The next time somebody asks you take part in a consumer survey or opinion poll, ask them how much they’re prepared to pay for your time and opinion. They’ll probably stop pestering you in case you talk to them for hours about the aliens who stole your chocolate cake. Working for nothing is such an accepted part of the modern economy that it’s the person who calls it into question who is labelled crazy. Millions of us toil away humbly for well-known companies without getting paid. Some airlines won’t even let you board unless you make your own ticket, or else they’ll charge you a fortune for printing it at check-in.
It’s obvious that by doing what a travel agent or airline employee used to, you’re saving the company money and helping to boost its profits. Some of your other contributions to corporate well-being aren’t so easy to define and measure though. If you upload a video, does the site add the same value if 10 people watch it or 1 million? And if the site uses your video to attract advertisers, is the ad money made in your country, the countries where the video is seen, the country where the computer storing it is kept, or none of these?
Increasingly, the last answer is the one favoured by multinationals, and that poses problems for taxation. Some businesses that are worth billions may pay practically no tax in the places where they operate and make profits. Not because they’re defrauding the system, but because tax systems simply haven’t kept up with how firms in the digital economy in particular add value and make profits, on intangible assets such as design and licensing for example, or even by exploiting your personal data.
Other firms also avoid paying what most citizens would consider “fair” taxes through “(tax) base erosion and profit shifting” or BEPS as the OECD calls it. As we discussed in this article, BEPS schemes themselves can be extremely complicated, but the basic idea is simple: shift profits across borders to take advantage of tax rates that are lower than in the country where the profit is made. Three popular mechanisms for doing this are hybrid mismatches, special purpose entities (SPE), and transfer pricing.
Hybrids try to have the same money or transaction treated differently (as debt or equity for instance) by different countries to avoid paying tax, and often feature dual residence – companies that are residents of two countries for tax purposes. An SPE is an entity with no or few employees, little or no physical presence in the host economy and whose assets and liabilities represent investments in or from other countries and whose core business consists of group financing or holding activities.
Transfer prices are the prices various parts of a company pay each other for goods or services. They are used to calculate how profits should be allocated among the different parts of the company in different countries, and are used to decide how much tax the MNE pays and to which tax administration. There is no simple method for calculating a transfer price and the lack of good “comparables” (similar operations carried out at market prices by unrelated entities) often results in profits being artificially shifted to no- or low-tax jurisdictions.
International tax rules are generally efficient in ensuring that companies are not subject to double taxation, but BEPS takes advantage of gaps in the rules to avoid paying tax completely, so-called “double non taxation” or to pay a sum across two or more countries that is less than what they would pay in a single country.
Opportunities for MNEs to pay less tax harm everybody. Governments lose revenue and may have to cut public services and increase taxes on everybody else. But businesses suffer too. Small businesses, businesses working mainly in one national market and new firms can’t compete with MNEs who shift profits across borders to avoid or reduce tax. And an MNE that doesn’t shift profits is at a disadvantage compared to its BEPSing rivals.
What can be done? Today, the OECD launched a 15-point Action Plan that will give governments the domestic and international arms they need to combat BEPS. The Plan recognises that greater transparency and improved data are needed to evaluate and stop the growing disconnect between where money and investments are made and where MNEs report profits for tax purposes.
The Action Plan will for example stop the abuse of transfer pricing by ensuring that taxable profits can’t be artificially shifted through the transfer of patents, copyright or other intangibles away from countries where the value is created, and it will oblige taxpayers to report their aggressive tax planning arrangements.
When we wrote about BEPS in February, we mentioned the sense of urgency surrounding the OECD work, with the proposal that a workable plan be agreed on within six months. The next steps will take a bit longer of course, but not that much longer. The actions outlined in the Plan will be delivered over the next 18 to 24 months by the joint OECD/G20 BEPS Project, regrouping all OECD members and G20 countries on an equal footing. To ensure that the actions can be implemented quickly, a multilateral instrument will also be developed for countries that want to amend their existing networks of bilateral tax treaties.
Some may protest and try to get the plan neutralised, but would they really prefer the alternative if the no action is taken to address the weaknesses that put the present consensus-based multilateral framework at risk and countries apply: “… unilateral measures, which could lead to global tax chaos marked by massive re-emergence of double taxation”?