Over the last few years, concerns have been repeatedly voiced about the effectiveness of the international tax system. Much of the debate has focused on the rules which deal with the allocation of income within multinational groups of companies. These concerns are illustrated by several recent high-profile disputes relating to the use of tax haven vehicles which involve companies such as Google, Starbucks, Amazon, and Apple.
In response to these concerns, the G20 and OECD initiated a massive and unprecedented global project designed to fix the perceived shortcomings in the rules for the international taxation of multinationals. This is referred to as the “BEPS” (Base Erosion and Profit Shifting) project. The bulk of the BEPS work on revamping the rules finished in late 2015. The output is currently being implemented across the globe, both in the domestic tax systems of individual states and in the tax treaties that deal with the interaction between those domestic tax systems.
A major part of this recent overhaul of international tax rules has concerned the rules dealing with the global allocation of income within multinational groups of companies. These rules are founded on the “arm’s length principle” (ALP) under which each group member is to be taxed as if it were a separate and independent entity, broadly required to deal with other related entities on the terms that third parties would have agreed to (hence, “arm’s length”).
The interpretation of the arm’s length principle has been controversial and has evolved continuously since its adoption in the 1920s. The immediate question now is whether these most recent reforms mean that we are on course to restore the integrity and effective operation of the ALP. Whilst the sponsors of the overhaul project, the G20 and OECD, might have little hesitation in proclaiming just that result, the reality is less straightforward. It is certainly true that some elements of the BEPS output represent a material advance. For example, tax authorities have always struggled with getting access to good quality and relevant information about the global activities of multinationals. A significant step in correcting this has been taken by the new BEPS transparency package, which involves a multi-pronged approach intended to ensure that a higher quality of information is provided by multinational groups to tax authorities. It is also true that the extensive new work dealing with intangibles (IP) should make it appreciably harder for multinational groups to magically shift their IP to tax haven jurisdictions, and claim that the significant profits associated with those intangibles belongs in those haven locations, even though the multinational groups involved may have little or no substantive presence in such jurisdictions.
Notwithstanding these successes, and the development and roll out of the revamped BEPS rules, major problems remain.
The goal of fixing the global income allocation rules […] within a matter of a few months was never going to be a realistic prospect.
First, some of the proposed fixes are likely to turn out as not being fixes at all. For example the new proposals on dealing with transactions that shift risks (and the financial rewards for bearing risk) among the members of a multinational corporate group seem to include certain conditions that would not be seen in agreements between unrelated parties, meaning they may well be contrary to the ALP standard itself.
A second set of problems is that some promised – and necessary – fixes have not materialized at all. The best example of this relates to the ability of multinationals to affect vast tax-driven capital shifts within the group. This was initially a high-profile target of the BEPS project, yet there have been no new rules directly confronting this issue in the output from the BEPS project.
Finally, the cost of the proposed cure is not negligible. The BEPS reform of the ALP rules has brought a tidal wave of complexity, and for many states – and taxpayers – it will be asking too much to ensure full compliance with all the new rules.
The chief lesson is that the goal of fixing the global income allocation rules (let alone the entire international tax system) within a matter of a few months was never going to be a realistic prospect. It is important that the realities of the situation are recognized. Going forward, obvious areas of difficulty still need to be pursued. It is also essential that some attention is given to the possibilities and options for longer-term strategic reform. The most damaging course now would be a politically-expedient posture that the BEPS project has been a complete success and the job is already done.
Featured image credit: ‘Photo’ by Anders Jildén. CCO Public Domain via Unsplash.