Tax Reform and the OECD BEPS Project

OECD BEPS project is a global tax reform initiative that’s revising the fundamentals of the international tax rules. The goal is to reduce base erosion and profit shifting (BEPS) across the world. Over 100 countries are participating in the project, making it the biggest global tax reform initiative in history.

For the past several months, Americans have been focused on domestic tax reform. But there’s a global tax reform initiative that’s revising the fundamentals of the international tax rules through treaties and other measures that shouldn’t be ignored.

The initiative is called the OECD BEPS project and the goal is to reduce base erosion and profit shifting (BEPS) across the world. Over 100 countries and jurisdictions are participating in the project, making it the biggest global tax reform initiative in history.

The Organization for Economic Cooperation and Development (OECD) is comprised of 35 Member countries.  Member countries include the United States and Japan, as well as emerging countries like Mexico, Chile, and Turkey.

According to the OECD website, BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity.

The BEPS Action Plan was published in the summer of 2013. It identifies 15 areas of focus–including the digital economy, hybrid mismatch arrangements, treaty abuse, and transfer pricing.

Once the new measures become applicable, the expectation is that profits will be reported where the economic activities that generate them are carried out instead of where they appear on paper.

According to the OECD, the current overall tax loss due to BEPS is between 4% and 10% of global corporate income tax revenues. This translates to at least $100 to $240 billion USD annually.

A report published by the Joint Committee on Taxation shows that the average tax rate for U.S. Controlled Foreign Corporations declined from 26.0 percent in 1998 to 10.6 percent in 2012.  See “Background, Summary, and Implications of the OECD/G20 Base Erosion and Profit Shifting Project” published November 30, 2015 at www.jct.gov.

The JCT report notes that the decline in the average tax rate can be linked to the general decline in statutory corporate tax rates around the world and a larger portion of earnings being reported in low-tax jurisdictions. This could be attributable to BEPS and/or general growth in overseas markets.

The OECD has acknowledged that limitations on existing data sources hinder the analysis of BEPS (e.g., non-tax return information). As a result, the organization has called for new data to be collected in an internationally consistent format.

The OECD has identified six indicators to analyze the impact of BEPS over time.

  1. Concentration of foreign direct investment
  2. High profit rates of low-taxed affiliates of MNEs
  3. High profit rates of MNE affiliates in lower-tax locations
  4. Effective tax rates of large MNE affiliates relative to similar non-MNE entities
  5. Concentration of royalty receipts relative to research and development spending
  6. Interest expense to income ratios of MNE affiliates in countries with above-average tax rates

Over the past couple years, both Congress and the Treasury Department have introduced proposals tied to the OECD BEPS project.

In 2016, the Treasury Department also published a new Model Tax Treaty. The Model Treaty incorporates several recommendations from the OECD BEPS project, including a more robust base erosion test in order to qualify for treaty benefits.

The new Model Treaty also includes rules that protect against contract splitting abuses tied to the 12-month permanent establishment threshold and a 12-month ownership requirement for the 5% withholding rate on direct dividends.

These policy changes demonstrate that the United States is committed to reducing base erosion and profit shifting. It also signals that fundamental changes to the international tax rules will remain the focus of policymakers and politicians well beyond domestic tax reform measures.

ABOUT THE AUTHOR

Tara Fisher is an independent tax consultant. She has been practicing international tax for over 15 years. Her professional background includes working for the U.S. Congress Joint Committee on Taxation, the national tax practice of Pricewaterhouse Coopers, and the University of Pittsburgh. Tara is a Certified Public Accountant and holds a Master of Science in Accounting from the University of Virginia.

 

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