Essentially, base erosion and profit shifting, or BEPS, occurs when multinationals exploit tax legislative gaps between countries to reduce or eliminate the taxation of profits.
As part of their plan, the OECD and G20 finalized 15 BEPS Actions in late 2015. The actions are intended to “equip governments with domestic and international rules and instruments to address tax avoidance, ensuring that profits are taxed where economic activities generating the profits are performed and where value is created.”
Since the release of the BEPS Actions, the pace of change as regards tax rules worldwide has been dizzying. In the last five years, over 135 countries — known as the OECD/G20 Inclusive Framework — have worked together to implement BEPS recommendations. According to the OECD website: more than 250 tax regimes that facilitated base erosion and profit shifting have been changed or eliminated; more than 85 countries have signed the multilateral BEPs convention (which closes tax loopholes in thousands of tax treaties); and more than 2,000 bilateral relationships for country-by-country exchanges are now in place.
The bottom line is that corporate groups with international supply chains and operations are increasingly facing myriad new and changing domestic and international tax rules. The most significant changes include recent and ongoing proposals to fundamentally reshape the taxation of the digital economy. It’s critical for multinationals to understand that these proposals will go way beyond the tech sector and affect virtually all multinational businesses.
As we enter a new decade, and more and more countries implement BEPS recommendations, the global tax landscape will continue to change. In this period of uncertainty, the boards, CFOs and indeed all corporate stakeholders of multinationals must prioritize achieving tax compliance while remaining tax efficient.
Some new and upcoming country-specific rules on digital taxation
While the OECD’s BEPS recommendations have provided the catalyst for many countries to revisit their own tax rules, not all OECD guidelines are adopted consistently across all jurisdictions. Many countries have continued to act unilaterally to protect their tax bases and make changes to account for the evolving global, digitalised economy. Here’s a list of examples of some unique, country-specific tax rules that primarily address digital commerce:
- The U.S. base erosion and anti-abuse tax (BEAT). This new minimum corporate income tax was introduced under the Tax Cuts and Jobs Act (TCJA) of 2017. It looks to curtail large multinationals with a U.S. presence from shifting profits to lower tax jurisdictions.
- Australia's diverted profits tax (Australia DPT). Widely referred to as the “Google tax,” Australia’s DPT has been in effect since 2017 and looks to prevent multinationals from shifting profits made in Australia to other jurisdictions to avoid paying tax. It imposes a 40 percent tax rate on diverted profits.
- The UK's diverted profits tax (UK DPT). Introduced in 2015 and amended in 2018, the UK’s DPT — like Australia’s — targets large groups (typically multinational enterprises) that shift profits outside the UK. The specifics of the two DPTs, however — including rates and penalties — are distinct.
- France's digital services tax (France DST). France unilaterally implemented its DST last July, retroactive to 1 January 2019. It imposes a 3 percent tax on revenue generated from digital services, and applies to companies with annual revenues of more than 750 million euros worldwide and more than 25 million euros in France.
- The UK's digital services tax (UK DST). The UK’s DST will go into effect in April 2020. It will impose “a new 2 percent tax on the revenues of search engines, social media platforms and online marketplaces which derive value from UK users.”
All of the above tax rules look to combat base erosion and profit shifting. It’s critical to understand, however, that they are being implemented at different times, with different levels of application, by different countries.
BEPS Pillar Two: The "GloBE" proposal
Many tax authorities, experts and even business leaders have recognized that our current patchwork system of country-specific tax laws that allows for base erosion and profit shifting in a global, digital economy is not sustainable. In language outlining the policy objective of its new digital services tax, UK tax authorities speak to the need for a unified approach, acknowledging that the UK’s DST is a stopgap measure: “The [UK] government still believes the most sustainable long-term solution to the tax challenges arising from digitalisation is reform of the international corporate tax rules and strongly supports G7, G20 and OECD discussions on the different proposals for reform. The government is committed to dis-applying the digital services tax once an appropriate international solution is in place.”
The OECD’s ongoing BEPS work informs and reflects this widely accepted belief. As we discussed in a previous post, the OECD’s current work plan on the taxation of the digital economy is divided into two pillars:
- Pillar One. This examines the allocation of taxation rights and profit allocation between countries, and the associated tax nexus.
- Pillar Two. This is referred to as the Global Anti-Base Erosion Proposal, or “GloBE.” It proposes to provide countries with a right to “tax back” when other countries have not imposed a minimum level of tax or not exercised their taxation rights.
In November 2019, the OECD issued a public consultation document on Pillar Two. As the OECD recognizes, notwithstanding its wider BEPS recommendations, the GloBE proposal “seeks to comprehensively address remaining BEPS challenges by ensuring that the profits of internationally operating businesses are subject to a minimum rate of tax.” The consultation document emphasizes that the GloBE proposal, like Pillar One, addresses challenges posed by the digital economy, but “goes even further and addresses these challenges more broadly.”
The GloBE proposal consists of four rules:
- An income inclusion rule. This effectively taxes the income of a foreign branch or controlled entity if that income was not subject to a minimum rate of tax.
- An undertaxed payments rule. This denies a tax deduction (or imposition of a de facto sourced-based withholding tax) for a payment to a related party if the associated income was not subject to a minimum rate of tax.
- A switch-over rule. This would be introduced to treaties that would permit a residence jurisdiction to switch from a tax exemption to a tax credit method, when profits attributable to a permanent establishment are not subject to a minimum rate of tax.
- A subect-to-tax rule. This would complement the undertaxed payments rule by subjecting a payment to source-based taxation and adjusting eligibility for treaty benefits on certain items of income when the income is not subject to a minimum rate of tax.
As the consultation document points out, Pillar Two “represents a substantial change to the international tax architecture.” Indeed, while there is consensus that the international tax framework needs to be updated to address current economic realities like the digital economy, getting countries to give up any element of their sovereign right to levy tax (which also serves as a driver of inward investment) remains problematic. For example, the European Union’s Common Consolidated Corporate Tax Base (CCCTB) — originally proposed in 2011 and revised and re-proposed in 2016 — calls for a single set of rules governing how EU corporations calculate and apportion tax across the EU. Yet it has encountered resistance, especially from smaller EU member states that may lose tax revenues if the proposal is put into practice.
The task of implementing the GloBE proposal is even more daunting than implementing the CCCTB, since the GloBE proposal engages all 36 OECD members, the G20 and 70 percent of the remaining countries around the world. And, of course, Pillar Two is only a part of a much broader rewrite of the international tax “rulebook.” As this collective effort is evolving, individual countries continuously shore up their own tax bases on a unilateral basis, while others continue to use “race-to-the-bottom” tax measures to attract inward investment.
Corporate taxation is, in short, undergoing profound changes. More than ever, multinational enterprises must monitor and remain abreast of country-specific tax changes and new tax requirements. They should also regularly review their corporate legal structures and internal and third-party supply chains against these implemented and proposed unilateral and global tax law revisions.
Finally, this process should not be seen as negative. Rather, multinationals should be mindful of the potential for operational efficiencies and tax opportunities (or tax-leakage reduction) that may be identified when performing these reviews. Even if tax savings aren’t immediately forthcoming, the reviews will at the least provide the boards, C-suites and stakeholders of multinationals with a higher level of tax assurance. This will in turn drive up the value of the multinational group by lowering tax-related risk, one of the main business expenditure outflows.
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