There have been a few inquiries from people in the media looking at our (and others’) recent critiques of the OECD’s recently-released BEPS project proposals to tackle international corporate tax avoidance. One pertinent question is this: which schemes, specifically, won’t BEPS stop?
Prof. Sol Picciotto, a TJN Senior Adviser and co-ordinator of the BEPS Monitoring Group, a network of tax justice groups looking at the project, provided the following answer to this question from a French journalist.
There are several kinds of structure which the BEPS proposals would not deal with:
(i) separating activities which can be considered to add low value (e.g. manufacturing), from high value adding activities such as R&D, design, or central management, which can be located in countries which apply low tax especially on foreign profits. For example, Colgate-Palmolive some 10 years ago reorganised its European operations, so that it could treat its plant in France as a “contract manufacturer”, and centred its high value adding activities in Switzerland, where they benefit from tax advantages. Several countries are now now indeed competing to offer advantages to attract such high-value activities, e.g. the UK, whose government announced it would reduce corporate tax to 18%, and in 2012 changed the tax laws to give favourable treatment to foreign profits. The UK also introduced a “patent box” in 2012 with a 10% tax on profits from R&D producing patents, and many countries are introducing similar “innovation boxes”. The BEPS proposals ask only that after 5 years (by 2021) such tax concessions must comply with some complex rules, relating the R&D expenditures to the income produced. Each country will be free to apply those rules as they wish to companies, and checking whether national laws comply with these rules will be done only by other countries, in a secretive and voluntary procedure.
(ii) companies which supply services can quite easily pay no tax in countries where they deliver such services, if they do not need a fixed base for 6-12 months in that country for that service. This works even if the company does have a related entity in the country if that entity is engaged in a different business. For example, the Big Four accounting firms have affiliates all over the world, but their local offices usually do only low value work, mainly audit. The high value work, such as business or tax advice, can be done by staff mainly located elsewhere, who only make short visits to the country. The same applies to law firms, advertising, etc. However some countries, mainly developing countries such as India, apply a tax on the fee for such services, though not on the actual profit.
(iii) The BEPS proposals do not automatically resolve even some of the well known avoidance structures. In particular, “digitalised” companies such as Google could still reports profits on their sales of advertising and other digital products in a low-tax place, if they do not have an affiliate in the country which is directly involved with concluding the contracts with customers for the advertising etc. They can still have affiliates doing other functions, even related ones, such as customer support. This applies to a wide range of internet-based activities, such as video streaming, electronic book sales, etc. The report on BEPS Action 1 identifies 3 solutions countries can use to deal with these, though they are not OECD recommendations. Also, countries which may want to use these ideas may need to renegotiate their tax treaties to apply such solutions.
(iv) This uncertainty also applies to many other structures, even common ones, e.g. the ‘Dutch sandwich” IP-holdings, or the “cash box” financial structures. The BEPS outputs give tax authorities powers to attack them, but using complex rules which must be applied by doing a specific analysis of each corporate structure, and the “functions performed, assets used and risks assumed” of each affiliate. Tax authorities can adjust prices charged for the affiliates to each other to what may be considered a ‘normal’ price for the actual activities performed. But this requires skilled staff with enough time to do the analysis well enough to defeat the arguments of the tax advisers hired by companies to invent and defend these structures. Tax authorities everywhere are short of such skilled staff, even the US IRS had to hire outside consultants, paying $2m, to help with its audit of Microsoft. This is obviously especially difficult for small and developing countries.
More in due course.