BASE EROSION AND PROFIT SHIFTING (BEPS)

Planned Measures against Aggressive Tax Planning


By Olesya Kazantseva


[This 2015 Master’s thesis is translated abridged from the German on the Internet,  http://www.grin.com/de/e-book/310328/base-erosion-profit-shifting-beps-geplante-massnahmen-zur-bekaempfung.]


1. Introduction


In the last years, both public and academic interest in the tax planning strategies of international businesses has greatly increased. [1] Big businesses that successfully reduced their corporate tax burden by utilizing international tax differentials provoked this dissertation. US companies like Google, Apple and Starbucks pay less than 5% tax on their profits gained outside the US. [2] Businesses like Amazon recognized the “tax savings trend” and implemented tax-optimizing measures. [3] Their “aggressive” tax planning can be seen as “unethical” tax evasion. However this is by no means an illegal tax fraud amounting to violations of the law. The savings benefit the businesses.


A general definition of aggressive tax planning did not exist in the past. The new phenomenon has intensely negative consequences. An unethical tax optimization leads to massive profit shifts or profit reductions and resulting losses in tax revenue. [5] Many empirical discoveries on profit shifts by multinational businesses are already documented. For example, a study by Eggert and Winner shows that the tax payments of multinational businesses turn out lower than comparable national businesses. [6] In their meta-study, Hockemeyer and Overesch evaluate empirical studies of profit shifts by 25 international businesses. [7] Studies estimate the concrete extent of profit shifts and profit contractions. According to Murphy, the annual corporation tax shortfalls from tax avoidance or evasion in Britain amounted to 12 billion GBP. [8] In Germany, the German Institute for Economic Research carried out a similar investigation. In 2001, profit shifts and profit reductions already amounted to 100 billion euros. [9]


In the meantime, the problem of profit shifting and profit contraction has increased enormously. [10] The EU, the OECD and the G20 states oppose aggressive tax structures. [11] In July 2013, the OECD in its action plan named 15 measures against profit shifting and profit reduction (Base Erosion and Profit Shifting, BEPS). Since December 2012, the EU Commission also proposed different measures against tax avoidance by multinational businesses.


However, the proposed solutions were rather vague in some passages and did not fully consider the complexity of international taxation. [12] Thus, the question is raised whether and to what extent individual measures are workable and which show deficits. The goal is to analyze the possibilities of multinational businesses and critically judge the measures for fighting abuses.


First, a definition of international tax planning with its goals and instruments will be attempted. The problem fields in taxing multination al businesses will be identified. In the next step, the typical forms of aggressive international tax structures and the possibilities for combating these structures will be thematicized. OECD-, EU- and nation-state measures will be compared. The proposals will be analyzed as to their applicability. At the end, the central conclusions will be summarized and critically examined.


2. Tax Planning in the International Context


Increasing globalization of the markets as well as growing border-crossing business relations leads to changes in questions of business taxation. While a far-reaching freedom of capital transactions prevails nowadays, the national tax systems of individual countries have clear differences and need an international harmonization. [13] For multinational businesses, globalization is a challenge for tax planning because these businesses come under the tax sovereignty of other states. [14] For this reason, considering the operational tax planning in the international context becomes increasingly important. How business decisions are carried out is very relevant since every alternative can lead to different tax law consequences in international tax law. [15]


2.1 Goals and Instruments of International Tax Planning


The term tax planning is composed of two elements “taxes” and “planning.”… Tax payments can be regarded like material- and wage-costs as expense factors that must be borne and planned for the long-term. [17]… In this study, the terms “tax planning” [32] and aggressive tax structures are understood as exploiting inter-state possibilities in a way harmful to competition…


More and more businesses have cross-border activities. The goals and instruments of tax planning in the international environment should be defined on that background. When a business conducts international commercial activities, it is confronted with the tax law norms of other states and different interpretations of certain facts. A problem results that one and the same business transaction is liable for tax both at home and abroad. [35] Therefore, the core idea of international tax planning consists in avoiding double international taxation that can occur in border-crossing business activities. [36]


In addition, the different worldwide taxation principles lead international businesses to “lower their relative tax payments and uncouple from the existing tax rate.” [38] Since tax payments are considered negative components, another goal arises in the course of international tax planning – the relative minimization of the cash-value of the tax payment. [39]…


International tax planning has a broad palate of available instruments. The different instruments of international tax planning could be subdivided in three areas – planning the structure of groups, control of the assessment basis and avoidance of internal profit realization… Ultimately, a continuous monitoring of tax planning could help integrate tax chances in tax planning, minimize tax risks and improve the overall tax position of the business. [48]


2.2 Fields of Conflict in Border-Crossing Taxation


2.2.1 Poor Harmonization of Tax Systems


In the growing international linkage of the economy, many businesses have developed into an expanded system of mother- and subsidiary companies, holdings and financing partnerships so their border-crossing revenue streams can be taxation-objects for several states. International tax planning faces great challenges. Three regulations must be considered in the border-crossing reality – the domestic or source tax law, the foreign national tax law and the interstate agreements of the concerned countries. Tax law conditions are marked by a great diversity. [50] The poor harmonization of tax systems can prove to be problematic.


On principle, the border-crossing revenues of a multinational business are subject simultaneously to a country of residence and a source land principle. The amassed profits are taxed both by the country of residence (the land where the business has its headquarters) and by the source land (the land where the revenues originate). The revenues of a domestic business are subject to the unrestricted tax obligation, including foreign revenues. With their domestic revenues, foreign businesses are simultaneously subject to a limited tax obligation. [51]


However, double international taxation represents an undesired eventuality because all double taxation reduces international trade and the competitiveness of multinational businesses. Thus, states try to avoid double taxation in different ways. [52] Two standard methods are applied to avoid double taxation – the exemption method (the revenues taxed in the source land are exempt from the home country) and the enrichment method (the tax levied in the source land is credited to the required tax in the home country). [53] In addition, the deduction method and the generalization method are also used to avoid double taxation. [54]


The application of these methods should guarantee the competition-neutrality for international businesses without violating the tax law autonomy of individual countries. [55] That inconsistent nation al tax systems can lead to a double non-taxation or reduced taxation makes these procedures problematic. [56] Withdrawing the tax liability through measures for avoiding a double taxation entails the risk that some revenues will not be fiscally captured and thus could be completely ignored. [57]…


The arising double non-taxation or reduced taxation is a by-product of non-harmonized or uncoordinated tax systems in globalized markets [60] and should be removed. Whether and how far a stronger harmonization of national tax systems increases the effectiveness of international taxation is questionable since “every change in the norm structure of international tax law in favor of one state necessarily lowers revenues in at least one other state.” [61] An international standardization of tax regulations means that the national and regional peculiarities of national tax systems of individual countries will not be fully considered and their own tax policy possibilities like fiscal incentives cannot be used to the full extent. Finally, the adjustment measures could burden the international tax competition since every state wants to ensure its “fair” share in the total tax revenue. [62]


Despite many open questions on the current harmonization in international tax law, the adjustment of the tax systems is unavoidable… The basis of tax assessment of member states cannot be undermined by utilizing present system distinctions so tax revenues will not be cut in the future. [64]


2.2.2 International Tax Competition


The tax competition of the states accompanied by diverse tax planning strategies of international businesses is another vantage point under which the missing harmonization of tax systems should be considered. [65] States in international competition compete for workers and consumer spending and not only for capital. The competitive pressure for lowering the (effective) tax rates on business profits intensified in the last decades since the competitiveness of a country depends on the relation between the tax burden {66} and other location factors like infrastructure, education level and social and economic stability. [67] A strong downward trend can be shown for the collective tax rates of OECD countries. The average tax rate that was still 47.5% in 1986 has nearly been cut in half to 25.5%. [68]


On one hand, a “healthy” tax- and location competition is regarded as positive since the states must critically examine again and again the relation between their services and their tax burdens. [69] Tax competition enables businesses and well-to-do skilled workers to “vote with their feet” on the respective location. [70] In this sense, international tax competition can be seen as an effective political-economic instrument for improving the “price-service relation” of taxation. This should help states discover the tax system that corresponds best to their national preferences. [71]


On the other hand, an uncoordinated tax-cutting competition can cause a mutual race to the bottom and as a result can lead to inefficient low tax rates. Here the tax competition can give rise to negative consequences because the shortage of public goods then be comes greatly magnified to compensate for the ever-lower tax revenues. [72] Besides this political-economic perspective, mobile factors increasingly withdraw from fiscal burdens and thereby contribute to the erosion of national tax revenue and shift the tax burden to the immobile factors. [73]


The positive aspects of international tax competition are often emphasized. [74] On the other hand, an unfair tax competition is described as harmful and always to be avoided. Competition with unfair means is not consistently defined. Harmful tax competition includes the tax practices of tax havens and tax preference systems. The term “tax haven” describes a country or area where tax evasion is very attractive on account of the tax law regulations effective there. [75] Under tax preference systems, tax policy instruments and measures are subsumed in which foreign taxpayers are favored with reduced tax rates. [76] By granting considerable tax advantages, states hope to attract foreign investors or highly trained workers. [77]


In the past, an international consensus formed on whether tax competition should be supported or prevented in international tax planning. A harmful competition over favors should be prevented since “renouncing on `unfair’ and dangerous tax practices is an important precondition for functioning competition. That much is clear.” [78]


2.2.3 Insufficient Taxation of Business Profits


The combination of two fields of conflict in international tax planning – the inconsistent organization of tax systems and the tax competition of the states – leads to multination al corporations creating legal systems for profit reduction and profit shifting. Multinational businesses are not taxed when they cross borders. [79] The widespread insufficient taxation of international businesses (so-called reduced taxation) is an important problem alongside the double non-taxation of business profits resulting from taxation gaps that imperil the system.


All tax reductions not in harmony with the principles of an even and competition-neutral business taxation come under the term “reduced international taxation.” [80] For example, reduced taxation occurs when a business with headquarters in a home country shifts its company headquarters to a low-tax country without renouncing on its economic interests at home. [81]


Agreement exists on the fundamental problematic although there is no complete agreement both in theory and in legal praxis on the definition of reduced taxation. [84] From a business management perspective, reduced taxation increases the realized profits of border-crossing investments because the net proceeds of investments rise by lowering the financial burden. Reduced international taxation represents an advantage in financing- and competition for international businesses while domestic businesses are disadvantaged. [85] From a political-economic standpoint, reduced taxation systems prove problematic because they distort competition. To protect its international market position, every state is interested in resident businesses in its sovereign territory being as successful as possible abroad. In the case of a reduced foreign taxation, the home country loses tax revenues and must also expect possible locational effects since investments at home with unchanged state spending are subject to a higher tax burden. [86]


These negative business management and political-economic effects show that insufficient taxation of business profits leads to harmful competition distortions and should be removed as much as possible.