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Global Tax Fairness$

Thomas Pogge and Krishen Mehta

Print publication date: 2016

Print ISBN-13: 9780198725343

Published to Oxford Scholarship Online: March 2016

DOI: 10.1093/acprof:oso/9780198725343.001.0001

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The Taxation of Multinational Enterprises

The Taxation of Multinational Enterprises

Chapter:
(p.173) 7 The Taxation of Multinational Enterprises
Source:
Global Tax Fairness
Author(s):

Lee Corrick

Publisher:
Oxford University Press
DOI:10.1093/acprof:oso/9780198725343.003.0008

Abstract and Keywords

The OECD’s work on tax base erosion and profit shifting (BEPS) and automatic exchange of information, with strong political support from the G20, will pave the way for rehabilitating the global tax system. The gaps between domestic tax systems, combined with economic incentives and legal accounting practices have allowed some multinationals to pay little, or no corporate tax at all. OECD and G20 economies are working together to address BEPS, providing consistency for both business and tax sovereignties. G20 leaders endorsed the OECD’s Action Plan to address the gaps in the international tax system through BEPS. This chapter outlines the rationale, content, and progress of the Action Plan and also presents the capacity-building work of the OECD Task Force on Tax and Development to assist developing countries in the taxation of multinational enterprises.

Keywords:   base erosion, profit shifting, BEPS, OECD, G20, multinational corporations, automatic exchange of information, tax policy, double non-taxation, development

7.1 Base Erosion and Profit Shifting

7.1.1 Introduction

Multinational enterprises (MNEs) now represent a large proportion of global GDP. MNEs sales as a share of world GDP have increased from 27 percent in 1990 to 58 percent in 2007 (UNCTAD, 2009). Also, intra-firm trade represents a growing proportion of overall trade. The United Nations estimates that approximately 60 percent of international trade happens within MNE companies (African Economic Outlook, n.d.). Globalization has resulted in a shift from country-specific operating models to global models based on matrix management organizations (organizations that manage across functions and across business groups, e.g. sales and production functions) and integrated supply chains that centralize several functions at a regional or global level. Moreover, the growing importance of the service component of the economy, and of digital products that often can be delivered over the Internet, has made it much easier for businesses to locate many productive activities in geographic locations that are distant from the physical location of their customers. These developments have been exacerbated by the increasing sophistication of tax planning, which focuses on identifying and exploiting arbitrage opportunities that result in income being taxed nowhere.

These developments have opened up opportunities for MNEs to greatly minimize their tax burden and this has led to a tense situation in which citizens have become more sensitive to tax fairness issues. It has become a critical issue for all parties:

  • Governments are harmed. Many governments have to cope with less revenue and higher costs to ensure compliance. Moreover, base erosion and profit shifting (BEPS) undermines the integrity of the tax system, as the public, the media, and some taxpayers deem reported low corporate (p.174) taxes to be unfair. In developing countries, the lack of tax revenue leads to critical under-funding of public investment that could help promote economic growth. Overall resource allocation, affected by tax-motivated behavior, is sub-optimal.

  • Individual taxpayers are harmed. When tax rules permit businesses to reduce their tax burden by shifting their income away from jurisdictions where income-producing activities are conducted, other taxpayers in that jurisdiction bear a greater share of the burden.

  • Businesses are harmed. MNEs may face significant reputational risk if their effective tax rate is viewed as being too low. At the same time, different businesses may assess such risk differently, and failing to take advantage of legal opportunities to reduce an enterprise’s tax burden can put it at a competitive disadvantage. Similarly, corporations that operate only in domestic markets, including family-owned businesses or new innovative companies, have difficulty competing with MNEs that have the ability to shift their profits across borders to avoid or reduce tax. Fair competition is harmed by the distortions induced by BEPS.

7.2 The OECD/G20 BEPS Project

Taxation is at the core of countries’ sovereignty, but the interaction of domestic tax rules in some cases leads to gaps and frictions. When designing their domestic tax rules, sovereign states may not sufficiently take into account the effect of other countries’ rules. The interaction of independent sets of rules enforced by sovereign countries creates frictions, including potential double taxation for corporations operating in several countries. It also creates gaps, in cases where corporate income is not taxed at all, either by the country of source or the country of residence, or is only taxed at nominal rates. In the domestic context, coherence is usually achieved through a principle of matching—a payment that is deductible by the payer is generally taxable in the hands of the recipient, unless explicitly exempted. There is no similar principle of coherence at the international level, which leaves plenty of room for arbitrage by taxpayers, though sovereign states have cooperated to ensure coherence in a narrow field, namely to prevent double taxation.

The international standards have sought to address these frictions in a way that respects tax sovereignty, but gaps remain. Since at least the 1920s, it has been recognized that the interaction of domestic tax systems can lead to overlaps in the exercise of taxing rights that in turn can result in double taxation (League of Nations, 1928). Countries have long worked and are strongly committed to eliminate such double taxation in order to minimize trade distortions and impediments to sustainable economic growth, while (p.175) affirming their sovereign right to establish their own tax rules. However, gaps and conflicts among different countries’ tax systems have emerged that were not taken into account in designing the existing standards and which are not dealt with by bilateral tax treaties. The global economy requires countries to collaborate on tax matters in order to be able to protect their tax sovereignty.

In many circumstances, the existing domestic law and treaty rules governing the taxation of cross-border profits produce the correct results and do not give rise to BEPS. International cooperation has resulted in shared principles and a network of thousands of bilateral tax treaties that are based on common standards and that therefore generally result in the prevention of double taxation on profits from cross-border activities. Clarity and predictability are fundamental building blocks of economic growth. It is important to retain such clarity and predictability by building on this experience. At the same time, instances where the current rules give rise to results that generate concerns from a policy perspective should be tackled.

Over time, the current rules have also revealed weaknesses that create opportunities for BEPS. BEPS relates chiefly to instances where the interaction of different tax rules leads to double non-taxation or less than single taxation. It also relates to arrangements that achieve no or low taxation by shifting profits away from the jurisdictions where the activities creating those profits take place. No or low taxation is not per se a cause of concern, but it becomes so when it is associated with practices that artificially segregate taxable income from the activities that generate it. In other words, what creates tax policy concerns is that, due to gaps in the interaction of different tax systems, and in some cases because of the application of bilateral tax treaties, income from cross-border activities may go untaxed anywhere, or be only unduly lowly taxed.

The spread of the digital economy also poses challenges for international taxation. The digital economy is characterized by an unparalleled reliance on intangible assets, the massive use of data (notably personal data), the widespread adoption of multi-sided business models capturing value from externalities generated by free products, and the difficulty of determining the jurisdiction in which value creation occurs. This raises fundamental questions as to how enterprises in the digital economy add value and make their profits, and how the digital economy relates to the concepts of source and residence or the characterization of income for tax purposes. At the same time, the fact that new ways of doing business may result in a relocation of core business functions and, consequently, a different distribution of taxing rights which may lead to low taxation is not per se an indicator of defects in the existing system. It is important to examine closely how enterprises of the digital economy add value and make their profits in order to determine whether and to what extent it may be necessary to adapt the current rules to take into account the specific features of that industry and to prevent BEPS.

(p.176) 7.2.1 Time to Modernize the Rules for the Taxation of MNEs

BEPS is not primarily an issue of compliance. While there are certainly companies that do not pay the taxes they legally owe, there is a more fundamental policy issue, which is that the international tax rules have not kept pace with the changing business environment.

The OECD published its report Addressing Base Erosion and Profit Shifting in February 2013.1 The report analyzes the root causes of BEPS and identifies six key pressure areas: (1) hybrids and mismatches which generate arbitrage opportunities; (2) the residence-source tax balance, in particular in the context of the digital economy; (3) intra-group financing, with companies in high-tax countries being loaded with debt; (4) transfer pricing issues, such as the treatment of group synergies and location savings; (5) the effectiveness of anti-avoidance rules, which are often watered down because of heavy lobbying and competitive pressure; (6) the existence of preferential regimes.

The report was sent to and discussed at the G20 Finance Ministers meeting in Moscow on 15–16 February 2013: The G20 stated “We welcome the OECD report on addressing base erosion and profit shifting and acknowledge that an important part of fiscal sustainability is securing our revenue bases. We are determined to develop measures to address base erosion and profit shifting, take necessary collective actions and look forward to the comprehensive action plan the OECD will present to us in July” (G20, 2013: §20).

In Saint Petersburg in September 2013 the G20 leaders endorsed an Action Plan2 to address BEPS. In response to this call, the OECD/G20 BEPS Project was launched to develop the measures envisaged in the fifteen-point Action Plan.

7.2.2 Fifteen Actions to Put an End to BEPS

The digital economy provides a good illustration of the types of challenges facing the international tax system, including novel and ever-changing business models, the importance and mobility of intangible assets, and the ability to provide goods and services without a physical presence. While the actions in the BEPS Action Plan will clearly have an impact on BEPS in the digital economy, there is also a need for a thorough analysis of this sector.

Action 1: Address the Tax Challenges of the Digital Economy

A dedicated task force has been established that will identify the issues raised by the digital economy and possible actions to address them. The work of the (p.177) Task Force on the digital economy will cut across the work done on the other fourteen actions, which are organized according to three main principles: preventing double non-taxation due to gaps in countries’ tax rules; aligning taxation with substance; and improving transparency.

7.2.2.1 Preventing Double Non-taxation Due to the Gaps that Exist between Countries’ Tax Rules

Tax policy is at the core of countries’ sovereignty, and each country has the right to design its tax system in the way it considers most appropriate. Domestic tax systems are coherent—tax deductible payments by one person results in income inclusions by the recipient. At the same time, the increasing interconnectedness of domestic economies has highlighted the gaps that can be created by interactions between domestic tax laws. Currently, there are no international standards to address these gaps and prevent the double non-taxation that can arise as a result. International coherence in corporate income taxation is needed to complement the standards that prevent double taxation with a new set of standards designed to avoid double non-taxation. Four actions in the BEPS Action Plan (Actions 2, 3, 4, and 5) focus on establishing this coherence:

Action 2: Neutralize the Effects of Hybrid Mismatch Arrangements

Mismatches in the way countries’ tax laws treat entities and instruments can allow companies to claim multiple deductions for the same economic expense or cause taxable income to disappear (so-called hybrid mismatch arrangements). This Action will result in treaty and domestic law provisions to neutralise these schemes.

Action 3: Strengthen Controlled Foreign Companies (CFC) Rules

One of the sources of BEPS concerns is the use of offshore subsidiaries to stash income in low or no tax jurisdictions through creating offshore entities in those jurisdictions and routing income through them to escape taxation. Strong CFC rules can address this issue by including the income of these offshore entities in the parent entity’s income on a current taxable basis.

Action 4: Limit Base Erosion via Interest Deductions and Other Financial Payments

Current rules often allow the use of excessive interest deductions to erode their taxable profits, or use of debt (which generates interest expense deductions) to finance the production of tax-exempt income. This Action will result in (p.178) recommendations regarding best practices in the design of rules to prevent BEPS through the use of interest expense and other financial payments.

Action 5: Counter Harmful Tax Practices more Effectively

Countries have long recognized that a “race to the bottom” would ultimately drive applicable tax rates on certain mobile sources of income to zero for all countries, whether or not this was the tax policy a country wished to pursue. Agreeing to a set of common rules will help countries make their sovereign tax policy choices, and this Action will result in revamping the work on harmful tax practices to that end.

7.2.2.2 Aligning Taxation with Substance

Existing tax treaty and transfer pricing rules are generally effective, and prevent double taxation of profits, but may in some cases facilitate the separation of taxable profits from the value-creating activities that give rise to those profits. The Action Plan will restore the intended effects of these standards by aligning taxation with substance, while at the same time continuing to prevent double taxation.

The involvement of third countries in the bilateral framework established by treaty partners puts a strain on the existing rules, in particular when done via shell companies that have little or no economic substance: e.g. office space, tangible assets and employees. The Action Plan will ensure that shell companies cannot be used to achieve double non-taxation by inappropriately claiming treaty benefits.

In addition the current interpretation of the arm’s length principle used in transfer pricing rules is challenged by the ability of MNEs to artificially shift profits by transferring easily movable assets (such as intangibles and capital). In some cases, MNEs have been able to use and/or misapply the existing rules to separate income from the economic activities that produce that income. This most often involves transfers of intangibles or other mobile assets, over-capitalisation of group companies, and contractual allocations of risk. The Actions in the Action Plan will result in rules to prevent BEPS through transfers of intangibles, through transfers of risk or excessive allocations of capital, or through transactions which would not, or would only very rarely, occur between third parties.

The Action Plan will fix these issues with measures, either within or beyond the arm’s length principle, to ensure that taxable profits can no longer be artificially shifted away from the countries where value is created.

Five Actions in the BEPS Action Plan focus on aligning taxing rights with substance (Actions 6, 7, 8, 9, and 10):

(p.179) Action 6: Prevent Treaty Abuse

While tax treaties are designed to prevent double taxation, in some cases they are used to create double non-taxation, in particular through the use of conduit companies. This Action will result in model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances.

Action 7: Prevent the Artificial Avoidance of Permanent Establishment (PE) Status

Under the international standard, a country may not tax the business profits of a foreign company unless the company has a permanent establishment (PE) in that country. For the purposes of the OECD Model Tax Convention a Permanent Establishment means a fixed place of business through which the business of an enterprise is wholly or partly carried on. If the company is not taxed on those profits in its jurisdiction of residence the result is double non-taxation. This Action will result in changes to the definition of PE to prevent the artificial avoidance of PE status in relation to BEPS.

Actions 8 to 10: Assure that Transfer Pricing Outcomes Are in Line with Value Creation

(Action 8) Intangibles—This Action will result in rules that prevent BEPS via the transfer of intangibles.

(Action 9) Risks and Capital—This Action will result in rules that prevent BEPS via transfers of risk or excessive allocations of capital.

(Action 10) Other High Risk Transactions—This Action will result in rules that prevent BEPS through transactions which would not, or would only very rarely, occur between third parties.

7.2.2.3 Improving Transparency

Addressing BEPS will also require greater transparency between taxpayers and tax administrations, and among tax administrations. The Action Plan will level the playing field between companies and tax administrators by creating a common template for MNEs to report to all relevant governments their global allocation of profits, economic activity, and taxes paid among countries. At the same time, work will be done to provide the necessary certainty to encourage global investment and make sure that disputes are resolved quickly. Four Actions in the BEPS Action Plan focus on improving transparency (Actions 11, 12, 13, and 14):

(p.180) Action 11: Establish Methodologies to Collect and Analyze Data on BEPS and the Actions to Address It

Further work needs to be done to measure the scale and effects of BEPS, and to monitor the impact of the actions taken to address it. This Action will identify tools to monitor and evaluate the effectiveness and economic impact of the actions taken to address BEPS, including its spill-over effects.

Action 12: Require Taxpayers to Disclose their Aggressive Tax-planning Arrangements

Improved disclosure measures can help tax administrations and tax policy makers identify emerging risk areas, and can also serve as a deterrent against aggressive planning. This Action will result in mandatory disclosure rules targeting these kinds of arrangements.

Action 13: Re-examine Transfer Pricing Documentation

This Action will result in rules regarding transfer pricing documentation that enhances transparency for tax administrations while taking into account compliance costs for businesses, and will include a requirement that MNEs provide all relevant governments with the required information on their global allocation of income, economic activity, and taxes paid among countries.

The rules aim to simplify transfer pricing documentation rules and make them more uniform across different tax jurisdictions.3

Action 14: Make Dispute Resolution Mechanisms more Effective

The actions to counter BEPS must be complemented with actions to ensure the certainty and predictability needed to promote investment in today’s environment. This Action will ensure such certainty by developing solutions to address obstacles that prevent countries from solving treaty-related disputes.

Action 15: Develop a Multilateral Instrument

The delivery of certain actions will result in changes to the OECD Model Tax Convention, which are not directly effective without amendments to bilateral tax treaties. If undertaken on a purely treaty-by-treaty basis, the sheer number of treaties in effect may make such a process very lengthy, the more so where countries embark on comprehensive renegotiations of their bilateral tax treaties. A multilateral instrument, which is innovative in the area of international taxation, will greatly speed up this process.

(p.181) 7.2.3 How Will the Actions Be Implemented? How Long Will It Take?

The BEPS Action Plan calls for the development of tools that countries can use to shape fair, effective and efficient tax systems. Because BEPS strategies often rely on the interaction of countries’ different systems, these tools will have to address the gaps and frictions that arise from the interface of these systems. Some Actions, for example work on the OECD Transfer Pricing Guidelines4 and the Commentary to the OECD Model Tax Convention5, will result in changes that are directly effective. Others will be implemented by countries through their domestic law, bilateral treaties, or a multilateral instrument.

Addressing BEPS is critical for most countries and must be done in a timely manner so that concrete actions can be delivered quickly before the existing consensus-based framework unravels. At the same time, governments need time to complete the necessary technical work and achieve widespread consensus. Against this background, it is expected that the Action Plan will largely be completed in 2 years.

7.2.4 Deliverables and Milestones

The BEPS work will result in a number of outputs, scheduled to be finalized in three phases (see Tables 7.1, 7.2, and 7.3):

Table 7.1 Timeline: September 2014

Action

Expected Output

Action 1

Address the tax challenges of the digital economy

Report identifying issues raised by the digital economy and possible actions to address them

Action 2

Neutralize the effects of hybrid mismatch arrangements

i) Changes to the Model Tax Convention

ii) Recommendations regarding the design of domestic rules

Action 5

Counter harmful tax practices more effectively, taking into account transparency and substance—phase 1

Finalize review of member country regimes

Action 6

Prevent treaty abuse

i) Changes to the Model Tax Convention

ii) Recommendations regarding the design of domestic rules

Action 8

Assure that transfer pricing outcomes are in line with value creation/intangibles—phase 1

Changes to the Transfer Pricing Guidelines and possibly to the Model Tax Convention

Action 13

Re-examine transfer pricing documentation

Changes to Transfer Pricing Guidelines and Recommendations regarding the design of domestic rules

Action 15

Develop a multilateral instrument—phase 1

Report identifying relevant public international law and tax issues

(p.182)

Table 7.2 Timeline: September 2015

Action

Expected Output

Action 3

Strengthen CFC Rules

Recommendations regarding the design of domestic rules

Action 4

Limit base erosion via interest deductions and other financial payments

Recommendations regarding the design of domestic rules

Action 5

Counter harmful tax practices more effectively, taking into account transparency and substance—phase 2

Strategy to expand participation to non-OECD members

Action 7

Prevent the artificial avoidance of PE status

Changes to the Model Tax Convention

Action 8

Assure that transfer pricing outcomes are in line with value creation/intangibles—phase 2

Changes to the Transfer Pricing Guidelines and possibly to the Model Tax Convention

Action 9

Assure that transfer pricing outcomes are in line with value creation/risks and capital

Changes to the Transfer Pricing Guidelines and possibly to the Model Tax Convention

Action 10

Assure that transfer pricing outcomes are in line with value creation/other high-risk transactions

Changes to the Transfer Pricing Guidelines and possibly to the Model Tax Convention

Action 11

Establish methodologies to collect and analyze data on BEPS and the actions to address it

Recommendations regarding data to be collected and methodologies to analyze them

Action 12

Require taxpayers to disclose their aggressive tax planning arrangements

Recommendations regarding the design of domestic rules

Action 14

Make dispute resolution mechanisms more effective

Changes to the Model Tax Convention

7.2.5 An Inclusive Process: The OECD/G20 Project on BEPS

The work on BEPS is being carried out within the context of the OECD/G20 BEPS Project, to which the eight non-OECD G20 Countries (Argentina, Brazil, China, India, Indonesia, Russia, Saudi Arabia and South Africa) participate as Associates, on an equal footing with OECD countries. Colombia (p.183)

Table 7.3 Timeline: December 2015

Action

Expected Output

Action 4

Limit base erosion via interest deductions—phase 2

Changes to the Transfer Pricing Guidelines

Action 5

Counter harmful tax practices more effectively, taking into account transparency and substance—phase 3

Revision of existing criteria to identify harmful tax practices

Action 15

Develop a multilateral instrument—phase 2

Multilateral instrument

and Latvia (who have started the OECD Accession Process) have also joined the OECD/G20 BEPS Project as Associates.

Associates in the OECD/G20 BEPS Project participate in the entire range of the BEPS-related work carried out by the CFA and its subsidiary bodies, including playing a full part in setting the agenda, in the discussions and in the decision-making process. This means that Associates take an active part in establishing the international tax rules and principles provided for in the BEPS Action Plan and in implementing the consensus on all outcomes related to the OECD/G20 BEPS Project.

7.2.6 How Will the OECD Ensure Developing Countries Concerns Are Addressed?

BEPS is a global issue and requires a global solution. The Action Plan marks a turning point in the history of international cooperation on taxation and it is critical that the work include all relevant stakeholders. Developing countries also face issues related to BEPS and the work will take into account the specificities of their national legal and administrative frameworks. In this respect, the Global Fora on Tax Treaties, on Transfer Pricing, on VAT6 and on Transparency and Exchange of Information for Tax Purposes7 will be useful platforms for developing countries to provide relevant input as will the OECD’s Task Force on Tax and Development.8 In addition, the CFA will benefit from the input of the United Nations (UN), which has been an observer to the CFA since January 2012.

(p.184) 7.2.7 The Process of Consultation has Already Begun

At the Global Forum on Tax Treaties meeting held in Paris in September 2013 over 300 senior tax officials from more than 100 jurisdictions and international organizations met to discuss solutions to BEPS. Participants discussed the content of the Action Plan and ways through which developing countries can engage and provide input. Discussions with developing countries were also held at the OECD Advisory Group for Co-operation with Non-OECD Partners9 meeting and the OECD’s Task Force on Tax and Development meeting in Seoul, Korea, in October 2013. The Task Force welcomed international action to address BEPS. Four high-level policy events were also held in the first quarter of 2014 in Africa (hosted by the African Tax Administration Forum (ATAF)), Asia, Europe (hosted by Center de rencontre des administrations fiscales (CREDAF)), and Latin America to obtain further input from developing countries and relevant stakeholders. In addition, a special meeting of the Tax Force on Tax and Development on BEPS was held back-to-back to the Global Forum on Transfer Pricing on 26 to 28 March 2014. The meetings considered the views and perspectives of developing countries on the BEPS project and this input informed Part 1 and Part 2 of the OECD report to the G20 Development Working Group titled “A Report to G20 Development Working Group on the Impact of BEPS in Low Income Countries” which the OECD prepared at the request of the G20.10 In addition to highlighting certain BEPS issues that are of more relevance to developing countries, the report presents several issues, such as tax competition through the use of tax incentives and measures to identify indirect transfers of assets, which are of particular concern to developing countries, but are not included in the BEPS Action Plan. In response, the G20 Finance Ministers have called on the OECD, the International Monetary Fund (IMF), UN, and World Bank Group “to build on its current engagement with developing countries and develop a new structured dialogue process, with clear avenues for developing countries to work together and directly input in the G20/OECD [BEPS] project.”11

7.2.8 Progress Thus Far

In September and November of 2014, the OECD submitted the first set of deliverables under the BEPS Action Plan to the G20 Finance Ministers and G20 Leaders, respectively. Reports were presented under Action 1 on the Digital Economy and Action 15 on a Multilateral Instrument. Reports were (p.185) also presented on hybrid mismatch arrangements, treaty abuse, transfer pricing aspects of intangibles, and transfer pricing documentation and a template for country-by-country reporting. Finally, an interim progress report on the review of country regimes in order to counter harmful tax practices more effectively was presented. The summary of recommendations under each Action Point follows below:

Action 1: Addressing the Tax Challenges of the “Digital Economy”

The Task Force on the Digital Economy has produced a report outlining specific tax challenges of the digital economy. The Task Force has concluded that because the digital economy is increasingly becoming the economy itself, it would be difficult, if not impossible, to ring-fence the digital economy from the rest of the economy. The Task Force has identified certain specific issues generated by the key features of the digital economy that warrant attention from a tax perspective. Work on the actions of the BEPS Action Plan will take these issues into account to ensure that the proposed solutions fully address BEPS in the digital economy. These include: ensuring that core activities cannot inappropriately benefit from the exception from permanent establishment (PE) status, and that artificial arrangements relating to sales of goods and services cannot be used to avoid PE status, the importance of intangibles, the use of data, and the spread of global value chains, and their impact on transfer pricing, the possible need to adapt CFC rules to the digital economy, addressing opportunities for tax planning by businesses engaged in VAT-exempt activities. The Task Force work will also evaluate how outcomes from other BEPS project action points affect the broader tax challenges raised by the digital economy, such as nexus, data, and characterization of transactions. The Task Force recommends a further evaluation of options to address these broader tax challenges in a supplementary report to be delivered in December 2015.

Action 2: Neutralizing the Effects of Hybrid Mismatch Arrangements

The report under Action 2 sets out draft recommendations in two parts. Part 1 provides recommendations for domestic rules to neutralize the effect of hybrid mismatch arrangements. Part 2 sets out recommended changes to the OECD Model Tax Convention to deal with transparent entities, including hybrid entities and addresses the interactions between the recommendations included in Part 1 and the provisions of the OECD Model Tax Convention. Once translated into domestic law and tax treaties, these recommendations and model provisions will neutralize mismatches and put an end to multiple deductions for a single expense, deductions in one country without corresponding taxation in another, or the generation of multiple foreign tax credits for one amount of foreign tax paid.

(p.186) The work will now turn to developing guidance, in the form of a Commentary which will explain how the rules would operate in practice, including via practical examples. Furthermore there are a number of specific areas where the recommended domestic rules in Part I may need to be further refined. This is the case for certain capital market transactions (such as on-market stock lending and repos) and the rules on imported hybrid mismatches. In addition, concerns were raised by a number of countries and by business in the consultation responses over the application of the rules to hybrid regulatory capital that is issued intra-group. These concerns need to be further explored in order to clarify whether a special treatment under the hybrid mismatch rules is justified. Finally, the report will need to clarify whether or not income taxed under a controlled foreign company (CFC) regime should be treated as included in ordinary income for the purposes of this report and the related language is in brackets. No consensus has yet been reached on these issues but discussion will continue with a view to reaching agreement and to publishing the outcome together with the Commentary no later than September 2015.

Part I of the report recommends specific changes to domestic law to achieve a better alignment between domestic and cross-border tax outcomes. In particular, this report recommends:

  • denial of a dividend exemption for the relief of economic double taxation in respect of deductible payments made under financial instruments

  • the introduction of measures to prevent hybrid transfers being used to duplicate credits for taxes withheld at source

  • improvements to controlled foreign company and other offshore investment regimes to bring the income of hybrid entities within the charge to taxation under the investor jurisdiction and the imposition of information reporting requirements on such intermediaries to facilitate the ability of offshore investors and tax administrations to apply such rules

  • rules restricting the tax transparency of reverse hybrids that are members of a controlled group.

In addition to these specific recommendations on the tax treatment of entities and instruments, which are designed to prevent mismatches from arising, Action 2 calls for hybrid mismatch rules that adjust the tax outcomes in one jurisdiction to align them with the tax consequences in another. Action 2 states that these rules may include domestic law provisions that:

  • deny a deduction for a payment that is also deductible in another jurisdiction

  • prevent exemption or non-recognition for payments that are deductible by the payer

  • deny a deduction for a payment that is not includible in ordinary income by the recipient (and is not subject to taxation under CFC or similar rules).

(p.187) Action 2 therefore calls for domestic rules targeting two types of payment:

  • payments under a hybrid mismatch arrangement that are deductible under the rules of the payer jurisdiction and not included in the ordinary income of the payee or a related investor (deduction/no inclusion or D/NI outcomes)

  • payments under a hybrid mismatch arrangements that give rise to duplicate deductions for the same payment (double deduction or DD outcomes).

In order to avoid the risk of double taxation, Action 2 also calls for “guidance on the coordination or tie breaker rules where more than one country seeks to apply such rules to a transaction or structure.” For this reason the rules recommended in this report are organized in a hierarchy so that a jurisdiction does not need to apply the hybrid mismatch rule where there is another rule operating in the counterparty jurisdiction that is sufficient to neutralize the mismatch. The Report recommends that every jurisdiction introduce all the recommended rules so that the effect of hybrid mismatch arrangement is neutralized even if the counterparty jurisdiction does not have effective hybrid mismatch rules.

Action 5: Countering Harmful Tax Practices more Effectively, Taking into Account Transparency and Substance

Under Action item 5, the Forum on Harmful Tax Practices (FHTP) is to deliver three outputs: first, finalization of the review of member country preferential regimes; second, a strategy to expand participation to non-OECD member countries; and, third, consideration of revisions or additions to the existing framework.

The report outlines the progress made on the delivery of these outputs under Action 5. It shows progress made and identifies the next steps towards completion of this work, in particular on the first output. As regards the review of the existing preferential regimes, the emphasis has been put on (i) elaborating a methodology to define a substantial activity requirement in the context of intangible regimes and (ii) improving transparency through compulsory spontaneous exchange on rulings related to preferential regimes. Finally, it provides a progress report on the review of the regimes of OECD member and associate countries in the OECD/G20 Project on BEPS. Further work on defining “substantial activity” and developing a transparency framework, as well as the review of preferential regimes and outreach to non-OECD countries, will take place in 2015.

Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances

The report under Action 6 includes proposed changes to the OECD Model Tax Convention. Section A of the report includes recommendations intended (p.188) to prevent the granting of treaty benefits in inappropriate circumstances. For that purpose, a distinction is made between two types of cases:

  1. 1. Cases where a person tries to circumvent limitations provided by the treaty itself.

  2. 2. Cases where a person tries to circumvent the provisions of domestic tax law using treaty benefits.

Cases where a Person Tries to Circumvent Limitations Provided by the Treaty Itself

The recommendations for new treaty anti-abuse rules included in the report first address treaty shopping strategies through which a person who is not a resident of a Contracting State attempts to obtain benefits that a tax treaty grants to a resident of that State. Additional recommendations address other strategies aimed at satisfying different treaty requirements with a view to obtain inappropriately the benefit of certain provisions of tax treaties.

The report recommends that a three-pronged approach be used to address treaty shopping arrangements:

  • First, it is recommended that treaties include, in their title and preamble, a clear statement that the Contracting States, when entering into a treaty, intend to avoid creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty shopping arrangements (this recommendation is included in Section B of the report).

  • Second, it is recommended to include in tax treaties a specific anti-abuse rule based on the limitation-on-benefits provisions included in treaties concluded by the United States and a few other countries (the “LOB rule”). Such a specific rule will address a large number of treaty shopping situations based on the legal nature, ownership in, and general activities of, residents of a Contracting State.

  • Third, in order to address other forms of treaty abuse, including treaty shopping situations that would not be covered by the LOB rule described above (such as certain conduit financing arrangements), it is recommended to add to tax treaties a more general anti-abuse rule based on the principal purposes of transactions or arrangements (the principal purposes test or “PPT” rule).

The report includes additional recommendations for new specific treaty anti-abuse rules that seek to address strategies, other than treaty shopping, aimed at satisfying treaty requirements with a view to obtain inappropriately the benefit of certain provisions of tax treaties. These targeted rules, which are supplemented by the PPT rule described above, address: (1) certain dividend transfer transactions; (2) transactions that circumvent the application of the (p.189) treaty rule that allows source taxation of shares of companies that derive their value primarily from immovable property; (3) situations where an entity is resident of two Contracting States; and (4) situations where the State of residence exempts the income of permanent establishments situated in third States and where shares, debt-claims, rights, or property are transferred to permanent establishments set up in countries that do not tax such income or offer preferential treatment to that income.

Cases where a Person Tries to Abuse the Provisions of Domestic Tax Law Using Treaty Benefits

The report refers to the parts of the Commentary of the OECD Model Tax Convention that already deal with this issue. It indicates that further work may be needed to take account of recommendations for the design of new domestic rules that may result from the work on various Action items, in particular Action 2 (Neutralize the effects of hybrid mismatch arrangements), Action 3 (Strengthen CFC rules), Action 4 (Limit base erosion via interest deductions and other financial payments) and Actions 8, 9, and 10 dealing with Transfer Pricing.

The report adds that the recommendation to include a PPT rule in treaties, which will incorporate the principle already included in paragraph 9.5 of the Commentary on Article 1 of the OECD Model Tax Convention, will provide a clear statement that the Contracting States intend to deny the application of the provisions of their treaties when transactions or arrangements are entered into in order to obtain the benefits of these provisions in inappropriate circumstances. The report recommends the inclusion of additional guidance in the Commentary included in the OECD Model Tax Convention in order to clarify that the incorporation of that principle into tax treaties will not affect the existing conclusions concerning the interaction between treaties and domestic anti-abuse rules.

The report also addresses two specific issues related to the interaction between treaties and specific domestic anti-abuse rules. The first issue relates to the application of tax treaties to restrict a Contracting State’s right to tax its own residents. The report recommends that the principle that treaties do not restrict a State’s right to tax its own residents (subject to certain exceptions) should be expressly recognized through the addition of a new treaty provision based on the so-called “saving clause” already found in US tax treaties. The second issue deals with so-called “departure” or “exit” taxes, under which liability to tax on some types of income that has accrued for the benefit of a resident (whether an individual or a legal person) is triggered in the event that the resident ceases to be a resident of that State. The report recommends changes to the Commentary included in the Model Tax Convention in order to clarify that treaties do not prevent the application of these taxes.

(p.190) Section B of the report addresses the second part of Action 6, which required that work be done in order to “clarify that tax treaties are not intended to be used to generate double non-taxation.” This clarification is provided through a reformulation of the title and preamble of the Model Tax Convention that will clearly state that the joint intention of the parties to a tax treaty is to eliminate double taxation without creating opportunities for tax evasion and avoidance. Given the particular concerns arising from treaty shopping arrangements, such arrangements are expressly mentioned as one example of tax avoidance that should not result from tax treaties. Under applicable rules of international public law, this clear statement of the intention of the signatories to a tax treaty will be relevant for the interpretation and application of the provisions of that treaty.

Section C of the report addresses the third part of the work mandated by Action 6, which was “to identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country.” The policy considerations that are described in Section C should help countries explain their decisions not to enter into tax treaties with certain low- or no-tax jurisdictions; these policy considerations will also be relevant for countries that need to consider whether they should modify (or, ultimately, terminate) a treaty previously concluded in the event that a change of circumstances (such as changes to the domestic law of a treaty partner) raises BEPS concerns related to that treaty. It is recognized, however, that there are many non-tax factors that can lead to the conclusion, amendment, or termination of a tax treaty and that each country has a sovereign right to decide whether it should do so.

Action 8: Guidance on Transfer Pricing Aspects of Intangibles

The Report contains final revisions to Chapters I, II, and VI of OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (Guidelines). These changes to the Guidelines clarify the definition of intangibles under the Guidelines, provide guidance on identifying transactions involving intangibles, and provide supplemental guidance for determining arm’s length conditions for transactions involving intangibles. These final modifications to the Guidelines also contain guidance on the transfer pricing treatment of local market features and corporate synergies. The guidance is supplemented with numerous examples illustrating the application of the principles contained in the revised text of the Guidelines.

The final guidance contained in this document represents the first installment of the transfer pricing work mandated by the BEPS Action Plan. Because the interactions between work on ownership of intangibles, hard to value intangibles, risk and recharacterization are particularly pronounced, a decision has been made not to finalize the work on some sections of this document (p.191) at this time. Accordingly, bracketed and shaded portions of this document should be viewed as interim drafts of guidance, not yet fully agreed by delegates, that will be finalized in 2015 in connection with other related BEPS work. It is the intention of the countries involved in the BEPS project to complete these sections of the revised intangibles guidance during 2015 in conjunction with the BEPS work on risk, recharacterization, and hard-to-value intangibles.

Action 13: Guidance on Transfer Pricing Documentation and Country-By-Country Reporting

This report under Action 13 contains revised standards for transfer pricing documentation and a template for country-by-country reporting of income, earnings, taxes paid, and certain measures of economic activity. The revised standards require a three-tiered transfer pricing documentation structure, consisting of: a country-by-country report (CBCR), a master file, and a local file. The CBCR requires multinational enterprises (MNEs) to report annually and for each tax jurisdiction in which they do business the amount of revenue, profit before income tax, and income tax paid and accrued. It also requires MNEs to report their total employment, capital, retained earnings, and tangible assets in each tax jurisdiction. Finally, it requires MNEs to identify each entity within the group doing business in a particular tax jurisdiction and to provide an indication of the business activities each entity engages in.

The guidance on transfer pricing documentation requires MNEs to provide tax administrations high-level global information regarding their global business operations and transfer pricing policies in a “master file” that would be available to all relevant country tax administrations. It also requires that more transactional transfer pricing documentation be provided in a local file in each country, identifying relevant related party transactions, the amounts involved in those transactions, and the company’s analysis of the transfer pricing determinations they have made with regard to those transactions.

Action 15: Developing a Multilateral Instrument to Modify Bilateral Tax Treaties

Drawing on the expertise of public international law and tax experts, the report explores the technical feasibility of a multilateral hard law approach and its consequences on the current tax treaty system. The report identifies the issues arising from the development of such an instrument and provides an analysis of the international tax, public international law, and political issues that arise from such an approach. It concludes that a multilateral instrument is (p.192) desirable and feasible, and that negotiations for such an instrument should be convened quickly.

7.2.9 What are the Next Steps?

In order to facilitate active involvement of all stakeholders, including developing countries in the BEPS project:

  • Regular briefs will be delivered through webcasts and will be accessible for free by all interested parties.

  • Requests for input are published on the OECD website to inform the work at an early stage.

  • Discussion drafts are published on the OECD website on the Center for Tax Policy and administration page for comments.

  • Public consultations are organized to discuss the comments received.

The BEPS Project has brought together forty-four countries working on an equal footing: all OECD members and the BEPS Associates. In addition, during the first phase of the Project, more than eighty developing countries and other non-OECD/non-G20 economies have been consulted, and their input has been fed directly into the BEPS process, through four in-depth regional consultations organized in cooperation with regional tax organizations such as the African Tax Administration Forum (ATAF) and the Inter-American Center for Tax Administration (CIAT), five thematic global fora on topics such as tax treaties, transfer pricing, and value-added taxation, as well as targeted seminars at our regional tax centers in Mexico, Korea, and Turkey. This engagement has also been critical to identifying the specific challenges and priorities of low-income countries faced with BEPS issues. These priorities, and how the G20 can provide support to address them, was the subject of the two-part report prepared by the OECD under a mandate from the G20 Development Working Group mentioned earlier in this paper.

Based on the results of that report and at the request of finance ministers, the OECD is now expanding the engagement of developing countries. A number of interested countries, along with key regional tax organizations, will be directly involved in the standard-setting process, while we are institutionalizing a broader, structured dialogue.

Developing countries, drawn from a cross-section of regions and per capita income-levels, will immediately be invited to take part in the meetings where key decisions on BEPS issues are made—the Committee on Fiscal Affairs (CFA)—as well as in its technical working groups. Interaction with countries not able to participate directly will be ensured through regional networks. (p.193) Leading regional tax administrations have also been invited to participate in the CFA and all technical working groups, in line with the role the IMF, the WBG, and the UN already have. The OECD will draw on their unique expertise and benefit from their input in the standard-setting process while working with them to ensure that developing countries reap the benefits of this work. This move will ensure developing countries’ views are reflected throughout the development of the technical work and standard-setting process.

The report also makes clear that developing countries often face specific policy and other conditions that impact on their abilities to address BEPS. It notes that the interests of developing countries have been addressed in some key areas of the BEPS Action Plan, including for example proposals for country-by-country reporting (Action 13) and the multilateral instrument (Action 15). Drawing on these findings, the OECD, working with other international organizations and regional tax organizations, has been mandated to develop tools to translate the BEPS Action Plan into practical support for lower capacity developing countries, to be delivered over the next two to three years.

7.3 The OECD Tax and Development Program

The OECD’s Task Force on Tax and Development was created in January 2010 following the Joint Meeting on Tax and Development between the Committee on Fiscal Affairs (CFA) and the Development Assistance Committee (DAC). Its members include OECD and developing countries, international and regional organizations, civil society, and business and is co-chaired by South Africa and the Netherlands. The role of the Task Force is to advise the OECD Committees in delivering a Tax and Development Program to improve the capacity for developing countries to collect taxes fairly and effectively.

The Task Force has developed a coherent program focusing on key areas of importance to developing countries. The program has four key pillars:12

  • Statebuilding, taxation, and aid—which includes transparency initiatives in respect of tax incentives and taxpayer morale, taxpayer education, and guidance for donors. Work is also underway on a feasibility study on “Tax Inspectors Without Borders,” a new initiative to deliver tax audit experts to developing countries on a demand-led basis.

  • Effective transfer pricing in developing countries—a program of capacity building in specific countries and support to regional organizations in this field.

  • (p.194) Increased transparency in the reporting of relevant financial data by MNEs—by identifying best practices in enabling public access to local statutory accounts and tracking ongoing transparency initiatives.

  • Supporting the work of the Global Forum on Transparency and Exchange of Information.

What will be the impact of a tax and development program in developing countries?

  • A closer relationship between state and taxpayers, including both citizens and MNEs in the tax area

  • More effective aid for building strong tax systems

  • Strengthened tax capacity, particularly in transfer pricing

  • Improved tax transparency and increased accountability

  • In the long term this will lead to tax systems which are better able to finance government expenditures in a fair and efficient manner

  • Reduced cross-border tax evasion through effective exchange of information.

7.3.1 Transfer Pricing (TP) Program

In terms of strengthening tax capacity, particularly in transfer pricing, most OECD and many non-OECD countries have introduced transfer pricing rules into their tax legislation. They have done this in order to ensure that the profits reported by MNEs in their jurisdictions are computed in line with internationally accepted principles, and to counter any inappropriate or abusive transfer pricing by MNEs. In most countries that have transfer pricing rules, the benchmark adopted is the “arm’s length principle.”

Relatively few developing countries have fully effective transfer pricing regimes in place. Many developing countries that have legislation in place often lack the administrative, technical, and auditing capacity to conduct effective and efficient audits.

In 2011, the OECD’s Task Force on Tax and Development began a program of support for developing countries seeking to implement or strengthen their transfer pricing rules (the “TP Program”). The work is being carried out in partnership with the World Bank Group and European Commission to assist developing countries build their capacity to implement effective tax regimes to address issues relating to BEPS, in particular in the area of transfer pricing.

The work helps countries put in place measures designed to protect their tax bases, but also supports efforts towards a transparent and predictable investment climate through the introduction of rules that create certainty and consistency for business. A program of intensive support in the area of transfer pricing is (p.195) currently underway in five pilot countries: Colombia, Ghana, Kenya, Rwanda, and Vietnam. Other country and regional projects are in the formative stages.

A key feature of these demand-led transfer pricing programs is cooperation between the international agencies involved in their delivery. The OECD, European Commission and World Bank/IFC are working together on each of the country projects providing coherent and coordinated support. The program also works closely with other partners such as German Federal Enterprise for International Cooperation (GIZ), Economic Cooperation and Development Division of the Swiss Secretariat for Economic Affairs (SECO), United States Agency for International Development (USAID) and the Presidential Agency for Social Action and International Co-operation of Colombia. This ensures that work in this area supports wider financial governance reform and country-owned approaches to development.

This work is also closely aligned with existing country tax reform programs.13 Additional World Bank/IFC projects also benefit, as required, from technical input by the OECD’s Tax and Development Program, particularly by the development of tools, guidance, and training materials to assist countries in the practical application of their transfer pricing rules.

The TP Program has already had a significant impact:

Colombia—In Colombia, where the three-year Program worked closely with the EU, the Presidential Agency for Social Action and International Co-operation of Colombia, and World Bank Group, transfer pricing adjustments made as a result of audits of multinational enterprises have increased revenues ten-fold from US$3.3m in 2011 to over US$30m in 2014. The Colombian administration states this has been possible because of the practical advice provided by the Tax and Development Program.

In December 2012, Congress in Colombia passed revised and improved transfer pricing legislation which is aligned with international standards and in December 2013 passed a new Transfer Pricing Decree. The Tax and Development Program has provided significant input and advice to Colombia on the drafting of the new legislation and Decree.

GhanaNew transfer pricing regulations, aligned with international standards, were introduced in Ghana in September 2012. The TP Program has worked closely with Ghana from July 2011, which saw the beginning of Ghana’s current initiative to build an effective transfer pricing regime. The TP Program has provided significant input and advice on the drafting of the new legislation, as well as the drafting and design of a Transfer Pricing Practice Note for the guidance of taxpayers and tax officers.

The TP Program has also assisted Ghana in the design of a Transfer Pricing Annual Return Form and in setting up a team of specialist auditors to (p.196) enable it to effectively identify and address transfer pricing risk in Ghana. It has also undertaken a comprehensive skills-building program with the newly established team of specialist auditors.

KenyaIn Kenya, where the Program is working closely with World Bank Group, the tax administration in 2012 embarked on a significant training program for its staff on advanced transfer pricing issues. This initiative followed advice from the Tax and Development Program, which is providing support in developing and delivering the training program. The capacity-building program is specifically tailored to Kenya’s needs and auditors’ level of knowledge.

This skills-building program has resulted in more efficient work by the Kenyan Revenue Authority (KRA) resulting in an increase in the number of audit cases completed, revenue collected, and number of cases going to dispute resolution. Revenue collection from transfer pricing audits has doubled from US$52m for year ended 30 June 2012 to US$107m for year ended 30 June 2014. More specifically, in three recent cases, the KRA successfully negotiated transfer pricing adjustments based on the advice given by the Program, which resulted in additional tax revenue of US$47.3m.

Rwanda—A full assessment of the risk of profit shifting has been carried out with the Rwandan Revenue Authority as the basis on which a new transfer pricing regime is being planned. New transfer pricing guidelines that align with international standards are expected to be implemented in 2015.

Vietnam—In Vietnam, where the Program is working closely with the EU and World Bank Group, the tax administration has significantly increased its capacity to enforce its transfer pricing rules, resulting in an increase in the number of audits conducted by the tax administration from one audit in 2012 to forty audits in 2013, giving rise to transfer pricing adjustments of US$110m by the end of 2013. Vietnam tax administration records the completion of twenty-five audits between 2013 and the first six months of 2014 that resulted in revenue collection of close to US$19m.

The Program has also provided support on organizational changes in the tax administration and policy issues relating to legislation, advance pricing arrangements, safe harbours, and thin capitalization.

7.3.2 Development of Tools and Materials

The TP Program has also developed extensive support and training materials for use by developing countries and by specialists working with developing countries on capacity-building initiatives. This has included:

  • A transfer pricing “Needs Assessment” tool to assist developing countries to assess the potential risk to their tax base from transfer pricing

  • (p.197) A “Results Measurement” tool to assist the TP program to assess its impact in each country it is working in

  • Training material on APA rules, thin capitalization rules, administrative simplification, safe harbours, secondary adjustments, and return-filing schedules

  • Numerous training exercises based on practical examples.

7.3.3 Lessons Learned from the TP Program

The lessons learned through working intensively on transfer pricing in the developing country context are being fed back into the OECD’s processes to ensure that a developing country perspective is consistently considered in the development of standards and guidance on transfer pricing. In this context, the TP Program has close links with the OECD’s Global Forum on Transfer Pricing, and with the ongoing OECD work on BEPS.

7.3.3.1 Obtaining Relevant Information

The work done with developing countries has highlighted that one of the major challenges tax administrations in developing countries face in effectively implementing their transfer pricing regimes is obtaining all of the relevant information regarding the non-resident members of the MNE which are parties to transactions with their taxpayer. This issue has been fed back into the work that OECD Working Party 6 is currently undertaking on transfer pricing documentation and into the debates held and the work done on country-by-country reporting by the Task Force. This has helped to raise awareness of the importance of increasing transparency in financial reporting by MNEs for tax compliance, particularly for developing countries.

This work fed into the G8 Lough Erne Summit in June 2013 which called on the OECD to develop a common template for country-by-country reporting to tax authorities by MNEs.14 The objective is to improve the flow of information between MNEs and tax authorities in the countries in which the MNEs operate, enhancing transparency and improving risk assessment. The OECD has responded to that request by taking this work forward through the BEPS Action Plan (Action 13) which will develop rules regarding transfer pricing documentation to enhance transparency for tax administrations, taking into consideration the compliance costs for business. The rules to be developed may include a requirement that MNEs provide all relevant governments with (p.198) the required information on their global allocation of income, economic activity, and taxes paid among countries.

Another area of concern expressed by developing countries is the availability and quality of financial data on transactions between unrelated parties that can be used for comparability purposes, which is critical to implementing an effective transfer pricing regime. In response to those concerns the OECD is now exploring, in cooperation with other stakeholders, approaches it might adopt to respond to those concerns.

7.3.3.2 Other Pricing Methodologies

In an attempt to prevent base erosion through reduced sales prices for mineral and commodity products in related party transactions, a number of resource rich countries, in particular in Latin America, have developed what is sometimes referred to as a “sixth method.” Certain African countries have now either adopted similar measures or are considering their adoption.

The sixth method requires pricing of commodity transactions in accordance with publicly available data from commodity exchanges as of the date of shipment under certain circumstances. This has the effect of preventing the shifting of commodity product-related income to low-substance trading companies, and the practice of shifting income ostensibly attributable to forward price discounts to such companies. Depending on the country, a variety of exceptions and let-out clauses exist which are intended to have the effect of limiting the method to cases that are deemed potentially abusive. Consideration is currently being given to this issue under the BEPS project.

7.3.3.3 Industry Knowledge

A critical skills gap in building capacity to address transfer pricing risks for many tax administrations is a lack of knowledge of the key industries in the country, in particular, understanding the global value chain and where the resident taxpayer fits into that value chain. The TP Program has received support from certain businesses which have provided industry experts to facilitate training for tax administrations on the global value chains of certain key business sectors in their country. For example Rio Tinto provided a mining expert for a skills-building workshop for the Colombian tax administration’s (DIAN) transfer pricing auditor in Bogota on the global value chain in the gold and coal mining industries.

7.3.3.4 Cooperation between Organizations

In October 2012, the TP Program conducted a “Train the Trainers” event at the Vienna Multilateral Tax Center. The event formed the centerpiece of an (p.199) initiative designed to provide relevant specialists from developing countries with skills and materials to conduct internal and regional training on transfer pricing. Since 2013 the specialists have delivered basic transfer pricing training in their own country/region. This work demonstrates the significant capacity in some developing countries to deliver South-South assistance.

The TP Program has also identified that developing countries often find that the work the tax administrations undertake on transfer pricing issues is closely related to the issues that arise in terms of import duties on goods brought into the country by the MNE. The issue of the interaction of Customs Valuation rules and transfer pricing is therefore an issue of particular importance to developing countries. In response to this the OECD has commenced a collaborative project between the OECD and World Customs Organization (WCO) on the issue of the interaction of customs valuation rules and transfer pricing.

7.4 Addressing the Governance and Management of Tax Incentives

The Task Force has produced Principles to Enhance the Transparency and Governance of Tax Incentives for Investment in Developing Countries.15 Consequently, several developing countries have requested OECD support to analyze their tax incentives based on these principles. At the request of developing countries, reviews of tax incentives for investment have been undertaken, applying these principles as a standard diagnostic framework. Key findings of the country reviews include:

  • Ghana. The analysis revealed an alarming level of revenue loss attributable to special tax provisions and exemptions—6.13 percent of GDP in 2011. This sent shock waves through the government and is triggering a political debate about the rationalization of the tax incentives regime. GIZ and the World Bank are considering follow-up support.

  • Tunisia. OECD analysis fed directly into recommendations in the new Investment Incentive Code, supporting the efforts of the post-revolution Tunisian government in designing a more effective and transparent framework for tax incentives for investment.

  • Zambia. The review examined the current level of transparency in the tax incentives regime, which fed a new reform process aimed at streamlining tax incentives and making the tax system more equitable. For example, (p.200) tax incentives in the mining sector have been curtailed and those offered to Special Economic Zones and industrial parks have been rationalized. GIZ is following-up.

  • Myanmar. The Tax and Development Program conducted a Tax Policy review of Myanmar under the Policy Framework for Investment (PFI). The key recommendations concerning streamlining tax incentives for investment and simplifying tax rates have reinforced the ongoing efforts of the International Monetary Fund (IMF) and the Asian Development Bank (ADB) in the implementation of a comprehensive tax reform.

  • Costa Rica. The Tax and Development Program conducted a review of Costa Rica’s investment incentives system under the PFI. The review concluded that a highly targeted, transparent, and well-managed tax incentives regime has been essential in attracting technology-intensive investors.

In 2013, the Tax and Development Program revised the Tax Chapter (Chapter 5) of the OECD’s Policy Framework for Investment16—a key element of the OECD’s Development Strategy.17

The Principles to Enhance the Transparency and Governance of Tax Incentives for Investment in Developing Countries have become an international “good practice” reference point and an essential tool for undertaking reviews in developing countries.

The Tax and Development Program completed further country reviews in 2014, on a demand-led basis to address the needs of developing countries in improving the governance of tax incentives. In conducting these reviews, close cooperation will have been fostered with other agencies at the country level (including the World Bank, GIZ, IMF, and USAID).

The Program supported regional/global engagements on tax incentives and provided specific and practical tax incentives policy guidance for the Southern African Development Community (SADC), building on the experience of the member countries while integrating the latest methodologies and research in the tax incentives area. In close cooperation with the World Bank and IFC, it supported the Myanmar’s Chairmanship of ASEAN in harmonization of tax incentives regimes across ASEAN and safeguarding tax bases of the member countries.

A knowledge-sharing event was organized on tax incentives in 2014 to gather and share the latest thinking and research, integrating findings from the country case studies. The event served as a multi-lateral forum for exchange of experience among countries and institutions active in this area.

(p.201) The Tax and Development Program has also identified that resource-rich developing countries face challenges to ensure they reap the developmental benefits from the exploitation of their natural resource endowments and promote more inclusive growth. Within the framework of the OECD Development Strategy adopted at ministerial level in May 2012, the OECD Development Center is leading efforts for establishing a multi-year structured Policy Dialogue on Natural Resource-based Development among OECD and partner producing countries to identify and address common challenges in this area.

7.5 Tax Inspectors Without Borders (TIWB)

The Tax and Development Program is also leading an initiative to expand the reach of practical assistance to tax administrations in developing countries, focusing on tax audit activities. The Tax Inspectors Without Borders (TIWB) initiative18 aims to improve tax audit skills in practice, by facilitating the deployment of experts to work on real audit cases. Under TIWB, experts, who are either currently serving or recently retired tax audit officials, will be deployed to apply a “learning-by-doing” approach. Experts work alongside local tax officials to progress current audits, expanding the range and depth of audit techniques and skills as they do so. TIWB focuses on international tax issues, but also general audit skills—for example, cases involving transfer pricing, thin capitalization, exchange of information, or advancing pricing agreements, as well as pre-audit risk assessment, case selection, and audit investigatory techniques.

Deployments are flexible depending on need as well as expert availability and funding; they can be for as little as one-week duration or up to six months or more. The assistance is also flexible in how it is provided. For example, in some cases the expert will reside full-time in the country, in others, they will be periodic deployments, for example where the expert is in-country for a period of ten weeks over a minimum of three visits in a six-month period. For such periodic deployments, when the expert is not in-country, often they will be available to provide assistance over the phone or by email to the local officials, subject to confidentiality requirements.

By focusing on peer-to-peer assistance on real audit cases, TIWB targets a niche area of demand, helping officials shift from a theoretical understanding of international tax issues, to applying that understanding on a daily basis in their audit work. Housed within the OECD, TIWB can also draw on its network of tax administrations and development agencies, to put in place a (p.202) database of experts and make links to funding to support deployments under the initiative. By helping developing countries to acquire appropriate expertise and overcome the potential conflict of interest and tax confidentiality issues which can arise, TIWB aims to make this type of practical assistance more broadly accessible. The first review of the TIWB initiative took place at the end of its first eighteen-month mandate, in December 2014.

7.6 Conclusion

The very low effective tax rates that multinationals can achieve through international tax planning continue to raise serious concerns. Leaders, civil society, and everyday taxpayers have renewed demands for changes to the international tax rules to restore the fairness and integrity of their tax systems. The above initiatives support governments’ efforts to ensure the integrity of tax systems, restore trust in their tax systems by setting the standards, and providing the instruments to combat tax evasion. The OECD’s work on Base Erosion and Profit Shifting (BEPS) aims to bring the international tax rules into the twenty-first century. It will provide a level playing field for both companies and countries. The additional revenues collected will give governments greater flexibility in supporting economic recovery. The OECD Tax and Development Program will complement that work by assisting developing countries to build their capacity to address issues relating to BEPS.

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Notes:

(1) See OECD (2013a).

(2) See OECD (2013b).

(3) See OECD (2014a).

(4) See OECD (2010).

(5) See OECD (2012a).

(6) See OECD (n.d. a).

(7) See OECD (n.d. b).

(8) The OECD’s Task Force on Tax and Development brings together all major stakeholders on tax and development, including representatives from developed and developing countries, international organizations, business, and NGOs. It is co-chaired by senior officials from an OECD and a non-OECD country, and is supported by a Secretariat—incorporating extensive government transfer pricing experience—managed jointly by the OECD’s Center for Tax Policy and Administration and Development Coordination Division, with staffing and other costs met by the OECD and donor contributions.

(9) See OECD (n.d. c).

(10) See OECD (2014b) and OECD (2014c).

(11) See G20 (2014).

(12) See OECD (n.d. d).

(13) In Ghana, for example, the transfer pricing work is closely integrated into Ghana/GIZ’s Good Financial Governance program.

(14) See G8 (2013).

(15) See OECD (n.d. e).

(16) See OECD (2006).

(17) See OECD (2012b).

(18) See OECD (n.d. f).