The OECD's Base Erosion and Profit Shifting (BEPS) initiatives have significantly influenced international tax policies, focusing on curbing tax avoidance, disallowing treaty-shopping and harmonising tax rates around the globe. Here's a detailed look at these developments.
BEPS Multilateral Instrument (MLI)
By way of summary, the BEPS project, initiated by the OECD and G20, aims to close gaps in international tax rules that allow corporate profits to be shifted to low or no-tax locations. A critical component of this initiative is the BEPS Multilateral Instrument (MLI). The MLI allows countries to update their existing bilateral tax treaties swiftly to incorporate BEPS measures without the need for lengthy renegotiations.
Key Features of the MLI:
- Anti-abuse Provisions: The MLI includes provisions to prevent treaty abuse, such as treaty shopping, where companies exploit tax treaties to reduce tax liability inappropriately.
- Permanent Establishment Rules: It redefines what constitutes a permanent establishment, making it harder for companies to avoid tax by claiming no significant presence in a country.
- Dispute Resolution: Enhancements to dispute resolution mechanisms, including mandatory binding arbitration, help resolve tax disputes more efficiently and fairly.
Over 100 jurisdictions have adopted the MLI, demonstrating a widespread commitment to combating tax avoidance and improving international tax cooperation. Hence, it is close to impossible, unless a considerable risk is absorbed by an organisation to structure groups in a tax efficient manner.
OECD's Pillar Two
In addition to the BEPS measures, the OECD has introduced Pillar Two as part of its efforts to establish a fairer international tax system. Pillar Two focuses on ensuring that multinational corporations (MNCs) pay a minimum level of tax on their global profits.
Key Components of Pillar Two:
- Global Minimum Tax Rate: Pillar Two sets a minimum effective tax rate of 15% on the profits of MNCs. This measure is designed to prevent profit shifting to low-tax jurisdictions. Malta: On 20 February 2024, Malta enacted the relevant provisions of the EU Minimum Tax Directive through the publication of Legal Notice 32 of 2024. The legal notice was later complemented by a Guidance Note issued by the Malta Tax and Customs Authority explaining the purpose of the legal notice, its interaction with Malta's option to defer the implementation of parts of the EU Directive, and the compliance obligation of local entities affected by the EU Directive. The legal notice applies for fiscal years beginning from 31 December 2023.
- Income Inclusion Rule (IIR): This rule requires the parent company to pay additional tax if its subsidiaries are taxed below the minimum rate. It ensures that the profits of subsidiaries are taxed at least at the minimum rate, either in the country of the subsidiary or the parent company's jurisdiction.
- Undertaxed Payments Rule (UTPR): Allows countries to increase taxes on payments made to related entities in jurisdictions where the income is taxed below the minimum rate, preventing base erosion through deductible payments such as interest or royalties.
- Subject to Tax Rule (STTR): Ensures that certain payments, like interest and royalties, are subject to at least a minimum level of tax. If these payments are subject to a low or no tax, the source country can impose a withholding tax to meet the minimum rate.
Pillar Two aims to harmonize tax rates globally, reducing the incentives for MNCs to shift profits to lower-tax jurisdictions. The EU has been at the forefront of implementing these rules, requiring member states to adopt the income inclusion rule and undertaxed payments rule by the end of 2023 and 2024, respectively.
Scrutiny by the European Commission on Tax Arrangements
The European Commission has scrutinized the tax arrangements of several major multinational companies, including Google, Starbucks, Amazon, and Fiat, under its state aid rules. These cases revolve around whether these companies received favorable tax treatment from EU member states, which could be considered illegal state aid. Here's a brief assessment of each case:
The European Commission has investigated Google's tax practices, particularly focusing on the company's use of structures that shift profits to low-tax jurisdictions. Although the most high-profile cases involving Google have been related to antitrust issues, its tax practices have also been under scrutiny. The investigations have highlighted concerns about how Google's tax arrangements might allow it to significantly reduce its tax liabilities in the EU, potentially distorting competition within the single market.
Starbucks
In 2015, the European Commission ruled that Starbucks received illegal state aid from the Netherlands. The Commission found that the tax ruling provided by the Dutch authorities to Starbucks allowed the company to significantly reduce its taxable profits. The ruling was seen as a way for Starbucks to shift profits from higher-tax jurisdictions to the Netherlands, where they were taxed at a lower rate. As a result, Starbucks was ordered to pay up to €30 million in back taxes to the Dutch government.
Amazon
Amazon's tax arrangements in Luxembourg were the subject of another significant state aid investigation by the European Commission. In 2017, the Commission concluded that Luxembourg granted undue tax benefits to Amazon, allowing it to avoid paying taxes on almost three-quarters of its profits from EU sales. The arrangement, which involved a complex structure of intra-group transactions and royalty payments, was deemed to have granted Amazon selective advantages in violation of EU state aid rules. Consequently, Amazon was ordered to repay €250 million in back taxes to Luxembourg.
Fiat
The European Commission also ruled against Fiat Chrysler Automobiles (Fiat) for its tax arrangement with Luxembourg. In a decision similar to the Amazon case, the Commission found that Luxembourg had granted Fiat selective tax advantages through transfer pricing arrangements that artificially lowered Fiat's taxable profits. These arrangements were found to be in breach of EU state aid rules, and Fiat was ordered to pay around €30 million in back taxes.
Summary
The European Commission's investigations into the tax arrangements of Google, Starbucks, Amazon, and Fiat highlight the ongoing effort to ensure fair competition within the EU by addressing preferential tax treatments that distort the market. These cases underline the Commission's commitment to preventing member states from offering selective tax advantages that undermine the integrity of the single market. While the rulings have faced appeals and legal challenges, they represent significant steps towards greater tax transparency and fairness in the EU. High-profile cases, such as these, have set precedents that dissuade aggressive tax planning. These cases have resulted in substantial back tax payments and have highlighted the risks of using aggressive tax structures.
Enhanced Anti-Avoidance Measures
Many countries have strengthened their anti-avoidance rules, including:
- Controlled Foreign Corporation (CFC) Rules: These rules prevent MNEs from shifting income to subsidiaries in low-tax jurisdictions.
- General Anti-Avoidance Rules (GAAR): These provide tax authorities with broad powers to counteract tax avoidance schemes.
- Transfer Pricing Regulations: Enhanced rules ensure that transactions between related entities are conducted at arm's length prices, reflecting economic reality.
- Increased Exchange of Information: International agreements, such as the Common Reporting Standard (CRS) and bilateral tax treaties, have led to greater exchange of tax-related information between countries. This increased transparency makes it more difficult for MNEs to hide income or assets offshore.
Conclusion
The OECD's BEPS initiatives and Pillar Two represent significant strides toward a more equitable international tax landscape. By addressing tax avoidance strategies and ensuring a minimum tax rate on global profits, these measures aim to create a level playing field for countries and companies alike, fostering transparency and fairness in global taxation.
It is not impossible to create tax-efficient structures in the current international tax landscape, but it has become significantly more challenging due to recent developments. The global push for tax transparency and the implementation of stricter regulations have narrowed the scope for aggressive tax planning.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.