Base Erosion And Profit Shifting

Published Mar 22, 2024

Definition of Base Erosion and Profit Shifting (BEPS)

Base Erosion and Profit Shifting (BEPS) refers to tax planning strategies used by multinational companies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid. BEPS practices are a major cause of concern for both developed and developing countries due to the significant tax revenue losses they entail.

Example

Consider a multinational corporation operating in both Country A and Country B. Country A has a high corporate tax rate, whereas Country B offers a tax haven with significantly lower tax rates. To minimize its tax liability, the corporation shifts its profits from Country A to Country B by using strategies such as pricing its inter-company transactions (transfer pricing) in a way that maximizes costs in Country A and profits in Country B, even though the actual economic activities (like production and sales) take place in Country A.

This artificial profit shifting results in Country A losing a substantial amount of tax revenue, whereas Country B does not gain significant revenue due to its low tax rate. The multinational corporation benefits by lowering its overall tax expenses, enhancing its profits at the expense of public finance.

Why Base Erosion and Profit Shifting Matters

BEPS has significant adverse effects on national and global economies. Countries lose billions of dollars in tax revenue each year due to BEPS, which could otherwise fund public services such as healthcare, education, and infrastructure. BEPS undermines the fairness and integrity of the tax systems, leading to increased tax burden on less mobile bases such as individual taxpayers and smaller businesses that cannot engage in BEPS strategies.

The widespread use of BEPS strategies by multinational enterprises (MNEs) emphasizes the need for international cooperation and reform in global tax rules to prevent tax avoidance and ensure that profits are taxed where economic activities generating the profits are performed and where value is created.

Frequently Asked Questions (FAQ)

What are some common strategies used in Base Erosion and Profit Shifting?

Common BEPS strategies include the misuse of transfer pricing rules, exploiting differences in tax treatment between countries (hybrid mismatch arrangements), and shifting risks and intangibles to low-tax jurisdictions. Another tactic is the strategic allocation of excessive debt to high-tax jurisdictions to claim tax deductions on interest payments.

What is being done to combat BEPS?

The Organisation for Economic Co-operation and Development (OECD) launched an action plan on BEPS that outlines 15 actions to equip governments with the domestic and international instruments needed to tackle BEPS. These actions encompass reforms in tax treaty rules, transfer pricing guidelines, and requirements for tax transparency. The implementation of the BEPS Action Plan aims to close gaps that allow for artificial profit shifting and to ensure transparency and substance in international tax matters.

How does BEPS affect developing countries?

Developing countries are particularly vulnerable to BEPS practices due to their reliance on corporate income tax, especially from multinational corporations operating within their jurisdictions. The loss of tax revenue due to BEPS can hinder their ability to finance essential public services and development projects. Furthermore, the complexity of BEPS strategies and the lack of resources to combat such practices can leave developing countries at a disadvantage in securing their taxable base.

Can unilateral measures by countries effectively address BEPS?

While unilateral measures by individual countries can mitigate some aspects of BEPS, global problems require global solutions. Uncoordinated national actions may lead to an increase in double taxation and may not effectively address profit shifting. Consequently, international cooperation and coordination, such as that facilitated by the OECD’s BEPS project, are crucial in developing comprehensive and lasting solutions to the challenges posed by BEPS.

The complexity of BEPS involves not just tax laws but also issues of international business, global economic policy, and sovereignty. Therefore, tackling BEPS is an ongoing process that requires the collaborative effort of nations around the globe to ensure that corporate profits are taxed where real economic activity and value creation occur, supporting the global economy’s equitable and sustainable development.