Base Erosion and Profit Shifting (BEPS)

3 key takeaways

• BEPS involves strategies that exploit gaps and mismatches in tax rules to reduce tax liability.
• It allows multinational companies to shift profits to low or no-tax locations, minimizing their overall tax burden.
• The OECD has developed a comprehensive plan to address BEPS and ensure fair taxation across borders.

What is Base Erosion and Profit Shifting (BEPS)?

Base Erosion and Profit Shifting (BEPS) describes practices used by multinational companies to artificially shift profits to low or no-tax jurisdictions. These strategies exploit differences in tax laws and loopholes to reduce the amount of taxes paid in high-tax countries. BEPS can lead to significant revenue losses for governments and create an uneven playing field for businesses.

Common BEPS strategies include transfer pricing manipulation, treaty shopping, and the use of hybrid mismatch arrangements. These methods allow companies to allocate profits to subsidiaries in low-tax jurisdictions while attributing expenses to subsidiaries in high-tax jurisdictions, thereby reducing taxable income in higher-tax countries.

How does BEPS work?

1. Transfer pricing manipulation: Multinational companies set prices for goods and services sold between their subsidiaries in different countries to shift profits to low-tax jurisdictions.
2. Treaty shopping: Companies take advantage of tax treaties between countries to minimize tax liability by routing income through countries with favorable tax treaties.
3. Hybrid mismatch arrangements: Companies exploit differences in the tax treatment of entities or instruments between two or more countries to achieve double non-taxation or double deductions.

OECD’s BEPS Action Plan

The Organization for Economic Co-operation and Development (OECD) has developed a comprehensive plan to address BEPS, known as the BEPS Action Plan. This plan includes 15 actions aimed at ensuring that profits are taxed where economic activities generating the profits are performed and where value is created. Key actions include:

1. Addressing tax challenges of the digital economy: Ensuring that digital businesses are taxed fairly.
2. Neutralizing the effects of hybrid mismatch arrangements: Preventing tax benefits from exploiting differences in tax treatment between countries.
3. Strengthening controlled foreign company (CFC) rules: Ensuring that income earned by foreign subsidiaries is appropriately taxed.
4. Limiting base erosion via interest deductions: Restricting excessive interest deductions that erode the tax base.
5. Countering harmful tax practices: Ensuring transparency and aligning taxation with value creation.
6. Preventing treaty abuse: Safeguarding against inappropriate use of tax treaties.
7. Ensuring transparency and substance: Requiring detailed reporting of profits and activities in different jurisdictions.
8. Re-examining transfer pricing documentation: Ensuring that transfer pricing reflects where value is created.
9. Facilitating dispute resolution: Improving mechanisms for resolving tax disputes between countries.

Benefits of addressing BEPS

• Fair taxation: Ensures that multinational companies pay their fair share of taxes in the countries where they operate.
• Revenue protection: Helps protect the tax base of high-tax countries and prevent revenue losses.
• Level playing field: Creates a more equitable business environment by reducing the advantages of tax avoidance strategies.

Real-world application

Example: A multinational technology company has subsidiaries in several countries. It uses transfer pricing to allocate significant profits to a subsidiary in a low-tax jurisdiction, while attributing substantial expenses to subsidiaries in high-tax jurisdictions. This reduces the company’s overall tax liability.

OECD’s BEPS Action Plan: Under the BEPS Action Plan, new transfer pricing rules and documentation requirements ensure that profits are reported and taxed where the actual economic activities occur. The company’s tax practices are scrutinized, and adjustments are made to reflect the true value creation, leading to fairer taxation.