Google and Apple are among corporates that have been exposed in the media for ‘aggressive’ tax planning. But many large multinationals are taking advantage of tax loopholes, which exist because tax systems are run separately from one jurisdiction to another. Highly profitable companies are at liberty to pay virtually no tax on their profit, without breaking any rules.
The trend for corporates to move profit to countries that impose minimal tax on certain revenues is a thorn in the side of governments, particularly those in industrial countries where such revenues are mainly generated. This is not only because each country has an interest in protecting its own tax revenue, but also because many ordinary taxpayers are unaware of the impunity available to wealthy corporates. The rapid growth of the internet and its significant importance in today’s world has made it even easier for global companies to shift their profits and keep their overall tax burden low.
[T]he days of tax loopholes, whether they were created by design, or otherwise, may
be numbered
However, the days of tax loopholes, whether they were created by design, or otherwise, may be numbered as international cooperation improves in this area. The G20 finance ministers conceived the Base Erosion and Profit Shifting (BEPS) project, which aims to combat tax evasion and prevent substantial loss of tax revenue, along with competitive distortions between companies operating locally and internationally, and between different countries. Last year the OECD devised a 15-point action plan, which has been approved as the basis for developing effective and internationally aligned regulations against existing structures that enable profit shifting.
Avoidance is not evasion
Unlike tax evasion, companies are free to implement structures that capitalise on the current legal situation in different countries to reduce their tax burden. In evaluating corporate tax-saving strategies, governments have even purposely created tax loopholes in order to attract companies. In addition, companies have discovered further unintended loopholes. The so-called ‘Double Irish Dutch Sandwich’, also known as ‘Patent Box’, is one example of how these loopholes can be exploited. This structure allows companies to move profit generated in Europe to other parts of the world, without incurring any tax. It is not only companies with international operations that take advantage of this, but also a number of renowned brands and their rights holders – among them famous musicians, actors and television personalities.
Neither are all these organisations located in the Caribbean. One of the most attractive tax havens in the world sits at the heart of Europe; hence the name Double Irish Dutch Sandwich. Both the Netherlands and Ireland are attractive domiciles for companies wanting to avoid paying tax – or at least to use as a European address.
Even though multinational cooperation is a prerequisite to creating a level playing field in the competition for international tax revenues, bilateral agreements are expected to have more impact in future, especially Double Taxation Avoidance Agreements (DTAAs). The latter increasingly are designed to stop cross-border companies from escaping taxation on so-called white revenues – which are neither taxed by the state in which they are generated, nor by the state in which the company generating them is based. Due to this, different countries’ fiscal administrations are currently revising the terms of their DTAAs to include ‘subject-to-tax’ clauses, which prevent this practice by giving taxation rights over white revenues back, if the country holding the taxation right pursuant to the DTAA does not impose any taxes through its own national law.
Also at national level, countries are looking at possible legislative measures to prevent white revenues. In Germany, for example, a variety of methods to stop tax avoidance have been devised, among them rules regarding exit taxation, treaty shopping, transfer pricing, and cross-border loss utilisation.
Prevention on a multilateral level
Strategies for preventing tax avoidance are politically motivated, as is competition between countries to gain tax revenue. If big companies are paying virtually no tax, this is likely to impact the willingness of others to pay their share. That is why the leading industrial countries (G20) have joined forces to combat tax loopholes, and the practice of profit shifting. The OECD’s 15-point action plan ensures profit is taxed at an appropriate level, and in the country where it is generated. The action points are divided into five categories: addressing the digital economy; establishing internal coherence of corporate income taxation; restoring the full effects and benefits of international standards; ensuring transparency while promoting increased certainty in predictability; and the need for swift implementation of measures.
Since then, there has been considerable debate, through the publication of discussion documents and public consultation events, as to what the output of the BEPS project should be. What has become apparent is that changes to the international tax system, some of which may be radical in approach, will be made and that all multinational businesses will be affected to an extent. However, at least within the EU, the limits set by the freedom of establishment and free movement of capital have to be taken into account. The latter is also applicable to enterprises that have their domicile outside the EU.
Impending outcomes
The one issue around which most discussions will evolve is the future definition of permanent establishments. Fair taxation of e-commerce will particularly depend on the decisions OECD member states make regarding the allocation of profit. Only if a company’s activities in a country qualify as a permanent establishment, would the company become liable to tax in this country. As long as the criteria for the assumption of a permanent establishment are clear in the greatest possible extent and without ambiguity, businesses can be confident when undertaking cross-border activities. It will therefore be crucial to retain the current characteristics for permanent establishments – while also finding a way to define separate criteria for the allocation of profit generated through the use of the internet and electronic data in general. It is important that companies and their tax advisors keep an eye on these developments so that they are ready to react appropriately.
Implementing the BEPS action plan by the end of 2015 looks highly ambitious, particularly as it is doubtful that any state would willingly give up tax revenues out of ‘fairness’ towards other states. It will therefore be vital to ensure fair reconciliation of interests between countries and taxpayers. Should countries decide to go ahead establishing BEPS action points alone, this will lead to disadvantages for businesses in those countries and compensatory measures will have to be introduced. Also, in working to combat abuse, the international community should not lose sight of the main objective of DTAAs, which is to prevent double taxation. And while the struggle against tax evasion requires cooperation among all countries, abolishing tax competition between countries altogether is not expedient. For countries or regions with economic disadvantages, the possibility of creating attractive investment incentives by intentionally imposing zero to minimal tax on certain income for a limited amount of time should also be maintained in the future.