OECD's proposed system needs government, taxmen on board
The OECD's base erosion and profit shifting (BEPS) initiative seeks to create a tax system based on concepts reflecting years of financial and technological innovation so that countries can effectively tax the economic activity of global business. While its intent centers on promoting greater tax transparency, getting into the details around BEPS quickly brings the discussion into the realm of incomprehensible tax jargon for many people.

So let's strip away the technical changes, and look at the origins of BEPS and what it means for the global tax system. Let's understand what factors led to the current proposals for fundamental changes to the global tax system, and what changed people's sense of tax morality.

As with many significant events, there is no one cause. Let's start with governments, who, like most of us, eventually have to balance their books. They have income (taxes) and expenses, and any deficit has to be made up by borrowings. Before the global financial crisis, a significant portion of the developed world was running up increasing deficits - some still are. Then the crisis happened and everyone including governments needed to tighten their belts.

Many governments have limited ability to control the expense side of their budget. Fixed expenditures and changing demographics are causing rising expenditure in areas such as the provision of medical services and the payment of pensions. All of this put more attention on the tax side of the equation.

What had been happening on the tax side? Clearly global tax systems largely based on old-style manufacturing-based economies had not kept pace with globalization.

Increasingly mobile companies were setting up their business in ways which minimized their overall tax liability. Companies are able to earn significant revenues from a country without having any presence in that country.

Without such a presence, existing tax rules struggled to find an activity to tax. None of this was or is illegal. However, it does mean that tax liabilities became disassociated from the source of economic profits and value creation.

Many media stories describe how global companies made profits in many countries without any associated tax liabilities arising. A new tax morality discussion, fuelled by media stories, started to emerge but local tax authorities found it increasingly difficult to tax global businesses in a meaningful way.

Clearly, the tax system in many countries was broken and needed to be reset to bring it into line with the modern world.

There were a number of other factors adding to the global tax disconnect including:
  • Tax competition - many countries were reducing corporate tax rates and/or introducing special tax incentives to attract or retain business;
  • Tax havens offering low or no taxes;
  • Financial and technological innovation which made "money" and "business" increasingly fluid concepts; and
  • The existence of a global network of financial, legal and tax advisers assisting business to legally minimize their tax expense.
So, for all of these reasons, the new world needs a new tax system. The OECD stepped into the breach to offer solutions based on resetting the tax system to better align economic and tax outcomes. Hence, BEPS was born, proposing changes designed to create a new basis for taxing global companies on their economic profits, while limiting their ability to shift these profits via financial means or other innovative methods. But, will this work? We need to remember that the OECD is not a law-making body and all of its proposals need to be passed into law by national governments.

The big challenge for the BEPS-based tax system is that it needs to operate globally. This means that governments and tax authorities need to work together. We need aligned tax rules, international agreements and quick and effective global tax dispute resolution. We need an end to harmful tax competition between countries.

There are a number of unanswered questions including:
  • Will countries put aside the culture of tax competition?
  • Will some countries be seeking to tax more of the global profits of a company?
  • How will other nations react to such changes?
  • How will companies react to all of these changes? Will they migrate to countries which continue to offer tax incentives?
Forty-four countries have agreed politically on the next raft of measures but detailed implementation has yet to occur. What of the other countries around the globe? As the OECD does not make law, there is no guarantee of consistent implementation. There are reasons for this uncertainty regarding implementation. These include indications that some countries are not comfortable with the detail of various measures. There is also flexibility in some areas of the OECD recommendations, which means that rules will not always be aligned.

Added to this, there are also countries which appear to be running ahead of the OECD process. For example, Australia is conducting a detailed review of technology companies in consultation with some other tax authorities.

Lastly, mutual agreement or negotiation between countries on tax issues is notoriously difficult, and there is little to suggest that this will change.

Ultimately, while there may be alignment and enlightenment at the OECD level, how this process will play out in the trenches of tax administrations is not yet clear.

So, the modern world needs a modern tax system and the OECD has the template. The question now is whether this can be implemented in a coherent manner by the various governments around the globe.
This article was contributed by Simon Clark, Regional Partner, Alternative Investments at KPMG in Singapore. The views expressed are his own.
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