In the 1980s, a rising tech company named Apple, Inc. began developing a revolutionary tax strategy, ultimately saving them billions of dollars in deferred taxes. Although pioneered by Apple, this approach to tax planning has been adopted by countless Multi-National Firms (MNFs). In order to avoid the high corporate taxes of the US, global corporations routinely employ clever tactics to legally shift profits to low-tax regions around the world. By 2015, Fortune 500 companies had stockpiled an estimated $2.1 Trillion cash in overseas tax havens such as Bermuda and the Cayman Islands.
While governments complained that these companies weren’t paying their “fair share,” global firms maintained that all they were doing was looking out for their shareholders and operating efficiently within an outdated tax system. If governments of the world wanted change, they would need to work together and completely rethink the international tax system.
Fortune 500 companies have stockpiled an estimated $2.1 Trillion cash in overseas tax havens
The Winds of Change
In June 2012, at a summit in Los Cabos, the G-20 officially launched the “BEPS Project.” In what may become the largest shift in international tax policy since the 1920s, the BEPS Project aims to eliminate discrepancies between tax systems across the globe and prevent MNFs from exploiting gaps to divert profits to favorable tax regions.
ABOUT THE G20
The G20 is made up of the finance ministers and central bank governors of 19 countries: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United Kingdom, the United States of America. The remaining seat is held by the European Union, which is represented by the rotating Council presidency and the European Central Bank.
The Group of Twenty (G20) Finance Ministers and Central Bank Governors was established in 1999 to bring together industrialized and developing economies to discuss key issues in the global economy.
The inaugural G20 summit took place in Berlin, December 1999, hosted by German and Canadian finance ministers. This year’s meeting will be held in Brisbane, Australia.
To carry out the BEPS Action Plan, the G-20 tasked the Organization for Economic Co-Operation and Development (OECD) with researching and developing a list of detailed recommendations. Learn more about the G-20 and their partnership with the OECD.
According to the Organization for Economic Co-operation and Development (OECD), Base Erosion and Profit Shifting (BEPS) refers to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid.
In laymen’s terms: BEPS is used by global corporations to legally minimize tax costs.
In the most common scenario, MNFs set up entities in low or no-tax locations in order to shift profits via transfer pricing in return for intangible “products” – for example, paying fees to a subsidiary for Intellectual Property (IP) rights.
While the real-world application of this concept is much more complex, the underlying strategy remains the same. In fact, these tactics have proven so effective that a whopping 70% of Fortune 500 companies now implement some version of this approach.
In 2012, the media publicized Starbucks’ ability to achieve an astounding 0% effective tax rate in the UK from 2009 to 2011 due to “lost” profits in the region. In response, British lawmakers launched tax practice investigations and citizens hit Starbucks locations in London to protest what they viewed as unethical tax avoidance. In response to the PR nightmare, Starbucks elected to donate over $20 million in taxes to the UK government and promised to relocate certain tax entities to London.
Even four years after Starbucks made headlines in England, the company still hasn’t managed to escape the spotlight. Recently, the European Commission ordered the coffee giant to return over 30 million dollars they say Starbucks received from the Netherlands in illegal tax breaks. And Starbucks isn’t the only MNF facing these enormous tax repayments; similar decisions from the EU are expected to be handed out to tech giants Apple and Amazon in the coming months. Although Multi-National Firms have been using profit shifting as an international tax strategy for decades, governments around the globe are working together like never before to bring an end to the practice.
Finally, if bad PR and potential tax repayments weren’t enough to convince MNFs to begin reanalyzing their tax strategy, the OECD just delivered a BEPS Action Plan to the G-20 in October that should make them reconsider. The BEPS Action Plan includes in-depth guidelines to help align the international community and advise governments on addressing issues such as treaty shopping, transfer pricing for intangible products, and hybrid-mismatch arrangements. Unlike many political and legislative change efforts that stagnate and die before being implemented, the OECD’s BEPS Action Plan has been developed swiftly and has the support and commitment from 62 governments around the world (to include the entire G-20).
Weathering the Storm
In the future, IP will be taxed not where it is notionally owned, but rather where it is created and used. Therefore, if a company wants to realize the benefits of an entity located in a low-tax region, they will need to actually create valuable IP in that region. Developing a strategy to comply will be highly complex and impact many organizations within MNFs. Furthermore, in an effort to provide transparency to governments, emerging laws will require firms to report employees, sales, profits, and assets by country. This new requirement will provide unprecedented transparency into operations, marketing, and sales; this will not just be a paper exercise for accountants and finance managers.
In the future, IP will be taxed not where it is notionally owned, but rather where it is created and used.
The bottom line is, no matter how you feel about these global tax strategies, the days of corporations logging billions in profits in low-tax regions overseas are coming to an end (unless, of course, substantial economic activity actually exists there). Tax compliance often requires months, or even years, of analysis and planning by companies to fully adapt to even the smallest shifts in policy “and the impending revisions will be of historic magnitude. Change is coming fast and will be here to stay. If you’re a corporation with significant operations overseas, it’s time to read the writing on the wall and undertake change now!
For a complete snapshot of the OECD BEPS Action Plan:
For more information, go straight to the source:
Contributing Author: Chris Wigley, Senior Associate, Transformation