The Impact of Unilateral Action on BEPS and the Benefits of Waiting

By Madison Ure

Madison attended the 2015 OECD Forum in Paris. 

Abstract

Base Erosion and Profit Shifting (BEPS), is defined by the Organisation for Economic Co-Operation and Development (OECD) as “tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid”[1]

Governments around the world are currently looking at ways to address the issue of BEPS, with Australia adopting a leadership position in the push for multinational corporations to pay what is considered to be their fair share of tax.[2] The OECD, through the OECD Committee on Fiscal Affairs, is coordinating international multilateral action against BEPS by delivering the BEPS Project.

Corporate tax avoidance has a significant impact on the Australian government and therefore Australia is seeking to act unilaterally on the BEPS issue and implement new legislation prior to the release of the final OECD deliverables.[3] 

Recommendations

  • OECD Committee on Fiscal Affairs continue to cooperate to prepare meaningful deliverables that can be implemented by each national jurisdiction the tools necessary to allow sovereign nations to work together to deliver a coordinated strategy to international tax issues.
  • OECD and G20 member nations implement Action Item 15, a multilateral instrument to modify existing bilateral tax treaties, to prevent tax treaty abuse in a synchronised and efficient manner.
  • The Australian government to consider the entire international taxation landscape when considering possible responses to BEPS to ensure that any action is in line with the strategies developed by the OECD Committee on Fiscal Affairs.
  • Multinational corporations to consider the ethical and social aspects of taxation when developing taxation strategies and to behave in a way that is consistent with both the letter and the spirit of the law.

Introduction

Within an increasingly globalised economy there is a greater integration of national economies and cross-border operations businesses are able to locate business operations where they can be done most efficiently.[4] Within the digital economy this is a significant issue as intangible capital (including intellectual property and branding) has an increased significance. [5] As intangible capital has no physical location it is difficult, under the current concepts of taxation such as permanent establishment, to determine in which jurisdiction intangible capital is more appropriately taxed. Therefore even though it is the sovereign right of every government to tax, due to an increasingly globalised economy international collaboration to establish common standards is necessary.[6] Through the BEPS project, the OECD is attempting to target these issues.

Multinational corporations, in part due to developments in information technology and economic globalisation, have a high degree of flexibility to structure their business operations to reduce tax liabilities. [7] Digital disruption and globalisation have increasingly allowed multinational corporations to legally structure their business operations in a way that minimises their tax liabilities.[8] As businesses gain capacity to easily structure business operations for tax purposes, governments engage in competition to attract large multinational corporations that may be contribute to economic growth by providing an attractive tax rate.[9] The Australian treasury observed the trend of tax competition in 1999, and noted the following in the Australia’s Future Tax System Review:

“In a world of increased capital mobility, company income tax and other taxes on investment have a major impact on decisions by businesses on where to invest, how much and what to invest in and where to record their profits.”[10]

The magnitude of the impact on Australia’s corporate tax base is difficult to quantify due to the inability to extract the impact of businesses tax planning activities from other business activities.[11] However, regardless of the ultimate financial impact to Australia, or other countries, of BEPS, the ultimate issue is the underlying policy concern that tax law has failed to keep pace with changes to the business environment and therefore the legal framework needs to be reconsidered to better respond to the business environment.[12]

The BEPS Project

The OECD is of the view that BEPS poses a significant risk to national tax revenues, tax sovereignty and tax fairness.[13] Given the purpose of the OECD “is to promote policies that will improve the economic and social well-being of people around the world,”[14] BEPS is a serious consideration for the OECD. Consequently, action is being taken through the BEPS project. The BEPS project is a joint initiative lead by the OECD and the G20 which aims to secure revenues for government and realign the taxation system to ensure that taxation occurs where value is created.[15]

The OECD has made it clear that there will be challenges for countries to be able to act alone effectively to target BEPS and therefore a coordinated approach is required as unilateral action has the potential to replace instances of double non-taxation with instances of double taxation. [16]

As such, the OECD is coordinating an approach to target BEPS as [emphasis added]:

Failure to collaborate in addressing BEPS issues could result in unilateral action that would risk undermining the consensus- based framework for establishing jurisdiction to tax and addressing double taxation which exists today. The consequences could be damaging in terms of increased possibilities for mismatches, additional disputes, increased uncertainty for business, a battle to be the first to grab taxable income through purported anti-avoidance measures, or a race to the bottom with respect to corporate income taxes…. Because many BEPS strategies take advantage of the interface between the tax rules of different countries, it may be difficult for any single country, acting alone, to fully address the issue.”[17]

The success of the OECD BEPS project is dependent on the buy in from a broad representation of countries (including developed and developing countries) to develop and implement multilateral reform.[18]

In July 2013, the OECD and G20 nations (together forming the OECD Committee on Fiscal Affairs) delivered the BEPS Action Plan, comprising of 15 actions, to provide guidance on how to address BEPS. [19] In September 2014, the OECD Committee on Fiscal Affairs delivered the first of a series of reports and recommendations to address seven of the aforementioned actions.[20] The first deliverables produced by the OECD targeted hybrid mismatches, treaty shopping, abuse of transfer pricing in respect of intangibles, and discrepancies in country level reporting. [21]

The final deliverables are due in September 2015.

As noted above, the OECD has realised the potential impact of a country acting unilaterally to reduce the efficacy of the entire project. Given that BEPS is a global issue, a global solution is required. Fortunately, in the current context there is the international political consensus to allow for cooperation on the issue.[22] Further, the effectiveness of action on BEPS is dependent on equal cooperation between OECD and G20 nations to develop decisive actions. Given the need for consensus to develop the actions outlined in the BEPS plan, the size of the OECD Committee on Fiscal Affairs could be an impediment to reaching a decision due to the competing interests of stakeholders.

Specifically, this may be problematic where the United States knowingly enables its multinational corporations to actively avoid foreign income tax.[23] The United States seeks to minimise the impact of any action on BEPS due to the potential impact it may have on its multinational corporations.[24] Additionally, the inclusion of G20 nations, specifically India and China, in the process potentially creates difficulties in the implementation process, as traditionally the positions of these nations have not been aligned in relation to taxation.[25]

Given the ambitious nature of the BEPS Project and the tight timeline, cooperation of all involved parties is essential to the success.[26]

Australian Position

Australia has historically followed the lead of the OECD in relation to international taxation treaties, evidenced by the fact that Australian tax treaties are largely consistent with the OECD model treaty.[27]

By their nature, tax treaties are not easily updated, as an update requires the agreement of the treaty party and an often lengthy negotiation process.[28] On that basis, it is an inflexible approach that cannot be easily adapted when the tax treaty gives inappropriate outcomes due to a changing business environment. [29]

In October 2014, the Senate referred an inquiry into corporate tax avoidance to the Senate Economic References Committee to examine avoidance and aggressive minimisation by multinational corporations operating in Australia.[30]

The Senate inquiry was a result of public pressure to ensure multinational companies operating in Australia paid their ‘fair share’ of tax, combined with a growing international focus on combatting tax avoidance.[31]

Selected Australian companies and multinational corporations operating in Australia, were invited to provide submissions in relation to their tax arrangements in Australia, including their effective tax rate. [32] Interested parties, including members of the general public, were also invited to provide submissions.

The Income Tax Assessment Act 1936 (Cth) (ITAA 1936) and the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) both contain anti-avoidance provisions. These rules, developed to protect the Australian taxation base, have historically been enforced robustly and consistently by The Australian Tax Office (ATO).[33]

Currently 95% of Australian tax revenue stems from taxpayers who pay voluntarily.[34] This may be attributed to support in paying taxes, fair taxation laws and the activities of the ATO to encourage compliance, however a key factor is also the trust taxpayers have in the fairness of the taxation system.[35] Growing public perception that multinational corporations are not paying their ‘fair share’ has the potential to erode confidence in the Australian tax system on the basis that different taxpayers are treated differently.[36] In a system, such as Australia’s, which is dependent on voluntary compliance, the efficacy of the system is reduced where taxpayers do not believe that everyone is complying.

2015-16 Federal Budget

It is the intention of the current Federal Budget to ensure that the fairness of taxation is improved, and that “companies who ear tax in Australia, pay tax in Australia” in order to distribute the taxation burden fairly.[37]

Currently BEPS distorts the market by providing a benefit to large enterprises that operate internationally who are able to shift profits to low or no-tax jurisdictions. BEPS therefore advantages large multinationals over domestic companies who may not use international structures, or small to medium international enterprises that cannot afford the requisite complex taxation planning. [38] The current budget, with a focus on fairness, is seeking to correct this distortion.

The measures introduced in the current Federal Budget that are aligned with the BEPS Project are country-by-country reporting, hybrid mismatch arrangements, treaty abuse and compulsory exchange of rulings related to preferential regimes.[39] These measures are directly aligned with the position of the OECD and therefore represent a move towards multilateral action guided by the OECD.

In addition to the abovementioned actions, the current Budget also includes a range of domestic measures intended to prevent the avoidance of Australian taxes by multinational corporations, through the introduction of the Tax Laws Amendment (Tax Integrity Multinational Anti-avoidance Law) Bill 2015.[40] The Goods and Services Tax (GST) will also be extended to cover intangible goods, and will apply to cross border supplies of digital products and services effective from 1 July 2017. [41]   

Multinational anti-avoidance laws

Within the general political landscape, and particularly through the Senate enquiry, businesses have been criticised for structuring their operations specifically to achieve favourable taxation outcomes. The amendments announced with the Federal budget are specifically targeted at 30 companies that the treasury believe are currently avoiding tax in Australia.[42] The laws aim to ensure the ATO has the power to see through contrived business structures of multinational corporations to recover tax that should be payable within Australia.[43] Consequently, only large multinational corporations are impacted, the new laws apply only to global groups where the annual turnover is greater than $1 billion.[44]

Under the current legal framework, as provided for in Part IVA of the ITAA 1936 a business structure must have a commercial justification. Specifically, a business must be able to meet the dominate purpose test by demonstrating that the dominant purpose of a business structure is a business purpose, rather than the business structure being an artificial construction to avoid being deemed to have a permanent establishment in Australia therefore creating a favourable taxation outcome. Due to the dominant purpose test, any business structure must have commercial substance.

The new multinational anti-avoidance laws proposed in the current Federal Budget will replace the existing dominant purpose test of determining whether business operations are artificially structure for taxation purposes, with a primary purpose test. [45] This relates to the primary purpose of avoiding either Australian or foreign taxes, and therefore greatly extends scope of the anti-avoidance provisions.

The primary purpose test is a much lower threshold for the ATO to prove taxation avoidance as it is possible for there to be multiple purposes behind a corporate structure.[46] Consequently, the new laws if enacted in their current form will give significantly more power to the ATO in respect of multi-national corporations that structure their businesses in a manner that leads to profits being declared in a ‘no or low tax jurisdiction’.[47]

A potential issue in relation to the legislation in its current form is that the term ‘no or low tax jurisdiction’ is not currently defined .This therefore creates ambiguity as to what will be considered to fall within the scope of the term.

Should a business structure be deemed to be for the purpose of achieving a favourable taxation outcome, the Commissioner may tax the entity for the business profits attributable to business in Australia. Additionally, the ‘scheme shortfall amount’ will be subjected a base penalty amount of double the shortfall amount, which is double the administrative penalties currently applied, plus general interest charges. The penalty amount may be waived where the taxpayer has a reasonably arguable positon. The penalties applicable under the proposed amendments are significantly higher than the penalties applied in the United Kingdom under the Diverted Profits Tax.[48]

Businesses have structured their arrangements, which may be designed to achieve a certain taxation outcome, based on the current status quo. For business certainty, specifically when considering the significance of the potential penalties, clarity on the tests incorporated in the legislation would be beneficial to business to ensure that businesses have certainty in relation to the taxation implications of their international structure. The OECD recognises that within an increasingly globalised business environment with growing cross border investments providing certainty to the international business community is a key consideration in any action on BEPS. [49]

Transfer Pricing Documentation Standards

Historically, the information the ATO received regarding a corporations transfer pricing was limited to the methodology used and the approach taken in respect of international related party dealings provided at the time of lodgement of the tax return.[50] Further information was only provided in the event of an audit.

Effective from 1 January 2016, Australia will adopt the OECD Transfer Pricing Document Standards. The OECD Standards require:

  • Country-by-country reporting showing information on all the global activities of the company, including the location of income and tax paid.
  • A Masterfile containing an overview of the multinational’s global business operations, organisational structure and transfer pricing policies; and
  • A local file containing detailed information about the local companies’ tax liability.

As with the anti-avoidance laws there reporting requirements would only apply to groups with a turnover greater than $1 billion annually thereby ensuring that the compliance burden is borne by large international corporations that have the capacity to undertake tax planning in an increasingly complicated regulatory system rather than small to medium enterprises for whom increasing mandatory regulatory reporting would be unduly burdensome.

This change to the Transfer Pricing Documentation Standards aligns with Action Item 13 of the BEPS Project and provides an example of Australia acting directly on the advice of the OECD to combat the BEPS issue.[51]

Application of GST to digital goods

The aim of the extension of the GST to cover imported intangible goods is to improve the integrity of the GST and create a level playing field between Australian and international suppliers of intangible goods.[52] Colloquially, the extension of the GST has been referred to as ‘the Netflix Tax’.

When the GST legislation was drafted in 2000 to not include intangible goods sources from overseas, it did not foresee the growth in the supply of digital goods from an international supplier to be downloaded by a consumer in Australia.[53] Given the smaller supply of intangible goods at the inception of the GST measures were not implemented to capture these forms of transactions as it had a limited impact on the tax base in comparison to the cost of compliance. As such, the GST legislation in its current form provides a 10% taxation advantage for multinational businesses supplying digital products to Australia, over their Australian competitors.

As such within the measures announced in the current Federal budget, the government aimed to close the digital loophole and apply GST consistently over digital goods supplied by domestic and international suppliers.[54]

Through the BEPS Project the OECD’s has recognised the issues associated with inconsistent taxation on the supply of digital goods and is looking to finalise a recommendation in 2015.[55] Measures similar to the approach adopted by Australia will also be implemented by Japan, Norway, South Korea, Switzerland and European Union members.[56] Additionally the Canadian government has also indicated interest in adopting a similar policy approach.[57]

Critical Analysis

Taxation should not act as an impediment to economic growth or activity. Therefore any action on BEPS should consider the impact on the broader business environment to ensure that it can be coordinated and implemented effectively.

Compliance

The overarching aim of Australian action on BEPS is to increase the compliance of multinational firms with both the letter and the spirit of the law. The ATO recognises that “uncompetitive tax arrangements increase the incentive for multinational enterprises to seek tax avoidance opportunities.”[58] With regard to that view, the ability of Australia to be internationally competitive will impact future revenue through the incentive that competitiveness will provided to firms to be non-compliant. Historically, as outlined above, Australia has enjoyed a high level of compliance from both corporate and individual tax payers.

In a system such as Australia’s that is based on voluntary compliance it is important for multinational corporations to buy in to any action taken. The Australian government is therefore currently seeking to work with impacted corporations to develop a voluntary code of conduct in relation to the disclosure of tax information.[59]This sort of action demonstrates the important role that multinationals themselves have in targeting the BEPS issue.

Also as outlined above, in response to the BEPS issue Australia has significantly strengthened its already robust compliance regime with strict anti-avoidance provisions (Part IVA of the ITAA 1936) and transfer pricing rules (Division 815 ITAA 1997). Through these legislative provisions, the ATO has been able, and will continue to be able to, ensure compliance. However if through other unilateral actions the Australian taxation position becomes uncompetitive within the international context compliance within the self-assessment system will become increasingly troublesome as the incentives encouraging multinationals not to be compliance increases.

Double Taxation

Double taxation has long been identified as an issue impacting business efficiency:

“Double taxation, which affects mainly undertakings and persons who exercise their trade or profession in several countries, or derive their income from countries other than the one in which they reside, imposes on such taxpayers burdens which, in many cases, seem truly excessive, if not intolerable. It tends to discourage initiative, and thus constitutes a serious obstacle to the development of international relations and world production.
At the same time, any excessive taxation, by its very burden, brings in its train tax evasion, the nature and grave consequences of which have been emphasised on earlier occasions: the suppression of double taxation is therefore closely connected with the measures for the systematic prevention or checking of such evasion.”[60]

The above statement from the League of Nations, made in 1927, highlights the significance issues that may arise from double taxation.[61] Therefore primary aim of the OECD is to facilitate efficient trade, and therefore preventing instances of double taxation will always be of significant concern for the OECD.[62]

Historically tax treaties have been in place to provide for fair, certain and effective tax treatment of cross-border transactions in order to encourage international economic activity. [63] Action Item 15 of the BEPS Project is the development by the OECD of a multilateral instrument to modify existing bilateral tax treaties, to prevent tax treaty abuse which results in instances of double non taxation or artificially low taxation in a synchronised and efficient manner.

Given the impact outlined above of uncompetitive situations, such as double taxation, on compliance it is essential that countries act multilaterally with the guidance of the OECD on the BEPS issue to ensure that instances of double-taxation are not simply replaced with instances of non-taxation.

Conclusion

Tax is an important source of revenue for governments, as without taxation governments have no ability to provide resources for socio-economic development. On that basis there is a clear need for government to respond to the situation where multinational corporations are able to use complicated tax planning and structuring to reduce their total tax liability, as this in turn reduces the resources available to government.

The issue underpinning the need for action is that the taxation legal framework has failed to keep pace with changes in technology, and the broader business environment. [64]  As such businesses are able to exploit loopholes to reduce their tax liability and effective rate of taxation. Therefore, in an increasingly globalised society any action to BEPS must be multilateral to truly reflect the global nature of business and capital investment.

Unilateral action will not be as effective as a solution that is created largely because of the international integration of commerce through production networks and other economic activities, requires an international solution. As such, the most effective approach to the BEPS issue is for sovereign nations to provide support for the negotiations of the OECD Committee on Fiscal Affairs and follow the lead of the OECD when considering policies that can be implemented domestically.

Australia acting alone cannot implement a system to solve the global BEPS issue, a coordinated response from the OECD Committee on Fiscal Affairs, OECD and G20 member nations and multinational corporations is required to deliver a meaningful solution. There are benefits to waiting until everyone can act together.

Full Footnotes and Bibliography can be found here or by copying the following URL into your browser: http://bit.ly/madison-ure