Bringing the International Tax Rules into the 21st Century: The Progress Made So Far

Luisa Fernanda Ríos

The rapid change that the global financial system has experienced recently has outpaced tax systems around the world. Governments are facing increasing difficulties when trying to collect taxes where economic activity occurs, leading to a significant reduction in tax revenue. This widening gap makes it harder for governments to maintain growth-friendly tax systems and manage their expenses in a sustainable way to deliver essential services to their populations.

One of the G20’s goals is to strengthen international tax systems. Recently, several countries have taken important steps that have led towards stronger international cooperation to combat the two major sources of tax evasion in countries: tax base erosion and profit shifting (BEPS). The proposed solution considers better global exchange of tax information, and the progress in this area has been crucial for this purpose. The major objective is to modernize the international tax system in ways that strengthen public finances in these countries.

BEPS refers to the different tax planning strategies that exploit gaps and mismatches in tax rules to make corporate profits “disappear” for tax purposes, or to shift profits abroad to locations where there is little or no related business activity but the taxes are low or non-existent. As a result, the effective tax rate can be significantly decreased. This has been possible given our increasingly interconnected world. National tax laws have not been able to keep pace with multinational corporations, fluid capital, and the digital economy, leaving gaps that can be exploited by companies who avoid taxation in their home countries. This undermines the fairness and integrity of tax systems.

Although BEPS strategies are not illegal, they have created public outcry for a number of reasons. First, it distorts competition: businesses that operate cross-border may profit from BEPS opportunities, giving them a competitive advantage over enterprises that operate at the domestic level. Second, it may lead to inefficient allocation of resources by influencing investment decisions towards activities that have lower pre-tax rates of return, but higher after-tax returns. Third, it harms the ‘man on the street:’ when tax rules allow businesses to shift their income away from where it was produced, it erodes that country’s tax base and shifts the burden onto individual taxpayers. Additionally, in some countries the resulting lack of tax revenue leads to reduced public investment that could promote growth (Saint-Amans, 2013). That is why changes to international tax law may be a key pillar in supporting greater growth in the global economy.

Regulating BEPS is an issue of fairness: when individual and corporate taxpayers see multinational corporations legally avoiding income tax, it undermines voluntary compliance by all the taxpayers in a country, introducing even further tax evasion problems. These problems arise when taxpayers make, hold and manage investments through financial institutions outside of their country of residence. Consequently, vast amounts of money are kept offshore and go untaxed to the extent that taxpayers fail to comply with tax obligations in their home jurisdiction. Offshore tax evasion through tax havens is a serious problem for jurisdictions all over the world, including developing and developed countries. Countries therefore have a shared interest in maintaining the integrity of their tax systems, and they have acknowledged that cooperation between tax administrations will be critical in the fight against tax evasion. A key aspect of that cooperation is the exchange of information, particularly what the OECD refers to as automatic exchange of information. The automatic exchange of information considers the systematic and periodic transmission of “bulk” taxpayer information by the source country to the residence country concerning various categories of income, for example dividends, interest, royalties, salaries, and pensions. Then jurisdictions can provide timely information on non-compliance where tax has been evaded, either on an investment return or the underlying capital sum, even where tax administrations have had no previous indications of non-compliance. What this means is that foreign bank accounts and other foreign assets will no longer be secret because countries will share this information with each other on a regular basis (Saint-Amans, 2013).

Furthermore, the OECD working together with the G20 countries have developed a project known as the Action Plan on Base Erosion and Profit Shifting. This initiative looks at whether or not the current tax rules allow for the allocation of taxable profits to locations different from those where the actual business activity takes place, and what could be done to change this if they do. It is important to recognize that the point of crafting new international tax rules is not to punish the business community. Rather, its objective is to ‘even the playing field,’ and ensure predictability and fairness. One of the major objectives of the BEPS plan is to help countries foster economic growth by creating a reliable environment in which businesses can operate (Saint-Amans, 2013).

In addition, this plan recognizes the importance of addressing the borderless digital economy, and will develop a new set of standards to prevent double taxation or double non-taxation, which may arise when an item of income can be taxed by more than one jurisdiction.

This will require closer international co-operation, greater transparency, and stricter reporting requirements. Hence, to ensure that these actions can be implemented quickly, a multilateral instrument to amend bilateral tax treaties will be developed. Moreover, the development of tools that countries can use to shape fair, effective, and efficient tax systems will be required because BEPS strategies often rely on the interaction of countries’ different tax systems. As a result, these tools will have to address the gaps and frictions that arise from the interface of these systems.

The significance of this project is that the set of actions it has outlined has involved for the first time ever in tax matters non-OECD and G20 countries on an equal footing. The proposed actions are aimed to be delivered within the coming 18 to 24 months. Here is what has been accomplished to date:

  • April 2013 – The G20 Finance Ministers and Central Bank Governors endorsed automatic exchange as the expected new standard and asked the OECD to report on progress in developing a new multilateral standard for automatic exchange of information. Additionally, the Ministers of Finance of France, Germany, Italy, Spain and the UK announced their intention to exchange FATCA-type information amongst themselves in addition to exchanging information with the United States.
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  • June 2013 – The OECD presented a report to the G8 Summit on delivering a standardized and global model of automatic exchange. In addition, the European Commission adopted a legislative proposal to extend the scope of automatic exchange of information in its directive on administrative co-operation to items including dividends, capital gains, and account balances.
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  • July 2013 – The OECD launched its Action Plan on Base Erosion and Profit Shifting (BEPS), identifying 15 specific actions (see Appendix for a summary of these actions) required in order to equip governments with the domestic and international instruments to create a truly global standard model of automatic exchange of information. Furthermore, 17 countries including the Netherlands, Poland, Norway, Mexico, and Australia, among others, announced their intention to exchange FATCA-type information amongst themselves.
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  • September 2013 – The G20 Leaders fully endorsed the OECD proposal for a global model of automatic exchange and invited the OECD to work with G20 countries to present a new single standard for automatic exchange of information in time for the February 2014 meeting of the G20 Finance Ministers and Central Bank Governors.
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  • July 2014 – The OECD released the Standard for Automatic Exchange of Financial Account Information that calls on jurisdictions to obtain information from their financial institutions and automatically exchange that information with other jurisdictions on an annual basis. It sets out the financial account information to be exchanged, the financial institutions that need to report, the different types of accounts and taxpayers covered, as well as common due diligence procedures to be followed by financial institutions.
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    Even though much has been accomplished, global governance requires countries to continue to collaborate on tax matters, given that taxation is at the core of countries’ sovereignty. The biggest triumph so far has been the fact that sovereign states are now sufficiently taking into account the effect of other countries’ rules when designing their domestic tax rules. Through international, consensus-driven action, countries have stopped taking unilateral steps to further protect their tax bases. This should set the foundations to prevent tax chaos for the global business community in the future. The OECD in conjunction with the G20 have been able to create a unique forum for international cooperation and dialogue, that is, they have been able to work with governments around the world to bring the international tax rules into the 21st century. The time is ripe for the business community and governments to work together to achieve a fairer, more effective and more efficient international tax system that provides a “win” for everyone.

     

    Appendix

    Table. Action Plan on Base Erosion and Profit Shifting (specific actions)

    1. Address the tax challenges of the digital economy Identify the main difficulties that the digital economy poses for the application of existing international tax rules and develop detailed options to address these difficulties, considering both direct and indirect taxation.
    2. Neutralize the effects of hybrid mismatch arrangements Develop model treaty provisions and recommendations for the design of domestic rules to neutralize the effect of hybrid instruments and hybrid entities (e.g., double non-taxation, double deduction, and long-term deferral).
    3. Strengthen CFC rules Develop recommendations regarding the design of CFC rules.
    4. Limit base erosion via interest deductions and other financial payments Develop recommendations regarding best practices in the design of rules to prevent base erosion through the use of interest expense.
    5. Counter harmful tax practices more effectively, taking into account transparency and substance Revamp the work on harmful tax practices with a priority on improving transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, and on requiring “substantial activity” for any preferential regime.
    6. Prevent treaty abuse Develop model treaty provisions recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances.
    7.Prevent the artificial avoidance of Permanent Establishment (PE) status Develop changes to the definition of PE to prevent the artificial avoidance of PE status in relation to BEPS.
    8. Assure that transfer pricing outcomes are in line with value creation/intangibles Develop rules to prevent BEPS by moving intangibles among group members.
    9.Assure that transfer pricing outcomes are in line with value creation/risks and capital Develop rules to prevent BEPS by transferring risks among, or allocating excessive capital to, group members including adopting rules to prevent inappropriate returns from accruing to entities solely on the basis of provision of capital or contractual assumption of risks.
    10. Assure that transfer pricing outcomes are in line with value creation Develop rules to prevent BEPS by engaging in transactions that would not, or would occur only very rarely between third parties, clarifying the application of transfer pricing methods in global value chains, and protecting against base eroding payments such as management fees and head office expenses.
    11. Establish methodologies to collect and analyze data on BEPS and the actions to address it Develop recommendations on the indicators of the scale and economic impact of BEPS and ensure tools are available to assess effectiveness and impact of measures to address BEPS.
    12.Require taxpayers to disclose their aggressive tax planning arrangements Develop recommendations regarding the design of mandatory disclosure rules for aggressive or abusive transactions, arrangements, or structures.
    13. Re-examine transfer pricing documentation Develop rules regarding transfer pricing documentation to enhance transparency, including a requirement that multinational entities provide all “relevant governments” with information on global allocation of income, economic activity, and taxes paid among countries in accordance with a common template.
    14. Make dispute resolution mechanisms more effective Develop solutions to address obstacles that prevent countries from solving treaty-related disputes under Mutual Agreement
    Procedures (MAP).
    15. Develop a multilateral instrument Analyze tax and public international law issues related to the development of a multilateral instrument to enable jurisdictions that wish to do so to implement BEPS measures and amend existing bilateral treaties.

    Source: KPMG

     

    References

    Deloitte. (2011). FATCA Frequently Asked Questions. Retrieved from Deloitte: http://www.deloitte.com/assets/dcom- unitedstates/local%20assets/documents/tax/us_tax_fatca_faqs_061711.pdf

    KPMG. (2013). Summary OECD BEPS Action Plan. Retrieved from KPMG International: https://www.kpmg.com/ZA/en/IssuesAndInsights/ArticlesPublications/Tax-and-Legal- Publications/Documents/OECD%20BEPS%20Action%20Plan.pdf

    OECD . (2014). Action Plan on Base Erosion and Profit Shifting. Retrieved from OECD Home: http://www.oecd.org/ctp/BEPSActionPlan.pdf

    OECD. (2014). About BEPS. Retrieved from OECD Home: http://www.oecd.org/tax/beps- about.htm#deliverables

    OECD. (2014). Automatic Exchange of Information. Retrieved from OECD Home: http://www.oecd.org/ctp/exchange-of-tax-information/automaticexchange.htm

    OECD. (2014). Standard for Automatic Exchange of Financial Account Information.
    Retrieved from OECD Home: http://www.oecd.org/ctp/exchange-of-tax- information/automatic-exchange-financial-account-information-common-reporting- standard.pdf

    Saint-Amans, P. (2013, September 17). Bringing International Tax Rules Into the 21st Century. Retrieved from The World Post: http://www.huffingtonpost.com/pascal- saintamans/international-tax-rules_b_3943150.html

    RSM . (2014). Border Crossing.Retrieved from RSM: http://www.rsmbettyanddickson.co.za/images/publications/Border%20Crossing_Aug2014.pdf

     
     

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