Canada: Base Erosion, Profit Shifting And Tightening Tax Noose On Multi-National Enterprises

It has been almost five years since the worst economic crisis struck the modern world. While there appears to be some modest improvement in the U.S. economy, many other parts of the world are still struggling or worse (for example, unemployment throughout Europe remains stubbornly high, China's decade of double digit growth has come to an end, Japan is still struggling after 20 years of virtually no growth and Mexico's recent economic improvements are in jeopardy because of current political uncertainty). What is clear to most governments is the almost desperate need for more tax revenues in order to deal with national problems.

These problems range from the reduction of debt, dealing with unemployment and related social problems and the repair of crumbling national infrastructures such as modes of transportation, roads, bridges, sewers and power systems. Compounding these problems is the fact we live in a digital environment where many products and services do not always fall within the tax system of one country or another. Consequently, numerous tax loopholes exist that permit corporate profits to go untaxed. Moreover, many of the international tax rules are antiquated and were initially designed to assist businesses by preventing double taxation. In more modern times however, multi-national enterprises ("MNEs") have found ways to circumvent tax rules to achieve double non-taxation.

Given this setting, it should come as no surprise that for the first time in recent years, there appears to be a concerted effort on the part of the G-20 nations to combat the problems of base erosion and profit shifting ("BEPS"). Simply put, with dwindling tax revenues, governments have to act to bring a halt to MNEs successfully managing to transfer their profits to low tax jurisdictions.

Some time ago, Finance Ministers of the G-20 nations asked for assistance from the international Organisation for Economic Co-operation and Development ("OECD"). The OECD was asked to design an action plan to combat BEPS.

On July 19-20, 2013, at the G-20 Finance Minister's meeting in Moscow, the OECD action plan was unveiled to both the G-20 Finance Ministers and the Central Bank Governors. This plan consists of 15 proposed actions to address BEPS ("OECD Action Plan").

OECD Action Plan

Commencing with the realization that the world has indeed changed and we are now living in a global digital economy, the OECD proposed the establishment of a dedicated task force to examine all aspects of the global digital economy. The task force will aim to identify the significant challenges posed by the digital economy in relation to the current application of international tax rules and develop detailed options to address these problems.

The second point of the OECD Action Plan calls for the neutralization of the effects (e.g., double non-taxation, double deduction, long-term deferral, etc.) of hybrid instruments and entities. Considered by some observers as the most challenging aspect of the action plan, this action may require changes to the OECD Model Tax Convention and domestic laws and substantial cooperation among countries. The third action calls for the strengthening of controlled foreign company rules by developing recommendations regarding the design of these rules to prevent the deductibility of excessive payments including interest and other financial payments. The fourth point of the OECD Action Plan calls for the development of best practices in the design of rules to limit base erosion through excessive interest deductions and other financial payments.

The fifth point in the OECD Action Plan is the recommendation of the revamping of the work on harmful tax practices with a priority on improving transparency and on requiring substantial activity for any preferential tax regime.

The sixth action is preventing treaty abuse. The plan proposes the development of model treaty provisions and recommendations to prevent the granting of treaty benefits in inappropriate circumstances. This action focuses upon the updating of the definition of permanent establishment in order to prevent abuses.

Point seven of the OECD Action plan is in line with the sixth action and proposes the development of changes to the definition of permanent establishment in order to prevent the artificial avoidance of permanent establishment status in relation to BEPS.

The OECD Action Plan, points 8 to 10, deals with transfer pricing issues. Specifically, these actions propose the development of rules to prevent BEPS by moving intangible assets such as intellectual property rights (e.g., patents, trademarks, etc.) to tax havens where there is virtually little or no associated business activity.

The eleventh point of the OECD Action Plan focuses upon the promotion of the development of methodologies to collect and analyze data on BEPS. The twelfth action is the development of recommendations regarding mandatory disclosure rules in respect of aggressive or abusive tax planning transactions, structures or arrangements. The thirteenth action proposes the development of rules regarding transfer pricing documentation in order to enhance transparency for tax administration. The fourteenth point in the OECD Action Plan is aimed at developing more effective mechanisms to resolve treaty related disputes under the Mutual Agreement Procedure ("MAP"). Finally, the fifteenth action is the proposal for the development of a multilateral instrument to enable participating governments to efficiently implement measures developed pursuant to the OECD Action Plan and amend bilateral tax treaties.

Future Course of Action

At the end of the summit, the final joint communiqué of the G-20 nations reflected a complete and unified endorsement of the OECD action plan. UK Chancellor George Osborne declared that: "This weekend's agreement at the G20 to a new global tax standard for fighting evasion and addressing avoidance is an important step towards a global tax system that is fair and fit for purpose for the modern economy. The next step is to take these action plans and agreements and convert them into concrete reality". (From Daniel Boffey, "G20 deal opens way for developing countries to hunt down unpaid tax", The Guardian, 21 July 2013).

Skeptics may conclude that the final communiqué reflects nothing more than a political response to several high profile international cases involving MNEs such as Google, Apple and Starbucks having minimal tax liabilities in jurisdictions where these companies had significant operations. In other words, there was a public outcry that MNEs were not paying their fair share of tax and the politicians had to act now.

The cliché: "the devil is in the detail" is apt in this case. The desire by the OECD to get widespread governmental agreement to combat BEPS over the next two years may be wishful thinking. First, there will be strong opposition from the business community. Both the US Council for International Business and the UK's CBI have warned that poorly structured remedial actions could adversely impact job creation, trade and innovation. Second, the OECD Action Plan is dependent upon various governments implementing measures and some governments may choose not to do so because of the benefits that flow from providing certain forms of "tax breaks" to MNEs.

On balance however, one would have to conclude that there is a greater effort on the part of the G-20 nations to crack down on tax treaty shopping and cross-border shifting of profits for tax purposes than at any other time in modern history. The desperation for tax revenues may be the fuel for political will and action. The current G-20 tax avoidance policy approach seems to suggest this likely future course of action.

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