LegiStorm

Summary:

Taxes collected by countries around the world can be reduced through various avoidance mechanisms that shift corporate profits out of higher-tax-rate jurisdictions into lower-tax-rate jurisdictions and through other mechanisms that reduce taxes on interest, dividends, and royalties. The Organization for Economic Cooperation and Development (OECD) has been engaged in a project to reduce such base erosion and profit shifting (BEPS) in which firms use tax-avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low- or notax locations. In October 2015, the OECD published its final list of 15 BEPS action items. The OECD framework was endorsed by the G-20 Finance Ministers in February 2016. All OECD and G-20 countries agreed to implement four minimum BEPS standards: 1. Action 5, countering harmful tax practices (mostly aimed at patent boxes); 2. Action 6, preventing treaty abuse (largely about arranging payments to flow through countries with treaties that reduce withholding taxes on dividends and other passive payments); 3. Action 13, country-by-country (CbC) reporting; and 4. Action 14, increasing the effectiveness of dispute resolution. These action items have led to limited changes to U.S. companies because of either a lack of relevance (no patent box regime exists in the United States) or existing practices, although CbC reporting requires additional information from U.S. multinationals. Although implementation of some items can be done through regulation, others would require legislation or treaty amendments, which must be approved by the Senate. Other than the four agreed-upon standards, the remaining proposals are not specific recommendations because there was no agreement among the countries. Action Item 1 contains an extensive discussion of the digital economy, but its proposals relate only to the value added tax (VAT), which the United States does not have. Action Items 2-4 and 7-10 relate to profit shifting by multinational firms via a variety of mechanisms, including locating interest deductions in high-tax countries or through transfer prices of the sales of goods and services between related corporations. The United States has generally adopted few changes, although present practices in many aspects already embody the standards. One instance in which U.S. rules appear at variance with OECD proposals are check-the-box rules, which create hybrid entities with, for example, interest deducted in one country but not taxed in another. The OECD standards for transfer prices stress that the allocation of income should reflect functions, assets, and risks that are controlled and assumed, rather than contractual arrangements. Cost-sharing arrangements commonly used in the United States, which allow foreign subsidiaries to provide financing for research in the United States in exchange for a share of profits, is also an area in which U.S. practice appears inconsistent with BEPS proposals. The Government Accountability Office (GAO), in a study of the transfer-pricing issues, while indicating that a move from contract to content would reduce profit shifting, argued that risk could not be transferred between related firms in the same way as between unrelated firms. The United States and other countries would benefit by gaining revenues from reductions in base erosion and profit shifting which, according to Action Item 11 on measuring and monitoring BEPS, costs between 4% and 10% of global corporate tax revenues. There have, however, been concerns that the United States risks losing some revenue and companies paying additional taxes if other countries inappropriately increase their taxation of U.S. firms, eventually generating foreign-tax credits that offset U.S. income tax. These effects might occur through changes in the definition of permanent establishment and through the use of CbC data to move to an effective formula-based approach to taxation, which could produce double taxation. At the same time, a uniform set of standards and reporting requirements may be beneficial, as many countries were proceeding to enact unilateral changes and reporting requirements prior to the OECD project. Concerns have also been expressed by firms regarding confidentiality and compliance costs of CbC reporting. The United States has opted for bilateral agreements to share CbC data in part to help ensure confidentiality