An assessment of the G20/ OECD BEPS outcomes: Failing to reach its objectives
What’s the news?
The news, compared to the Base Erosion and Profit Shifting (BEPS) package that the OECD released last year is that:
What will happen after BEPS?
- We now see the complete picture of what BEPS will deliver, and it’s clear that BEPS will fail to reach the stated objective of ensuring that multinational corporations pay their taxes ‘where economic activities take place and value is created’. It will also fail to reach the objective of ensuring that developing countries benefit from the process.
- The failure of BEPS to deliver the necessary reforms will mean that problems such as those exposed in the LuxLeaks scandal and several other corporate tax scandals can continue to exist, even if the BEPS outcomes were to be implemented.
- The outcome of BEPS is increased complexity and a continued reliance on the much criticized ‘arm’s length principle’.
- Instead of abolishing the so-called patent boxes (or ‘innovation boxes’), the OECD has decided to develop weak and unclear guidelines for their use, and is thus legitimizing their use and adding further complexity to the international tax system.
- The OECD has failed to reach any agreement on how to use the profit split method, which was otherwise seen as an area where OECD BEPS could create some progress. The discussions will continue after BEPS.
- The outcome on country by country reporting was weakened even further in spring 2015.
The tax scandals are likely to continue
The LuxLeaks scandal unfolded when a number of secret tax rulings – also known as Sweetheart Deals – were leaked from Luxembourg. These secret rulings are negotiated between the tax administration and a multinational corporation (often represented by one of the big four accounting firms), and can provide the company with an up-front agreement on how the tax administration intends to apply the tax laws to the company. The fact that such rulings exist is strongly linked to the fact that the international tax laws are highly complex and full of loopholes, and that many countries have introduced different types of special tax arrangements for multinational corporations.
Whereas the OECD BEPS will not change the practice to use secret tax rulings, it will increase the complexity of the international tax system1
. The problems that were exposed in LuxLeaks therefore continue to exist and might even get worse after BEPS.Example: McDonald’s
The report ‘Unhappy Meal
’, which was released in early 2015, revealed how McDonald’s is using the so called ‘innovation box’ in Luxembourg to lower the company’s tax payments. BEPS failed to reach agreement on abolishing these ‘innovation boxes’ and instead issued a guarantee that the existing arrangements can be kept in place until 2021, and even created a window until June 2016 where new arrangements of the same sort can be set up. After June 2016, new arrangements should follow a set of complex guidelines adopted under BEPS, which will be implemented through voluntary guidelines and ‘policed’ by a secret discussion forum on harmful tax practices. This approach dates back to 1998, when the OECD first started working on harmful tax practices, and has proved to be deeply dysfunctional.
Whereas the countries defending ‘innovation boxes’ were few at the beginning of the BEPS process, more and more OECD countries are now announcing their intention to introduce this kind of arrangement.2The number of tax conflicts are likely to increase
OECD BEPS has increased the complexity of the global tax system and thus made it more difficult to define what the rules actually say. This situation will likely make it very difficult for tax administrations to tax multinational corporations, and there is a clear likelihood that tax administrations who attempt to challenge the transfer pricing arrangements of multinational corporations will face lawsuits. Example: Coca-Cola
When the U.S. Internal Revenue Service recently challenged the tax arrangements of Coca-Cola and concluded that the company owes $3.3 billion in extra tax, Cola-Cola announced that ‘we will vigorously defend our position
’ and made it clear that it expects to file a petition in the U.S. Tax Court to challenge the decision.
This is an example of the consequences of the complex global tax system. Rather than providing solutions, the OECD has started considering options for arbitration, something which risks undermining the ability of countries to apply their own tax laws even further.3The OECD countries will keep discussing
Issues such as harmful tax practices have been debated in the OECD since 1998, and it is clear that this will continue after BEPS. Several issues, including the discussion about profit split as well as the digital economy, remain issues of debate. Who will be impacted negatively by BEPS?
The failure of OECD BEPS to solve this problem will impact:
Myth buster - The reality of the OECD’s package on base erosion of profit shiftingMyth #1: OECD BEPS will end profit shifting and fix the global tax system
- Ordinary citizens, who have to compensate for the lost tax revenues from multinational corporations and finance the public services upon which we all rely, including the multinational corporations.
- Our national companies, including the small and medium enterprises, who don’t have access to all these lucrative tax tricks have to compete with multinational corporations that are not paying their taxes.
- The world’s poorest countries, which are left with a dysfunctional global tax system and will not be able to make multinational corporations pay a fair share of tax in their countries.
Legitimising harmful tax practices
At the beginning of the BEPS project, there was a hope that BEPS would lead to the end of the most controversial harmful tax practices, including the so called ‘innovation boxes’ or ‘patent boxes’. As late as a year ago, a few countries promoting this idea, including UK, Luxembourg and the Netherlands, seemed isolated
by a strong resistance from other countries, including Germany.
between the UK and Germany changed the situation, and the agreement
of the BEPS process is not the ban on patent boxes that many had hoped for. Instead, OECD BEPS has delivered a set of complicated guidelines with obvious loopholes to describe how patent boxes should be designed. This includes recommendations on a ‘Modified Nexus’ approach, which on the one hand requires that the corporation must show expenditures related to the kind of activity they are seeking tax incentives for, but on the other hand allows a 30% increase of the expenditures in certain cases. Thus the concept of ‘innovation boxes’ will be kept, but with an extra layer of complexity.
Equally worrying is that the guidelines allow countries to continue with the old type of regimes, without applying the new ‘modified nexus approach’, until June 2016, and these and all existing innovation box agreements will be allowed to continue business as usual until 2021. This caused tax advisors to issue the message ‘Patent Box still available
’, and it’s clear that the outcome leaves plenty of time for businesses to exploit the old loopholes while finding new options for profit shifting.
Finally, the compliance regime linked with harmful tax practices remains concerning. Since 1998, the OECD’s approach to these practices has been voluntary guidelines combined with secretive internal meetings between governments where possible instances of non-compliance are discussed behind closed doors. After more than 15 years, it has become very evident that this approach is not suited to combat harmful tax practices, and it is therefore under all critique that the OECD has decided to continue with this approach.
The international tax system has long suffered from a global race to the bottom among governments applying an ‘if you can’t beat them – join them’ solution to harmful tax practices. The ‘innovation box’ is no exemption, and a number of countries, including Ireland, Italy, Switzerland, Germany and the US are now considering introducing such arrangements. Wasted opportunities
In other areas, such as the rules on Controlled Foreign Corporations (CFC) and Profit Split, it was hoped that strong proposals could be developed which would allow new ways for governments to ensure that multinational corporations pay their fair share of taxes. Unfortunately, the CFC proposals ended with an extremely weak set of guidelines which will do little to help solve the problem, and the negotiations on Profit Split failed to reach any conclusion (discussions will continue after BEPS). Increasing the complexity of the international tax system
Over the last 50 years, the OECD has led the development of an extremely complex international tax system of complex tax rules. The OECD BEPS process has unfortunately accelerated this development.
Already last year, when the OECD released the first batch of BEPS outcomes, more than 500 pages of complex guidelines were added to the mix. With the final round of BEPS outcomes, this development continues.Maintaining the complex arm’s length principle
An important example of the complexity is the approach to transfer pricing, where OECD BEPS has insisted that tax authorities must treat the subsidiaries of multinational corporations as independent entities and assess their transfer pricing arrangements based on what the comparable price would have been if the transaction had been between two unrelated companies. However, such ‘comparables’ have proven extremely difficult and sometimes impossible to find. Furthermore, the OECD requires tax authorities to conduct complicated and ill-defined analysis of ‘facts and circumstances of functions, assets and risks’. The reality is that decisions on how to allocate the tax bases of multinational corporations are often a complex and secretive negotiation between the company and different tax authorities. Continuing the practice of secret tax rulings
The complex transfer pricing rules and growing use of special tax arrangements such as the ‘innovation boxes’ is what creates the space for tax administrations to issue secret tax rulings – also known as ‘Sweetheart Deals’ to multinational corporations. These rulings, which can be used to spell out how the tax administration intends to apply the complex rules in the case of the individual company, will remain an important component of the post-BEPS tax system, and the most recent data
from the European Commission shows a widespread use of such rulings, as well as a high demand from companies to get more rulings. OECD BEPS will not change this practice to keep all of these rulings secret to the public.Increasing conflicts
The complex and unclear rules will likely lead to an increase in conflicts between tax administrations and multinational corporations. In response to this, the business sector has demanded mandatory binding arbitration, which many OECD countries have agreed to. However, as India
has highlighted, there is a clear risk that such a process can undermine the ability of countries to apply their own laws and tax multinational corporations.
Regardless, the complex and unclear tax laws are likely to make it very difficult for tax administrations to tax multinational corporations, and there is a clear likelihood that tax administrations who attempt to challenge the transfer pricing arrangements of multinational corporations will face lawsuits, as has often been the case in the past. Myth #2: The OECD BEPS process didn’t exclude developing countries
from the G20 Finance Ministers and Central Bank Governors Meeting, 4-5 September 2015, Ankara, Turkey has created the impression that all developing countries will now be invited to participate in decision making on tax matters on an equal footing.
The reality is that now that the decisions on BEPS have been made, the OECD and G20 have called for all countries to follow the rules which have been decided, most likely through a ‘Global Forum’ approach. While all countries are thus expected to follow the rules ‘on an equal footing’, it doesn’t change the fact that more than 100 developing countries were excluded from the entire decision making process (see overview below).About the ‘Global Forum’ approach
The OECD has previously used a Global Forum to implement its decisions. This is for example what was used to implement ‘information exchange on request’. Developing countries that join are now only invited to follow the rules on an equal footing, but also at the risk of getting listed for being ‘non-compliant’ if they don’t. These OECD Global Forum lists are used by many countries to justify national blacklists of countries that don’t follow the OECD tax rules.
These types of setup can place developing countries in a situation where they are pushed to adopt rules that might not be in their favour. For example, in the existing Global Forum, one of the things developing countries can do to avoid blacklisting is to sign more tax treaties with other countries. This despite the fact that many have warned developing countries against signing tax treaties, even the IMF
, which has released a report underlining that tax treaties are very risky for developing countries and advises them to "sign treaties only with considerable caution". Overview of the involvement of developing countries in BEPS decision making
The G20 developing countries were invited on "an equal footing" from the beginning.
Furthermore, responding to criticism about the exclusion of developing countries, the OECD invited 14 additional developing countries
to BEPS meetings at the end of the project (but not on an equal footing). These countries were: Albania, Azerbaijan, Bangladesh, Croatia, Georgia, Jamaica, Kenya, Morocco, Nigeria, Peru, Philippines, Senegal, Tunisia and Vietnam.
More than 100 countries were never invited to the decision making meetings. They were invited to send comments to public hearings, participate in regional consultations, etc. (and so were civil society and business), but not to participate in decision making. Myth #3: OECD BEPS is a step forward for transparency
When the OECD released its first set of BEPS outputs in 2014, it announced that it would constitute “a major step forward in transparency
”. Transparency without transparency
Whereas most people would understand ‘transparency’ as meaning increased information to the public, the OECD has redefined the concept to mean ‘information to tax administrations’ – in reality some of the most confidential types of information we have in our societies. Thus, what OECD has really decided is that information about where multinational corporations do their business and where they pay (or do not pay) taxes4
shall remain confidential information5
. If this decision was implemented in the EU, it would in fact mean that the public would receive even less information than they have today, since the EU has already decided multinational banks must publish such information . Luckily, while the EU law is binding, the OECD recommendations are voluntary and can therefore not overturn the EU decision. Not all tax administrations will receive the information
Another sad reality is that even tax administrations will have a hard time getting this information. In May 2015, the OECD decided
that the country by country reports should be filed only in the jurisdiction of residence of the multinational corporation, instead of in all jurisdictions where the company has activity. Other tax administrations are supposed to receive the report through automatic information exchange.6
However, this process of automatic information exchange is expected to be cumbersome, slow and difficult, and furthermore, it is likely that some governments will refuse to exchange information with others. For example, Switzerland, which is the residence country of many multinational corporations, has previously indicated
that the country will have a selective approach to exchange of information and prioritize “countries with which there are close economic and political ties and which provide their taxpayers with sufficient scope for regularisation and which are considered to be important and promising in terms of their market potential for Switzerland's financial industry
A complex ‘secondary’ method of exchange is being developed, but will not change the fact that tax administrations will not have access to the information unless they comply with a number of confidentiality requirements. In reality, this means that in particular the poorest countries of the world will have great difficulties accessing this information. 85-90% of the world’s multinational corporations are not covered
The OECD also decided that all multinational companies with a turnover of less than € 750 million should be completely exempt from these reporting requirements. According to the OECD’s own estimates, this means excluding 85-90% of all the world’s multinational corporations.7Why is transparency important?
As the LuxLeaks scandal
revealed, the secret tax rulings issued by governments to multinational corporations provide companies with opportunities to lower their tax payments substantially, in some cases to less than 1%. However, since this information is confidential, the LuxLeaks scandal led to legal charges
against the whistleblower Antoine Deltour and one of the journalists who broke the story, Edouard Perrin. They both risk several years in jail.
Meanwhile, the little country by country information which has been released to the public has proven to contain important information. For example, the country by country report released by Barclay’s bank
in 2014 showed that although the bank had only 14 employees in Luxembourg, the bank generated £1.4 billion of profits there in 2013 – £100 million per employee. The country by country report released in 2015
also indicates that these reports might have a behavioural impact on multinational corporations, since Barclay’s bank had increased its number of employees in Luxembourg, lowered the amounts of profits generated there and increased its tax payments in the UK.
Myth #4 Developing countries have nothing to lose and everything to win from BEPS
A study by the IMF has concluded that developing countries currently seem to be losing more money due to BEPS (tax avoidance by multinational corporations) than the OECD countries.
Most developing countries will not be able to access the confidential country by country reports (because the reports will only be filed in the country where the headquarters of the multinational corporation is located and shared with other governments if they can comply with a number of requirements that developing countries are unable to fulfil). This can lead to a situation where tax administrations in OECD countries (mainly developed countries) have much better access to information about where multinational corporations pay taxes than their developing countries counterparts. Thereby, an incentive is created for the multinational corporation to shift a larger share of their profits to developed countries, where there is a risk that the tax administration will discover tax avoidance, at the expense of the developing countries that will not be able to discover the profit shifting.
The fact that the OECD has also decided to legitimise harmful tax practices such as the controversial patent boxes, which are now becoming more and more widespread among OECD countries, can also have very negative impacts on developing countries due to sustained or increased tax avoidance by multinational corporations.
Meanwhile, the OECD has failed to reach any real agreement on some of the measures that would have been important for developing countries, including the profit split method and strict limitations on interest deductions.
Myth #5 BEPS takes tools away from tax planners and gives tools to tax administrations around the world
The patent box regime, which the OECD has now legitimised, is clearly not a tool for tax administrations. As explained above, these structures are already today being abused by multinational corporations to avoid taxation.
The country by country reports are an important tool for tax administrations to detect tax avoidance. Unfortunately, due to the complex requirements for getting access to these reports they only be available to a select number of tax administrations, and noteworthy they will most likely not be available to tax administrations in the world’s poorest countries, who will not be able to comply with the requirements. Sadly, the reporting will also only cover 10-15% of the world’s multinational corporations (see above).
On a number of areas that would have been important to tax administrations, such as the profit split method, strict limitations on interest deductions, and efficient rules on controlled foreign corporations (CFC), the OECD has failed to reach real agreement on effective measures. The discussion on profit split ended without any conclusion at all, except for a promise to keep discussing. On interest deductions, the countries agreed to disagree and to try to converge over time, with an aim to potentially reaching an agreement in 2020. And the proposed CFC guidelines, which would have been useful if they would have provided guidance for tax administrations on how to tax multinational corporations based on the profits they hold in tax havens, with credits given for tax payments made abroad. Instead, the OECD proposal is so weak that it will not provide any guidance of this sort to tax administrations.
 See for example ‘Legitimizing harmful tax practices’ and ‘Maintaining the complex arm’s length principle’ below
 See below under ‘Legitimizing harmful tax practices’
 See below under ‘Increasing conflicts’
 This is the proposal often referred to as ’Country by Country reporting’
 See the EU’s 4th Capital Requirements Directive, article 89 (http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32013L0036&from=EN )
 See page 6 in the document ‘Action 13: Guidance on the Implementation of Transfer Pricing Documentation and Country-by-Country Reporting’ (OECD 2015) http://www.oecd.org/ctp/beps-action-13-guidance-implementation-tp-documentation-cbc-reporting.pdf
 See page 4 in the document ‘Action 13: Guidance on the Implementation of Transfer Pricing Documentation and Country-by-Country Reporting’ (OECD 2015) http://www.oecd.org/ctp/beps-action-13-guidance-implementation-tp-documentation-cbc-reporting.pdf
 IMF (2015). WP 15/118 Base Erosion, Profit Shifting and Developing countries. https://www.imf.org/external/pubs/ft/wp/2015/wp15118.pdf