Base erosion and profit shifting

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The United States Department of the Treasury decided against signing the 2016 OECD anti-BEPS MLI initiative from the § OECD BEPS Project, stating that the U.S.: "has a low degree of exposure to base erosion and profit shifting".[1] International tax academics showed in 2018 that U.S. multinationals are the largest users of BEPS tools in the world;[2] while U.S tax academics demonstrated, even as early as 1994, that the U.S. exchequer is a net beneficiary from the use of tax havens and BEPS by U.S. multinationals.[3][4]

Base erosion and profit shifting or BEPS refers to corporate tax planning strategies used by multinationals to "shift" profits from higher-tax jurisdictions to lower-tax jurisdictions, thus "eroding" the "tax-base" of the higher-tax jurisdictions.[5][6] The OECD defines BEPS strategies as also: "exploiting gaps and mismatches in tax rules";[6] however, academics proved corporate tax havens (e.g. Ireland, the Caribbean, Luxembourg, the Netherlands, Singapore, Switzerland, and Hong Kong),[a] who are the largest global BEPS hubs, use OECD-whitelisted tax structures and OECD-compliant BEPS tools.[7][5] Corporate tax havens offer BEPS tools to "shift" profits to the haven, and additional BEPS tools to avoid paying taxes within the haven (e.g. Ireland's "Green Jersey").[b] BEPS tools are mostly associated with U.S. technology and life science multinationals.[c][2] Tax academics showed use of BEPS tools by U.S. multinationals, via tax havens, maximised long-term U.S. exchequer receipts and/or shareholder returns, at the expense of other jurisdictions.[3][4][2]

Source and scale[edit]

A January 2017 OECD report estimates that BEPS tools are responsible for tax losses of circa $100–240 billion per annum.[8] A June 2018 report by tax academic Gabriel Zucman (et alia),[9] estimated that the figure is closer to $200 billion per annum.[10] The Tax Justice Network estimated that profits of $660 billion were "shifted" in 2015 (due to Apple's Q1 2015 leprechaun economics restructuring, the largest individual BEPS transaction in history[11]).[12][13] The effect of BEPS tools is most felt in developing economies, who are denied the tax revenues needed to build infrastructure.[14][15]

Most BEPS activity is associated with industries with intellectual property ("IP"), namely Technology (e.g. Apple, Google, Microsoft, Oracle), and Life Sciences (e.g. Allergan, Medtronic, Pfizer and Merck & Co) (see here).[c][16] IP is described as the raw materials of tax avoidance, and IP-based BEPS tools are responsible for the largest global BEPS income flows.[17][18] Corporate tax havens have some of the most advanced IP tax leglislation in their statutate books.[19]

Most BEPS activity is also most associated with U.S. multinationals,[20][21][5][16] and is attributed to the historical U.S. "worldwide" corporate taxation system.[5][22] Pre the Tax Cuts and Jobs Act of 2017 ("TCJA"), the U.S. was one of only eight jurisdictions to operate a "worldwide" tax system.[23] Most global jurisdictions operate a "territorial" corporate tax system with lower tax rates for foreign sourced income, thus avoiding the need to "shift" profits (i.e. IP can be charged directly from the home country at preferential rates and/or terms; the TCJA now enables this in the U.S. with the FDII-regime).[24][25][26]

U.S. multinationals use tax havens[d] more than multinationals from other countries which have kept their controlled foreign corporations regulations. No other non-haven OECD country records as high a share of foreign profits booked in tax havens as the United States. [...] This suggests that half of all the global profits shifted to tax havens are shifted by U.S. multinationals. By contrast, about 25% accrues to E.U. countries, 10% to the rest of the OECD, and 15% to developing countries (Tørsløv et al., 2018).

— Gabriel Zucman, Thomas Wright, "THE EXORBITANT TAX PRIVILEGE", NBER Working Papers (September 2018).[2]

Research in June 2018, identified Ireland as the world's largest BEPS hub.[27] Ireland is larger than the aggregate Caribbean tax haven BEPS system.[7] The largest global BEPS hubs, from the Zucman-Tørsløv-Wier table below, are synonymous with the top 10 global tax havens:

U.S. multinationals book over half of their non-U.S. profits in tax havens by using BEPS tools (2016 BEA).[2][28]
Zucman-Tørsløv-Wier. Missing Profits of Nations. Table 1: Shifted Profits (2015)[27]
Profits Shifted
(2015 $ bn)[27]
Jurisdiction Headline Corporate Tax Rate
(all firms)
Effective Corporate Tax Rate
(foreign firms)[27]
106 Ireland 12.5% 4%
97 Caribbean† (ex. Bermuda) <3% 2%
70 Singapore 17% 8%
58 Switzerland 21% 16%
57 Netherlands 25% 10%
47 Luxembourg 29% 3%
39 Hong Kong 18% 18%

(†) Mostly consists of The Cayman Islands and The British Virgin Islands

Research in September 2018, by the National Bureau of Economic Research, using repatriation tax data from the TCJA, said that: "In recent years, about half of the foreign profits of U.S. multinationals have been booked in tax haven affiliates, most prominently in Ireland (18%), Switzerland, and Bermuda plus Caribbean tax havens (8%–9% each).[2] One of the authors of this research was also quoted as saying: “Ireland solidifies its position as the #1 tax haven.”; and also that: “U.S. firms book more profits in Ireland than in China, Japan, Germany, France & Mexico combined. Irish tax rate: 5.7%.”[28]

Tools and techniques[edit]

Research identifies three main BEPS techniques used for "shifting" profits to a corporate tax haven via OECD-compliant BEPS tools:[29][30]

  1. IP-based BEPS tools,[e] which enable the profits to be extracted via the cross-border charge-out of internal virtual IP assets (known as "intergroup IP charging"); and/or
  2. Debt-based BEPS tools, which enable the profits to be extracted via the cross-border charge-out artificially high interest (known as "earnings stripping"); and/or
  3. TP-based BEPS tools,[e] shifts profits to the haven by asserting that a process performed in the haven (e.g., contract manufacturing), justifies a large increase in the transfer price ("TP") at which the finished product is charged-out by the haven to higher-tax jurisdictions.

BEPS tools could not function if the corporate tax haven did not have a network of bilateral tax treaties that accept the haven’s BEPS tools, which "shift" the profits to the haven. Modern corporate tax havens, who are the main global BEPS hubs, have extensive networks of bilateral tax treaties.[31] The U.K. is the leader with over 122, followed by the Netherlands with over 100.[32][33] The blacklisting of a corporate tax haven is a serious event, which is why major BEPS hubs are OECD-compliant. Ireland was the first major corporate tax haven to be blacklisted by a G20 economy; Brazil, in September 2016.[34][35]

An important academic study in July 2017 published in Nature, "Conduit and Sink OFCs", showed that the pressure to maintain OECD-compliance had split corporate-focused tax havens into two different classifications: Sink OFCs, which act as the terminus for BEPS flows, and Conduit OFCs, which act as the conduit for flows from higher-tax locations to the Sink OFCs. It was noted that the 5 major Conduit OFCs, namely, Ireland, the Netherlands, the United Kingdom, Singapore and Switzerland, all have a top-ten ranking in the 2018 Global Innovation Property Centre (GIPC) IP Index".[19]

Profitability of U.S. subsidiaries (2015 BEA data).[27]

Once profits are "shifted" to the corporate tax haven (or Conduit OFC), additional tools are used to avoid paying headline tax rates in the haven. Some of these tools are OCED-compliant (e.g. patent boxes, Capital Allowances for Intangible Assets ("CAIA") or "Green Jersey"), others became OECD-proscribed (e.g. Double Irish and Dutch Double-Dipping), while others have not attracted OECD attention (e.g. Single Malt).

Because of the need for BEPS hubs (or Conduit OFCs) to have extensive bilateral tax treaties (e.g. so that their BEPS tools will be accepted by the higher-tax locations), they go to great lengths to obscure the fact that effective tax rates paid by multinationals in their jurisdiction are close to zero percent, rather than the headline corporate tax rate of the haven (see Table 1). Higher-tax jurisdictions do not enter into full bilateral tax treaties with obvious tax havens (e.g. the Cayman Islands, a major Sink OFC). This is achieved with financial secrecy laws, and by the avoidance of country-by-country reporting ("CbCr") or the need to file public accounts, by multinationals in the haven's jurisdiction. BEPS hubs (or Conduit OFCs) strongly deny they are corporate tax havens, and that their use of IP is as a tax avoidance tool.[36] They call themselves "knowledge economies".[37]

Make no mistake: the headline rate is not what triggers tax evasion and aggressive tax planning. That comes from schemes that facilitate profit shifting.

— Pierre Moscovici, EU Commissioner on Taxation, Financial Times, 11 March 2018[38]

The complex accounting tools, and the detailed tax legislation, that corporate tax havens require to become OECD-compliant BEPS hubs, requires both advanced international tax-law professional services firms, and a high degree of coordination with the State, who encode their BEPS tools into the State's statutory legislation.[39][40] Tax investigators call such jurisdictions "captured states",[41][42][43] and explain that most leading BEPS hubs started as established financial centres, where the necessary skills and State support for tax avoidance tools, already existed.[44][45]

Complex agendas[edit]

James R. Hines Jr. testifying to the Senate Finance Committee on Corporate Taxation in 2016. Hines is the most cited academic on research into tax havens.[46] His 1994 Hines-Rice paper is the most cited paper in all tax haven research,[46] and its insight that the U.S. could benefit from allowing its multinationals to use tax havens and profit shifting tools, dictated U.S. tax policy for decades.[3][2]

The BEPS tools used by tax havens have been known and discussed for decades in Washington.[47] For example, when Ireland was pressured by the EU-OECD to close its double Irish BEPS tool, the largest in history, to new entrants in January 2015,[48] existing users, which include Google and Facebook, were given a 5-year extension to 2020.[49] Even before 2015, Ireland had already publicly replaced the double Irish with two new BEPS tools: the single malt (as used by Microsoft and Allergan), and capital allowances for intangible assets ("CAIA"), also called the "Green Jersey", (as used by Apple in Q1 2015).[50][51] None of these new BEPS tools have been as yet proscribed by the OECD.[52] Tax experts show that disputes between higher-tax jurisdictions and tax havens are very rare.[53]

Tax experts describe a more complex picture of an implicit acceptance by Washington that U.S. multinationals could use BEPS tools on non-U.S. earnings to offset the very high U.S. 35% corporate tax rate from the historical U.S. "worldwide" corporate tax system (see source of contradictions).[54] Other tax experts, including a founder of academic tax haven research, James R. Hines Jr., note that U.S. multinational use of BEPS tools and corporate tax havens had actually increased the long-term tax receipts of the U.S. exchequer, at the expense of other higher-tax jurisdictions, making the U.S a major beneficiary of BEPS tools and corporate-tax havens.[3][4][55]

Lower foreign tax rates entail smaller credits for foreign taxes and greater ultimate U.S. tax collections (Hines and Rice, 1994).[56] Dyreng and Lindsey (2009),[4] offer evidence that U.S. firms with foreign affiliates in certain tax havens pay lower pay lower foreign taxes and higher U.S. taxes than do otherwise-similar large U.S. companies.

— James R. Hines Jr., "Treasure Islands" p. 107 (2010)[3]

The 1994 Hines-Rice paper[56] on U.S. multinational use of tax havens was the first to use the term profit shifting.[5] Hines-Rice concluded that: low foreign tax rates [from tax havens] ultimately enhance U.S. tax collections.[56] For example, the Tax Cuts and Jobs Act of 2017 ("TCJA") levied 15.5% on the untaxed offshore cash reserves built up by U.S. multinationals with BEPS tools from 2004-2017. Had these U.S. multinationals not used BEPS tools, and paid their full foreign taxes, their foreign tax credits would have removed most of their residual exposure to any U.S. tax liability, under the U.S. tax code.

The U.S. was one of the only major developed nations not to sign up to the 2016 § OECD BEPS Project to curtail BEPS tools.[1]

OECD BEPS Project[edit]

The 2012 G20 Los Cabos summit tasked the OECD to develop a BEPS Action Plan,[57][58] which 2013 G-20 St. Petersburg summit approved.[59] An OECD BEPS Multilateral Instrument, consisting of 15 Actions designed to be implemented domestically and through bilateral tax treaty provisions, were agreed at the 2015 G20 Antalya summit.

The OECD BEPS Multilateral Instrument ("MLI"), was adopted on 24 November 2016 and has since been signed by over 78 jurisdictions. It came into force in July 2018. Many tax havens opted-out from several of the Actions, including Action 12 (Disclosure of aggressive tax planning), which was considered onerous by corporations who use BEPS tools.

Former Irish Taoiseach Enda Kenny (l), and PwC Partner Feargal O'Rourke (r) architect of two of the largest BEPS tools in the world, the Double Irish (including Microsoft, Google, Facebook, IBM, Johnson & Johnson and Pfizer, amongst many others), and the Green Jersey (as used by Apple in their Q1 2015 "leprechaun economics" restructuring in Ireland).[60]

Global legal firm Baker McKenzie,[61] representing a coalition of 24 multinational US software firms, including Microsoft, lobbied Michael Noonan, as [Irish] minister for finance, to resist the [OECD MLI] proposals in January 2017. In a letter to him the group recommended Ireland not adopt article 12, as the changes “will have effects lasting decades” and could “hamper global investment and growth due to uncertainty around taxation”. The letter said that “keeping the current standard will make Ireland a more attractive location for a regional headquarters by reducing the level of uncertainty in the tax relationship with Ireland’s trading partners”.

— Irish Times. "Ireland resists closing corporation tax ‘loophole’" (10 November 2017)[62]

The acknowledged architect of the largest ever global corporate BEPS tools (e.g. Google and Facebooks' Double Irish and Apple's Green Jersey), tax partner Feargal O'Rourke from PriceWaterhouseCoopers ("PwC), predicted in May 2015 that the OECD's MLI would be a success for the leading corporate tax havens, at the expense of the smaller, less developed, traditional tax havens, whose BEPS tools were not sufficiently robust.[63]

In August 2016, the Tax Justice Network's Alex Cobham described the OECD's MLI as a failure due to the opt-outs and watering-down of individual BEPS Actions.[64] In December 2016, Cobham highlighted that one of the critical anti-BEPS Actions, full public country-by-country-reporting ("CbCr"), had been dropped due to lobbying by the U.S. multinationals.[65] CbCr is the only way to conclusively observe the level of BEPS activitiy and OECD compliance in any country.

In June 2017, a U.S. Treasury official explained that the reason why U.S. refused to sign up to the OECD's MLI, or any of its Actions, was because: "the U.S. tax treaty network has a low degree of exposure to base erosion and profit shifting issues".[1][66]

Impact of the TCJA[edit]

Apple's Q1 2015 Irish quasi-tax inversion of USD 300 billon in IP, is the largest BEPS transaction in history, and double the blocked 2016 USD 160 billion Pfizer-Allergan Irish inversion.[11] Due to Irish secrecy laws, the transaction was only confirmed in January 2018, and was labelled "Leprechaun economics" by Nobel Prize-winning economist, Paul Krugman.

The Tax Cuts and Jobs Act of 2017 ("TCJA") moved the U.S. from a "worldwide" corporate tax system to a hybrid[f] "territorial" tax system. The TCJA includes anti-BEPS tool regimes including the GILTI-tax and BEAT-tax regimes. It also contains its own BEPS tools, namely the FDII-tax regime.[g] The TCJA could represent a major change in Washington's tolerance of U.S. multinational use of BEPS tools. Tax experts in early 2018 forecast the demise of the two major U.S. corporate tax havens, Ireland and Singapore, in the expectation that U.S. multinationals would no longer need foreign BEPS tools.[67]

However, by mid-2018, U.S. multinationals had not repatriated any BEPS tools,[h] and the evidence is that they have increased exposure to corporate tax havens. In March-May 2018, Google committed to doubling its office space in Ireland,[68] while in June 2018 it was shown that Microsoft is preparing to execute Apple's Irish BEPS tool, the "Green Jersey" (see Irish experience post-TCJA).[69] In July 2018, one of Ireland's leading tax experts forecasted a potential boom in U.S. multinationals on-shoring their BEPS tools from the Caribbean to Ireland, and not to the U.S. as was expected after TCJA.[70]

In May 2018, it was shown that the TCJA contains technical issues that incentivise these actions.[71] For example, by accepting Irish tangible, and intangible, capital allowances in the GILTI calculation, Irish BEPS tools like the "Green Jersey" enable U.S. multinationals to achieve U.S. effective tax rates of 0-3% via the TCJA's foreign participation relief system.[72] There is debate as to whether these are drafting mistakes to be corrected, or concessions to enable U.S. multinationals to reduce their effective corporate tax rates to circa 10% (the Trump administration's original target).[73]

See also[edit]

Notes[edit]

  1. ^ These are also the largest offshore financial centres ("OFCs"); a term considered by academics to be synonymous with the term tax haven
  2. ^ Green Jersey was the BEPS tool Apple used in Q1 2015 to restructure its non-U.S. IP. It created the famous "leprechaun economics" event in Ireland in August 2016, when restated Irish GDP rose 34.4% in a single quarter
  3. ^ a b The critical component of the most important BEPS tools is intellectual property ("IP"), which the BEPS tool converts into a charge that is deductible against pre-tax income. Technology and Life Sciences industries have the largest pools of IP.
  4. ^ The paper lists tax havens as: Ireland, Luxembourg, Netherlands, Switzerland, Singapore, Bermuda and Caribbean havens (page 6.)
  5. ^ a b Some academics consider IP-based BEPS tools to be a subset of TP-based BEPS tools (e.g. the corporate is transfer pricing the IP like any other product), however others consider IP to be a unique item (e.g. the IP is a virtual product whose value is decided internally by the corporation; it is more of an accounting invention rather than a tangible good), that it is a separate set.
  6. ^ The TCJA system is described as hybrid, because it still forces minimum U.S. tax rates on foreign income under the TCJA GILTI regime
  7. ^ The FDII regime allows U.S. multinationals to charge-out intellectual property ("IP") direct from the U.S., at a preferential 13.125% U.S. tax rate
  8. ^ This is not to be confused with the repatriation of the circa USD 1 trillion in offshore untaxed cash; these are the intellectual property ("IP") assets that U.S. multinationals house in locations like Ireland which are the raw materials for the BEPS tools. A repatriation of a major U.S. multinational BEPS tool would cause reverse-leprechaun economics events in various tax havens

References[edit]

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  61. ^ "After a Tax Crackdown, Apple Found a New Shelter for Its Profits". The New York Times. 6 November 2017. A key architect [for Apple] was Baker McKenzie, a huge law firm based in Chicago. The firm has a reputation for devising creative offshore structures for multinationals and defending them to tax regulators. It has also fought international proposals for tax avoidance crackdowns.
  62. ^ Jack Power (10 November 2017). "Ireland resists closing corporation tax 'loophole'". The Irish Times.
  63. ^ "Scion of a prominent political dynasty who gave his vote to accountancy". The Irish Times. 8 May 2015. Of the wider tax environment, O’Rourke thinks the OECD base-erosion and profit-shifting (BEPS) process is “very good” for Ireland. “If BEPS sees itself to a conclusion, it will be good for Ireland.”
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  65. ^ "OECD's BEPs measures seriously flawed". economia. 9 December 2016. The major problem, it says, has been the decision by the Organisation in 2013 when it came up with its standard on country-by-country reporting (CBCR) to give into intense lobbying, largely from US multinationals, and place limits on access to the data.
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  67. ^ Mihir A. Desai (June 2018). "Tax Reform: Round One". Harvard Magazine.
  68. ^ "Google, Facebook and Salesforce.com dramatically expand their Dublin office hubs". Irish Independent. 26 July 2018.
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  70. ^ Seamus Coffey, Irish Fiscal Advisory Council (18 July 2018). "When can we expect the next wave of IP onshoring?". IP onshoring is something we should be expecting to see much more of as we move towards the end of the decade. Buckle up!
  71. ^ Ben Harris (25 May 2018). "6 ways to fix the tax system post TCJA". Brookings Institution.
  72. ^ "A Hybrid Approach: The Treatment of Foreign Profits under the Tax Cuts and Jobs Act". Tax Foundation. 3 May 2018.
  73. ^ "Donald Trump seeks to slash US corporate tax rate". Financial Times. 27 September 2017. Cutting the official corporate tax rate to 20 per cent from its present 35 per cent — a level that US companies say hurts them in global competition — would leave companies short of the 15 per cent Mr Trump promised as a candidate

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