Base Erosion and Profit Shifting (BEPS): Techniques to Shift Profits and Reduce Tax Burdens

Methods used by companies to shift profits to low-tax jurisdictions, reducing their overall tax liabilities, along with implications and countermeasures.

Base Erosion and Profit Shifting (BEPS) refers to tax planning strategies used by multinational companies to exploit gaps and mismatches in tax rules to artificially shift their profits to low or no-tax locations. This results in little or no overall corporate tax being paid. The term BEPS gained prominence with the Organization for Economic Co-operation and Development (OECD)’s action plan to tackle tax avoidance.

Definition: What Is BEPS?

Base Erosion and Profit Shifting (BEPS) are corporate strategies that take advantage of international tax rules and loopholes to minimize tax obligations through profit shifting and erosion of tax bases in high-tax jurisdictions.

Methods of BEPS

Transfer Pricing

Transfer pricing involves setting the price for goods and services sold between controlled or related legal entities within an enterprise, which can be manipulated to shift income to low-tax jurisdictions.

Intellectual Property (IP) Location

Companies often locate IP in tax havens where royalty income is taxed at very low rates, thereby shifting substantial profits without substantial economic activity in those jurisdictions.

Controlled Foreign Corporation (CFC) Rules

Utilizing CFC rules, firms can defer or avoid immediate taxation of international subsidiaries’ earnings by keeping profits abroad in low-tax jurisdictions.

Hybrid Mismatch Arrangements

Employing hybrid entities or instruments to exploit differences in tax treatment between countries, allowing deductions in one jurisdiction without corresponding taxable income in another.

Deduction/Non-inclusion Schemes

These involve structuring transactions so that deductions are claimed by one entity without the corresponding income being reported by another entity.

Implications of BEPS

Revenue Loss

Significant revenue losses for high-tax jurisdictions, hindering public investment and economic growth.

Market Distortion

Creation of an uneven playing field where firms engaging in BEPS strategies gain unfair tax advantages over competitors.

Legal and Regulatory Challenges

BEPS introduces complexities in legal and regulatory frameworks as administrations strive to adapt and counter these practices.

OECD BEPS Action Plan

Action Points

The OECD has outlined a 15-point action plan to address BEPS issues, covering areas such as:

• Tax challenges of the digital economy
• Coherence of international tax rules
• Substance and transparency in tax systems

Multilateral Instrument (MLI)

The Multilateral Instrument (MLI) aims to quickly implement the tax treaty-related measures to prevent BEPS through a single legal document.

Examples of BEPS

Apple Inc.

Apple’s arrangement in Ireland, where it was reported to have negotiated tax rates significantly lower than standard corporate rates, exemplifies how companies can shift profits and minimize tax burdens.

Starbucks

Starbucks has been under scrutiny for using complex tax arrangements involving royalties and licensing fees between subsidiaries, to shift profits to lower-tax jurisdictions.

Related Terms

• Tax Avoidance: Legal strategies used by individuals or businesses to minimize tax liabilities.
• Tax Evasion: Illegal practices to escape paying taxes, such as underreporting income or inflating deductions.
• Double Taxation: The situation where the same income gets taxed by two different jurisdictions.
• Thin Capitalization: A situation where a company is financed through a relatively high level of debt compared to equity, often to take advantage of interest tax deductibility.

FAQs

How does BEPS affect developing countries?

BEPS practices have a disproportionate impact on developing countries as they are highly reliant on corporate tax income and have less capacity to counter these strategies.

Are all BEPS strategies illegal?

No, many BEPS strategies exploit legal loopholes and are considered tax avoidance rather than evasion, though there is growing regulatory pressure to close these gaps.

What is the role of transfer pricing in BEPS?

Transfer pricing is often central to BEPS strategies as it allows manipulation of intra-company transactions to shift profits to low-tax jurisdictions.

References

• OECD. (2015). “BEPS Action Plan.” Paris: OECD Publishing. Retrieved from OECD website
• Devereux, M. P., & Vella, J. (2014). “BEPS and Tax Policy in Developing Countries.” Oxford University Centre for Business Taxation.

Summary

Base Erosion and Profit Shifting (BEPS) encompass a range of strategies used by multinational corporations to minimize tax obligations by exploiting gaps in international tax law. Addressed by the OECD through a 15-point action plan, BEPS poses significant challenges to global tax equity, economic efficiency, and public revenue systems. Understanding and addressing BEPS is paramount for fair and effective global tax regulation.