Fundamental of Base Erosion and Profit Shifting
Fundamental of Base Erosion and Profit Shifting
FUNDAMENTALS OF BASE EROSION AND PROFIT SHIFTING
Base Erosion and Profit Shifting (BEPS) has emerged as one of the most important challenges for governments all over the world. The Liberalisation, Privatisation and Globalisation(LPG) has resulted;
- Free movement of Capital and Labour;
- Shift of manufacturing base from high cost to lower cost locations;
- Gradual removal of the trade barriers, and
- Rise of digital economy.
The digital economy has boosted trade and foreign investments in many countries, thereby supporting generation of employment, growth, innovation and removal of poverty. The LPG also helps in creation of multinational organisations all over the world.
There in past the fear of double taxation restricts multinational companies to spread outside their country. It was recognised that the interaction of the foreign companies with domestic tax system in host country might lead to double taxation, which might result in adverse impacts on growth and global prosperity.
The governments to eliminate double taxation started entering into Double Tax Avoiding Treaties. The bilateral treaties are effective in preventing double taxation, but they often fail to prevent double non-taxation that results from interactions among more than two countries. This led increased a number of sophisticated tax planners, who are expert in finding loopholes in these Double Tax Avoidance Agreements and helping MNCs to do aggressive treaty shopping and go for Base Erosion and Profit Shifting to reduce their Tax Burden.
Base erosion and profit shifting (BEPS) refers to corporate tax planning strategies used by multinationals to "shift" profits from higher–tax jurisdictions to lower–tax jurisdictions, thus "eroding" the "tax–base" of the higher–tax jurisdictions.
The Organization for Economic Co-operation and Development (OECD) define BEPS strategies as also: "exploiting gaps and mismatches in tax rules";
The BEPS is a term used to described “ tax planning strategies” that rely on mismatches and gaps that exist between the tax rules of different jurisdictions , to minimise the corporation tax that is payable overall, by either making tax profits “ disappear” or shift profits to low tax operations where their little or no genuine activity.
BEPS generally refers to those instances, where gaps between different taxation regimes leads to tax avoidance and loss to the concerned governments. The MNCs by taking advantage of gaps in taxation rules and regulations of two countries, shift their profit from higher taxation state to lower taxation state, causing tax loss to former. The BEPS refersto;
- Due to gap in application of the bilateral tax treaties, cross border activities may go untaxed in any of two countries;
- No or low tax is paid by shifting profits to low jurisdictions and shifting losses and high expenditure to high tax jurisdictions.
In generally BEPS activities are not illegal because these MNCs are exploiting the taxation gaps between two countries to avoid payment of tax in higher taxation country to lower taxation country.
The base erosion constitutes a serious risk to tax sovereignty, tax fairness and tax revenues for both developed and developing countries alike.
The Double Taxation Avoidance Agreement between two countries will be made on assumption that the same transaction should not be taxed in both countries. But due to tax planning and gaps available the MNCs plan their transaction in such a way that their transaction does not taxed any where in two countries.
TO UNDERSTAND THE PROCESS LETS’ CONSIDER TWO CASES;
- APPLE INC. -the US base and world leader MNE, used a verity of offshore structures, arrangements and transactions to shift billions of dollars of profit away from US and into Ireland, where Apple has negotiated a Special Corporate Tax less than 2%. On of Apple’s unusual tactics has been to establish and direct substantial funds to offshore entities in Ireland, while claiming that they are not residents of any jurisdiction. Apple has also transferred its economic rights to its intellectual property through cost sharing agreements with its own offshore affiliates, and thereby able to shift billions of dollars to low tax jurisdiction to avoid taxation in US.
- GOOGLE INC.- carried out aggressively expansion of its operations in 2011, its revenue reached nearly $38 billion and its profit $10 billion. Effective tax rate was 2.4% in that year, while the statutory tax rate in USE was 35%. The IT giant resorted to setting up of a subsidiary Ireland Holdings Limited and shifted intellectual property rights to Ireland through cost sharing agreement, since agreeable tax rate was 12.5% and there was an availability of appropriate personnel. IHL acquired rights to exploit Google IP’s rights for Europe, Middle East and Africa through CSA. The Google has also entered into APA through which the profits generated by exploiting of IP rights in these countries were taxed in Ireland and not in US.
In January 2017 OECD report estimates that BEPS tools are responsible for tax losses of circa $100–240 billion per annum. In June 2018 report by tax academic Gabriel Zucman , estimated that the figure is closer to $200 billion per annum.The Tax Justice Network estimated that profits of $660 billion were "shifted" in 2015 (due to Apple's Q1 2015 leprechaun economics restructuring, the largest individual BEPS transaction in history. The effect of BEPS tools is most felt in developing economies, who are denied the tax revenues needed to build infrastructure.
Most BEPS activity is associated with industries with intellectual property ("IP"), namely Technology (e.g. Apple, Google, Microsoft, Oracle), and Life Sciences (e.g. Allergan, Medtronic, Pfizer and Merck & Co) .IP is described as the raw materials of tax avoidance, and IP–based BEPS tools are responsible for the largest global BEPS income flows.Corporate tax havens have some of the most advanced IP tax legislation in their statute books.
Most BEPS activity is also most associated with U.S. multinationals, and is attributed to the historical U.S. "worldwide" corporate taxation system. Pre the Tax Cuts and Jobs Act of 2017 ("TCJA"), the U.S. was one of only eight jurisdictions to operate a "worldwide" tax system.Most global jurisdictions operate a "territorial" corporate tax system with lower tax rates for foreign sourced income, thus avoiding the need to "shift" profits (i.e. IP can be charged directly from the home country at preferential rates and/or terms.
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