The Organization for Economic Co-operation and Development (OECD) introduced its long-awaited plan to stave off tax evasion at the G20 meeting of finance ministers last week. But several obstacles remain in the way of implementing the plan, which attempts to level the tax playing field globally.
The OECD notes that tax-base erosion and profit-shifting issues “may arise directly from the existence of loopholes, as well as gaps, frictions or mismatches in the interaction of countries’ domestic tax laws.” To help bridge those gaps, it came up with 15 action points. Those include addressing the challenges that a digital economy now presents for businesses, such as in collecting data and figuring out the jurisdiction in which value creation occurs. OECD also says the digital economy gives rise to an unparalleled reliance on intangible assets.
The group will also be looking at rules aimed at governing controlled foreign companies, or CFCs. The rules would discourage the shifting of income to other jurisdictions by not allowing a CFC’s earned income to be deferred. They would also govern how a firm deducts interest expense, which could give rise to a condition of double non-taxation in two countries that a firm may operate in. As the OECD noted in its report, “a company may use debt to finance the production of exempt or deferred income, thereby claiming a current deduction for interest expense while deferring or exempting the related income.”
The OECD also hopes to rein in “preferential regimes” in which particular types of income from intangibles and financial activities can get tax advantages that end up harming other tax bases. It notes that “existing domestic and international tax rules should be modified in order to more closely align the allocation of income with the economic activity that generates that income.”
So how is the proposal being received? Rocco Femia, tax attorney at Miller & Chevalier, a Washington, D.C.-based law firm, calls the plan ambitious. Recommendations in the plan such as the handling of variations in multiple tax treaties and the development of the OECD’s ability to legally implement changes “are unprecedented on this scale,” he said.
The G20 countries asked the OECD to develop the global tax plan, which is set to take place over a two-year timeframe. By many accounts, though, that may be hard to achieve.
Sandy Bhogal, head of tax at international law firm Mayer Brown, sees implementation problems ahead for multinationals. The OECD’s “aim of linking the revenues of multinational businesses to particular territories and requiring reporting on a multilateral basis will be extremely complex to agree and implement.”
And a lack of coordination among the countries could be a further hindrance. “Notwithstanding the fact that the G20 leaders are far from united on how to proceed, any global reforms will have to be brought in through changes between countries on a bilateral basis (as well as any global agreements) and also by amending existing domestic laws. This process will take a considerable amount of time, even with the cooperation of all the relevant parties,” he says.
Indeed, Greg Wiebe, global head of tax at KPMG, notes that bringing the proposal “to fruition within the 24-month timetable presents an enormous challenge.”
Especially for an organization which, like OECD, is not a regulatory organization. To be sure, most of its developed-country members, including the United States, have agreed to support the organization in its efforts. But some lesser developed nations, such as Brazil, are still far behind in adhering to the OECD’s already established guidance on tax evasion.
Even if only half of the current action plans ever get implemented, however, it still would be a dose of tough medicine for companies that currently shift profits abroad. That’s because the OECD is specifically targeting transfer pricing (the shifting of company profits to offshore subsidiaries for tax reasons). As multinationals switch profits to other jurisdictions, they often deprive either the host country or their own home country of its fair share of taxes for the goods and services sold. Transfer pricing has enabled corporations such as Google and Apple, for example, to achieve sizable tax breaks.
While in some cases transfer pricing effectively allocates the income of multinationals among taxing jurisdictions, “multinationals have been able to use and/or misapply those rules to separate income from the economic activities that produce that income and to shift it into low-tax environments,” according to the OECD.
To help arrest some of the inequities in the global tax system, the OECD is calling to change the definition of what a “permanent establishment” is in jurisdictions abroad. Too often, it says, multinationals “artificially fragment their operations among multiple group entities to qualify for the exceptions to PE (permanent establishment) status.” The exceptions have helped firms gain significant tax savings, since permanent establishments would be subject to higher taxes.
The OECD also plans to assure that transfer pricing outcomes are “in line” with value creation. That means that when a multinational corporation’s foreign subsidiary sells it a product, the profits from the sale should be taxable to the same extent the would be if the sale were made by an unrelated company. Specifically, the OECD plans to develop rules that ensure “profits associated with the transfer and use of intangibles are appropriately allocated in accordance with (rather than divorced from) value creation.”
Despite some natural corporate dislike for the proposal, Femia notes that “companies and trade groups would be well advised to engage constructively with national governments and the OECD.” He says it’s critical that an objective, balanced approach be taken on international tax policies.
For his part, Mayer Brown’s Bhogal adds that the OECD’s proposal could be a catalyst to “significant changes to the interaction of tax regimes on a global basis.”