is most felt in developing economies, who are denied the tax revenues needed to build infrastructure.
Most BEPS activity is associated with industries with intellectual property (“IP”), namely Technology (e.g. Apple, Google, Microsoft, Oracle), and Life Sciences (e.g. Allergan, Medtronic, Pfizer and Merck & Co) . IP is described as the raw materials of tax avoidance, and IP–based BEPS tools are responsible for the largest global BEPS income flows. Corporate tax havens have some of the most advanced IP tax legislation in their statute books.
Most BEPS activity is also most associated with U.S. multinationals, and is attributed to the historical U.S. “worldwide” corporate taxation system. Pre the Tax Cuts and Jobs Act of 2017 (“TCJA”), the U.S. was one of only eight jurisdictions to operate a “worldwide” tax system. Most global jurisdictions operate a “territorial” corporate tax system with lower tax rates for foreign sourced income, thus avoiding the need to “shift” profits (i.e. IP can be charged directly from the home country at preferential rates and/or terms.
Note: In next article we shall read about actions plans from OECD and various governments to tackle BEPS.