BASE EROSION AND PROFIT SHARING (BEPS)- TAX EVASION OF MULTINATIONAL CORPORATIONS
OLD WINE IN A NEW BOTTLE
Before 1961, there was a minimal focus on national tax laws upon the multinational corporation’s tax and digital economy because during that time no country taxed the foreign source. During that time the nations were under the illusion that they lacked both the origin and residence of the foreign corporation. Lack of taxation imposed on multinational corporation has left the path opened for the multinational corporation to evade the global corporate tax. Furthermore, in 2008, the vast recession resulted in inequalities between the overseas nations and inter-city in the developed and developing countries. Politically influenced by the US and the UK were peeking into massive profits of multinational organizations such as Google, Apple, and Starbucks paying less than the fair share of taxes. For resolution of the global taxation chaos, the league of nations in the 1920s designed the “Draft Model Treaty on Double Taxation and Tax Evasion[i]” is as a reference by the United Nations and the Organisation for Economic Co-operation and Development (the OECD) in establishing model tax treaties. Furthermore, through model tax treaties, the government and the Multinational Enterprises (the MNE) were focusing on eradication of double taxation rather than interpreting the danger of double non-taxation. In response to the abovementioned scenario, in 2013 finance ministers of the world formed a group known as G20 and the OECD initiated the extension of the reevaluation of the global tax system known as “Base Erosion and Profit Sharing” (the BEPS). The OECD tax experts developed a set of principles for BEPS projects. BEPS project states that “economic activities generating the profits and creation of value, must ensure taxation on profits[ii].” BEPS project is formed to consider the issue of double non-taxation, and a stronger imposition of rules on Controlled Foreign Companies ( theCFC) which would allow taxing upon offshore subsidiaries[iii]. But the primary problem of BEPS is that it is not yet well redefined and structured. The aim of OECD in developing BEPS is to tax multinational corporations overseas to generate revenue for their citizens and to close the international tax loophole.
A COMPARATIVE STUDY BETWEEN THE UNITED STATES AND THE UNITED KINGDOM
The BEPS project was adopted by the Obama Administration in the United States (the U.S) in 2013. BEPS project was strongly endorsed by Treasury Secretary Jacob J who stated that “address the persistent issue of stateless income, which undermines confidence in our tax system[iv].” In 2016 budget, former president Barack Obama had imposed a new tax on corporate earnings held abroad which had resulted in additional revenue of $238 billion[v]. These political and economic factors have accelerated BEPS project in the US which have ultimately strengthened the US taxation which has to increase the inflow of the corporate tax revenue. Until now the US companies were paying lower tax rates by transferring their intellectual property to low tax countries like Luxembourg and United Kingdoms. In 1980s cost-sharing concept was developed by the Internal Revenue Service (the IRS) Regulations which became more significant due to increase in the importance of intellectual property. The US MNE’s like Apple Inc.took advantage of this cost-sharing concept and shared the cost of development of its project overseas such as in Ireland. For example, Apple Irelandcontributed 80% of the cost of developing the Iphone6 and the Apple Inc. would receive 80% of the profit earned from the sale of Iphon6 in Ireland. Another gamble made by Apple Ireland was that it had issued a license to right to use Apple’s brand and intellectual property to Apple Inc. that affiliates to other countries. Those affiliated with Apple Inc. brand in other countries were liable to pay massive royalties to Apple Ireland to shift its sales profit to Ireland. In 1997 Clinton administration adopted the rule called ‘check the box’under which Apple Ireland treated all its MNE as a separate entity and the profit earned through it as its own sales income. In 2015 Obama administration repealed the concept of ‘check the box,’ and Apple Ireland revealed that it paid the tax rate of 12.5% rather than US tax rate of 35%, on recognition by an Irish company in the Senate hearing.
Furthermore, Google saved billions in taxes worldwide. For example, in Australia Google just paid AUD$ 74,176 in 2013 despite making estimated revenue of AUD 1billion. Google reduced its overseas tax rate by 5%. Apple Inc. uses the same concept where it paid a tax bill of merely AUD$ 40 million despite generating estimated revenue of AUD$6 billion. In the United Kingdom, Starbucks a coffee shop just spent £8.5 million in tax between 1998 and 2008 despite generating revenue of £3 billion[vi].
A Similar case of Caterpillar Inc. vs. Williamsreveals another scam where US government encourages international corporate tax avoidance. A brief outline of the Caterpillar Inc. is that it is the US MNE which is in the business of manufacturing of industrial equipment and engines. Caterpillar Inc. has its subsidiary company in Switzerland named Caterpillar SARL (the CSARL) as a principal in sales of replacement parts. US Senate hearing reveals that Caterpillar Inc. paid $55 million to Price Water-house Cooper (the PWC) for design and implementation of tax structure in 2012. Furthermore, after execution of tax structure designed by PWC, Caterpillar Inc. continued its business of sales of replacement parts in Switzerland and return it received service fee which was equal to its cost plus 5% from CSARL. CSARL also paid 5-6% royalties to Caterpillar Inc. outside the US. In the US Senate hearing, it reveals that the US government is promoting its MNE’s in the avoidance of not only the foreign tax but also the US corporate tax. The issue of Caterpillar Inc. was highlighted not because of tax audit but because of the civil lawsuit between the company, and it’s internal tax manager who alleged that Caterpillar Inc. reacted against him since he had expressed his concern about the lack of economic substance in the company’s tax structure. This incident exposed the company’s international tax avoidance.
Additionally, in the case of Futuris Corporation Ltd. Vs. Federal Commissioner of Taxation(the FCT) where the taxpayer wanted to float some profit of the business, so to do that the taxpayer transferred some assets to other group companies through a tie-up with its shareholdings and capitalized some existing debts[vii]. The Commissioner argued the creation of tax benefits which were rejected by the Full Federal Court.
But now as per the guidelines of the BEPS suggest that payment of corporate tax to the countries where there is a creation of the value such as in the case of the US, it is California which is the IT hub. Furthermore, this shows that US economy is driven by intangible assets rather than tangible assets. In the US, corporate income tax was estimated to be 1.9% of GDP in 2015 as per the reports of Office of Management and Budget (the OMB). As seen in the OMB report it can be interpreted that the corporate taxes in the US are higher than marginal corporate income tax rate in the UK. For example, as per the survey conducted by the KPMG, United States pay 35% federal marginal tax rate on their profits along with its state and local taxes taken into account comes about a total marginal rate of 40%. Whereas, in comparison to the UK the marginal corporate income tax is 20%. If it is compared to the overall unit of Europe, then the average is 20% marginal corporate income tax rate. These BEPS rules are not only increasing the corporate tax payments globally but causing a vast corporate revenue loss to the United States since the US pays 15% marginal corporate income tax more than the other countries. If the situation in the US remains the same, then there will be a brain drain in the US since most of the skilled and creative workers will migrate to other countries. Many academic scholars debate the fact that most of the nations are implementing BEPS project without government approval and uses OECD international tax guidelines as the basis for their procedure. Therefore, BEPS project has given strict instructions to the national tax authorities to contemplate the functioning of multinationals overseas carefully.
Intellectual Property Tax Rate
The erosion of another significant issue in the United States is that due to tax pressure on the US companies, other European countries are offering lower tax rate for profits gained from intellectual property such as patents. For example, the United Kingdom provides 10% rate on intellectual property compared to 20% overall corporate tax rate. This concept of the lower tax rate on intellectual property is trending as patent boxes. Chief Executive Andrew Witty of GlaxoSmithKline has recently quoted upon patent boxes saying “Since the patent box, we have invested in upgrading 15 or 16 of our sites in the UK. It has made Britain the go-to place for our industry”[viii]. So, to benefit 10% tax rate on the patent boxes most of the research and development workers in the US multinationals are migrating to the UK. Due to the enormous difference in the tax rates between the United States and Europe, most of the multinationals are aggressively using these tax strategies. Therefore, to mild the situation BEPS are eliminating these aggressive tax strategies.[ix] On the other hand, BEPS rules are encouraging the US companies to shift these high paying jobs such as research scientist and software developers to Europe to incur lower tax rates.
It was proposed by trade partners in the US to modify the US Controlled Foreign Company (the CFC) which it states “base company sales income” which refers to foreign income tax.[x] They suggest that taxation on US MNE's would be as per the sales income acquired from its production. But the US government tax authorities have strictly formed the CFC rules that it would be applied upon the incorporation of the company and not upon its production income. Taxation imposed on corporation allows qualifying many entities of MNE taxable in the US. It has been debated by many US government officials and tax authorities that more transparency is required in the BEPS project to make it easier for the tax authorities to investigate in regards to international tax avoidance cases.
The adoption of the BEPS project in the UK in 2014, the former Exchequer Secretary expressed its UK’s support for OECD’s BEPS action plan to Treasury David Gauke. There is a debate on the ongoing issue of Brexit in the UK, whether it will affect the implementation of BEPS project in the UK for international tax avoidance or not. Anticipation by KPMG states that Brexit will not interrupt UK’s implementation of BEPS action plan.
This article concludes that from the above findings the study shows that most of the multinational corporations reallocate their profits globally to lower corporate tax. Notably, in the United States after the implementation of the BEPS project by Obama administration most of the prominent multinational companies are shifting their profits in the United Kingdom where the marginal corporate income tax is 20% which is 15% less than the US corporate income tax. Moving of prominent tech companies to the UK has incurred a massive loss of corporate revenue for the United States. BEPS rules have turn out to be a disadvantage for the US MNE’s, due to competitive taxation system in the US most of its skilled and creative workers are shifting to the Europe where there is 10% tax rate on the patent. In the current scenario, it is debated by the US government officials and tax authorities to modify BEPS rules to make it more transparent so that it becomes more comfortable for the tax authorities to interpret it while investigating in regards to international tax avoidance cases. On the contrary, there is a little success rate of BEPS in the UK since there is lower corporate income tax on multinational corporations and it will not be interrupted even after Brexit. The objectives of the BEPS projects are still vague and more defined rules are required to be structured by OECD to have a global impact of taxation on multinational firms.
[i]Reuven S. Avi-Yonah; Haiyan Xu, Evaluating BEPS, 10
Erasmus L. Rev. 3 (2017)
[ii]Johann Muller, BEPS Case Study, 24 Int'l Tax Rev. 29
[iii]Johann Muller, BEPS Case Study, 24 Int'l Tax Rev. 29
[iv]Reuven S. Avi-Yonah; Haiyan Xu, Evaluating BEPS, 10
Erasmus L. Rev. 3 (2017)
[v]Reuven S. Avi-Yonah; Haiyan Xu, Evaluating BEPS, 10
Erasmus L. Rev. 3 (2017)
[viii]Discussion Paper No. 13-078 Profit Shifting and “Aggressive” Tax Planning by Multinational Firms: Issues and Options for Reform Clemens Fuest, Christoph Spengel, Katharina Finke, Jost H. Heckemeyer, and Hannah Nusser.
[ix]Discussion Paper No. 13-078 Profit Shifting and “Aggressive” Tax Planning by Multinational Firms: Issues and Options for Reform Clemens Fuest, Christoph Spengel, Katharina Finke, Jost H. Heckemeyer, and Hannah Nusser.
[x]Johann Muller, BEPS Case Study, 24 Int'l Tax Rev. 29
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