The rapid growth in globalization and technology have led to an upward spiral growth in many Corporations and more especially the Multinational Enterprises. Globalization has benefited our domestic economies as it affects countries’ corporate income tax regimes. It’s purely asserted that as the economies becomes more globally integrated, so does corporations and the multinational Enterprises.
These multinational Enterprises in nature have been making headlines with their tax avoidance strategies. Their large scale of operations, their related party relationships, operations in different countries and the urge to minimize taxation at the expense of generating their profits, Globalization has resulted in a shift from country-specific operating models to global models based on matrix management organizations and integrated supply chains that centralize several functions at a regional or global level. The growing importance of the service component of the economy, and of digital products that often can be delivered over the Internet, has made it much easier for businesses to locate many productive activities in geographic locations that are distant from the physical location of their customers.
These developments have been worsened by the increasing sophistication of tax planners in identifying and exploiting the legal arbitrage opportunities and the boundaries of acceptable tax planning, thus providing MNEs with more confidence in taking aggressive tax positions
MNEs adopted Tax base erosion and profit shifting (BEPS) procedures. Base Erosion and profit shifting (BEPS) allows these MNES to shift profits from high tax havens to low tax jurisdictions
Tax evasion is illegal and punishable by law whereas tax avoidance is merely discovering the loopholes or gaps in the existing laws and capitalizes on them to gain your tax advantages. The multinationals have advantages in terms of financial powers, research and developments, human capital and expertise that enable them to discover these gaps in the existing tax laws and maximize on these gaps.
However, this deprives the source or residence countries from benefiting in their fair tax gains. Other tax avoidance schemes have been capped to loopholes in international taxation rules, tax competition of states, tax havens, digital economy, hybrid mismatch arrangements, transfer pricing among others.
It is imperative to note that besides, the existence of this loophole in the tax structures of different nations, there has been measures that the OECD BEPS Project designed to shut down the loopholes that have helped and enabled cross-border tax avoidance. Given that the OECD is the warden of the international tax regime, it was tasked to solve these problems, which it had faced over time.
Fundamental instrumental principles
At the onset of the OECD/G20 BEPS programs, they were majorly three fundamental instrumental principles for tax reform tabled.
- Collaboration.
It was envisaged that only collaboration among countries could succeed in tackling the BEPS challenges
- A comprehensive and holistic approach.
It was also seen that there was a need for a comprehensive and holistic approach rather than an ad hoc approach
- Innovations.
It was tabled that there some innovations needed or the acceptance of solutions that are not part of the brick and mortar for the tax policy measures.
BEPS Action Plan
Therefore, the resultant factors from the above were the Action plans for the BEPS. These are popularly known as the BEPS 15 Action Plans.
The Action Plan requests for major changes to the current mechanisms and the adoption of new consensus based approaches, including anti-abuse provisions, designed to prevent and counter base erosion and profit shifting.
Fundamental changes are needed to successfully prevent double non-taxation on top of cases of no or low taxation brought by the norms or failures to segregate taxable income from the activities that generate such incomes.
The OECD came up with different Action plans that were intended to tackle the challenges of BEPS in terms of tax arbitrage and shifting of profits.
Action No. 1: Address the tax challenges of the digital economy.
The digital economy is the result of a transformative process brought by information and communication technology (ICT). The ICT revolution has made technologies cheaper, more powerful, and widely standardized, improving business processes and bolstering innovation across all sectors of the economy.
However, in terms of taxations many nations have not been able to tax the incomes that accrues out of the digital economy. The existing taxation rules had hinged too much on the physical presence in certain jurisdiction, which could mandate the MNEs to be taxed. Thus the Action plan was intended to identify the main difficulties that the digital economy poses for the application of existing international tax rules and develop detailed options to address these difficulties, taking a holistic approach and considering both direct and indirect taxation.
Many Issues were to be examined which included, but are not limited to the following
- The ability of a company to have a significant digital presence in the economy of another country without being liable to taxation due to the lack of nexus under current international rules
- The attribution of value created from the generation of marketable location-relevant data through the use of digital products and services.
- The characterization of income derived from new business models.
- The application of related source rules, and how to ensure the effective collection of VAT with respect to the cross-border supply of digital goods and services. Thus this called of the establishment of international coherence of corporate income taxation.
Action No. 2: Neutralize the effects of hybrid mismatch arrangements.
This action was intended to develop model treaty provisions and recommendations regarding the design of domestic rules to neutralize the effects for example of double non-taxation, double deduction, long-term deferral of hybrid instruments and entities. Double non-taxations refers to a situation in which a cross-border transaction sustains a lesser tax burden than a comparable domestic transaction.
Action No. 3: Strengthen Controlled foreign company rules.
Anti-base erosion profit shifting (BEPS) measures may limit the maximum net interest deduction any interest that is above the limit is not deductible in the current year. This would strengthen the Controlled foreign company (CFC) rules to respond to the risk that taxpayers can strip the tax base of their country of residence and by shifting income into a foreign company that is controlled by the taxpayers.
Action No. 4: Limit base erosion via interest deductions and other financial payments.
There was need to limit the use of related-party and third-party debt to achieve excessive interest deductions or to finance the production of exempt or deferred income, and other financial payments that are economically equivalent to interest payments.
Action No. 5: Counter harmful tax practices more effectively, taking into account transparency and substance.
Existing domestic and international tax rules should be modified in order to more closely align the allocation of income with the economic activity that generates that income.
Action No. 6: Prevent treaty abuse.
The treaties must be observed and respected. Treaty provisions regarding the design of domestic rules must be done in such a way that prevents the granting of treaty benefits in inappropriate circumstances. Clarification must be done that these tax treaties are not intended to be used to generate double non-taxation.
Action No. 7: Prevent the artificial avoidance of PE status.
There was need to look at the changes in the definition of PE to prevent the artificial avoidance of
PE status in relation to BEPS, including with commissionaire arrangements and the specific activity exemptions
Action 8,9,& 10 are meant to assure that transfer pricing outcomes are in line with
value creation and these are explained below.
Action No. 8: Intangibles.
An intangible asset is an asset that lacks physical substance. Examples are patents, copyright, franchises, goodwill, trademarks, and trade names, as well as software. The intangible assets can be divided into two groups
- Intellectual property.
This is something that you create with your mind, such as a design.
- Good will.
It happens in accounting when a firm is purchased as a going concern.
Action No. 9: Risks and capital.
Rules were to be developed to prevent BEPS by transferring risks among, or allocating excessive capital to group members, it requires involvement in adopting transfer pricing rules or special measures. This will ensure that inappropriate returns will not accrue to an entity simply because it has contractually assumed risks or has provided capital. This requires some rules to be developed which will also require alignment of returns with value creation.
Action No. 10: Other high-risk transactions.
There is need to develop rules to prevent BEPS by engaging in transactions, which would not or would only very rarely, occur between third parties. This will involve adopting transfer-pricing rules or special measures to clarify the circumstances, in which transactions can be recharacterised, clarify the application of transfer pricing methods, in particular profit splits, in the context of global value chains; and provide protection against common types of base eroding Payments, such as management fees and head office expenses.
Action No. 11: Establish methodologies to collect and analyze data on BEPS and the actions to address it.
Recommendations regarding indicators of the scale and economic impact of BEPS and ensure that tools are available to monitor and evaluate the effectiveness and economic impact of the actions taken to address BEPS on an ongoing basis.
Action No. 12: Require taxpayers to disclose their aggressive tax planning arrangements.
There was need to develop recommendations regarding the design of mandatory disclosure rules for aggressive or abusive transactions, arrangements, or structures, taking into consideration the administrative costs for tax administrations and businesses and drawing on experiences of the increasing number of countries that have such rules.
Action Number13: Re-examine transfer pricing documentation
There was need to come up with rules regarding transfer pricing documentation to enhance transparency for tax administration. The issue of compliance costs for business is very important for consideration. The MNEs requirement is that all of them must be able to provide relevant information to the governments. In this regard, it must be understood that actions to counter BEPS must be in reliance with the canons and principals of taxation in terms of certainty and predictability. The work must be intended to improve the effectiveness of the mutual agreement procedure, which would be an important concept to work on BEPS issues. The obstacles that hinder countries from solving tax related disputes must be addressed under mutual agreement procedure with ease.
Action No. 14: Make dispute resolution mechanisms more effective
By making the dispute resolution mechanisms a harbor for all disputes and more effective, it would mutually bond the treaties. Thus, there is need to come up with solutions to address obstacles that prevent countries from solving treaty-related disputes under mutual agreement procedure, including the absence of arbitration provisions in most treaties and the fact that access to mutual agreement procedure and arbitration may be denied in certain cases. For example in Uganda the Alternative dispute resolution is taking center, stage in resolving tax matters amicably
Action No.15: Develop a multilateral instrument
There is a call to analyze the tax and public international law issues related to the development of a multilateral instrument to enable jurisdictions that wish to do so to implement measures developed in the course of the work on BEPS and amend bilateral tax treaties. Therefor the multilateral instruments are a key element to tackle the BEPS problems a strategy carried out by the MNEs to avoid taxes through their aggressive tax planning.
In a nutshell, the world is moving at an unprecedented level in terms of globalization. The International taxation rules are becoming versatile due to the growth in the Digital economy, which have narrowed the world to the global village. The trade in intangible assets, services and free movement of people and goods have promoted cross border trade. The issue have been in who must benefit from the taxes charged on revenues generated from those territories. The OECD Action plan came up with the 15 Action plan, which guides on how the taxation of such can be done putting into respect the source or residence rules.
The writer is a Certified Public Accountant ICPAU and attached in finance department of Uganda Baati Limited.
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