On October 5, the OECD issued it formal recommendations on the Base Erosion and Profit Shifting (BEPS) Action Plan. These recommendations have been subsequently adopted by the G20. We acknowledge the monumental effort that has been put forth to produce a modernized international system of tax rules through the BEPS initiative.
The BEPS recommendations do not address every instance of complexity in the tax laws of the global economy. In fact, they probably will lead to some new challenges. On the other hand, they do lay out an updated outline for solving some of the issues that exist today and most particularly for the alignment of substantive economic activity with related taxation in countries where a business operates. The recommendations as a set make sense, although the optionality in them that was required to get to consensus in areas such as the digital economy, leaves a number of areas open to local country interpretation and some uncertainty, which is unfortunate.
Now on to Implementation
Lawmakers and tax administrators must now move to implementation – and there is a lot to be done. Depending on their form of government, countries will adopt their version of the BEPS concepts either through legislation, regulation, or tax treaty changes. The time frame for these changes will vary depending on the country involved. As I've written before, businesses do not have the luxury of curtailing operations and stopping business expansions or innovation, while governments work on updates to their respective tax systems. As such, speed is of the essence in terms of government adoption following consideration of both sovereign interests and the interests of business in general. Reasonable transition rules will be needed.
BEPS has as one of its fundamental principles the alignment of taxing rights with value adding activities. It will require some time and extensive implementation to determine if this is the actual outcome. Some of the unsettled elements of BEPS (e.g., the digital economy) will continue to provide challenges to companies as they plan their operations, and to sovereign governments, as they compete and attempt to have sensible tax rules and regulations. Local alternatives to broad principles are likely to drive increased tax controversy.
"Lawmakers and tax administrators must now move to implementation – and there is a lot to be done."
BEPS also initiates broad use of the country by country reporting concept which will provide significant additional information to tax administrations around the world. This information will hopefully be used in a constructive manner and not used for unprincipled revenue grabs. After all, trust among taxpayers and tax administrations is critical. Secure systems must be designed to safely and accurately maintain privacy of the very sensitive country by country reporting information as it is collected and shared among tax administrators.
What should CEOs and Company Boards do?
The risk now is that during the multi-year implementation phase, some of the mismatches that result in either double non-taxation or double taxation will continue. Additional mismatches may arise because of uneven adoption of the action items. .During this transitional period CEOs and company boards need to take an active role in tax policy for their companies. They need to factor in current law, possible implications of future law, and the intent or overall spirit of these laws. CEOs and boards will face some difficult decisions. Companies need to determine their risk tolerance across a wide range of constituencies and fit their tax planning to these factors.
What should tax administrators do?
Tax administrators must avoid the temptation to apply BEPS principles before they are embodied in their laws. The uncertainty and negative implications for both trade and foreign direct investment that retroactive or anticipatory BEPS principles application would cause cannot possibly be worth the revenues that it might generate. Further, trust in the system of tax administration for global business activities is central to the reestablishment of trust in many of our national institutions. Any activities by tax administrations that undermine trust and create more uncertainty is something our global economy cannot afford.
Tax policy remains an important consideration for investment
Elsewhere in this issue of CEO Insights, there are a number of articles by ministers of finance. A common theme of these articles is the need for attraction of business and the need for activities that are supportive of international trade. Governments must balance the need to tackle tax avoidance with incentives for investment to create an overall environment that supports and stimulates business. If taxpayers believe that operations will be taxed more than once as a result of laws that are not consistent across borders, it is likely that international trade will be hurt. There is no doubt that foreign direct investment and its related benefits of jobs and innovation will be attracted by countries that are favourable to such investment. Tax laws play an important role in this set of considerations, as does the political stability of investee countries and the stability of their systems of laws. No one aspect of these will be the determining factor, but in total, they do add up to a driver of business decision making.
Sovereign governments will continue to act in their respective best interests. To encourage foreign direct investment, research and development, and other forms of economic activity favourable to each country, they are likely to interpret the BEPS recommendations with a locally-favourable element. BEPS does not envision the end of competition for investment. At the same time, taxpayers will continue to need to focus on their activities, the economics of those activities, and do the things that help them avoid double taxation
I acknowledge that none of this is easy. These are uncertain times and the complexity of international business has never been greater. Our tax laws are generally out of date and, while not perfect, the BEPS initiative gives us our best chance in years to make some serious progress on these issues