Base erosion and profit shifting (BEPS) is a category of corporate tax avoidance strategies used by multinationals to "shift" profits from higher-tax jurisdictions to lower-tax jurisdictions or no-tax locations where there is little or no economic activity, thus "eroding" the "tax-base" of the higher-tax jurisdictions using deductible payments such as interest or royalties. For the government, the tax base is a company's income or profit. Tax is levied as a percentage on this income or profit. When that income or profit is transferred to a tax haven, the tax base is eroded and the company does not pay taxes to the country that is generating the income. As a result, tax revenues are reduced and the country is disadvantaged. The Organisation for Economic Co-operation and Development (OECD) define BEPS strategies as "exploiting gaps and mismatches in tax rules". Relatively few tactics have been deemed illegal, while the majority have no associated penalty. Businesses that operate across borders can utilize BEPS to obtain an advantage over domestic businesses, while potentially undermining the authority and integrity of jurisdictions' tax systems. Because developing nations rely more heavily on corporate income tax, they are disproportionately affected by BEPS.
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 "CAIA tool"). BEPS activities cost nations 100–240 billion dollars in lost revenue each year, which is 4–10 percent of worldwide corporate income tax collection. It is alleged that BEPS tools are associated mostly with American technology and life science multinationals. A few studies showed that use of the BEPS tools by American multinationals maximized long-term American Treasury revenue and shareholder return, at the expense of other countries.
Scale In January 2017 the OECD estimated that BEPS tools are responsible for tax losses of circa $100–240 billion per annum. In June 2018 an investigation by tax academic Gabriel Zucman (et alia), estimated that the figure is closer to $200 billion per annum. 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. The effect of BEPS tools is most felt in developing economies, who are denied the tax revenues needed to build infrastructure.
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) as our economy is changing to become more digital and knowledge based. IP is described as the raw materials of tax avoidance, and IP–based BEPS tools are responsible for the largest global BEPS income flows. Intangible assets such as patents, designs, trademarks (or brands) and copyrights are usually easy to identify, value and transfer, which is why they are attractive in tax planning structures for multinational companies, especially since these rights are not generally geographically bound and are therefore highly mobile. As a result, they can be relocated without significant costs using planned licensing structures. Several multinational companies use IP structuring models to separate the ownership, funding, maintenance and use rights of intangible assets from the actual activities and physical location of intangible assets to operate in a manner that the income made from the intangibles in one location is received in another location with a low or no tax regime. As such IP models have a meaningful role in the taxation of multinationals. Multinationals, for instance can establish licensing and patent holding companies suitable for offshore locations to acquire, exploit, license or sublicense IP rights for their foreign subsidiaries. Then profits can be shifted from the foreign subsidiary to the offshore patent owning company where low to no taxes are applied on the royalties earned. Any fees derived by the licensing and patent holding company from the exploitation of the intellectual property will be exempt from the tax or subject to a low tax rate in the tax haven jurisdiction, these companies can also be used to avoid high withholding taxes that are normally charged on royalties coming from the country in which they are derived, furthermore they can be reduced by double taxation treaties between countries. Many countries allow for the deductions in respect of expenditure on research and development (R&D) or on the acquisition of IP. As such MNE's can set up R&D facilities in countries where the best tax advantage can be obtained. As such MNEs can make use of an attractive research infrastructure and generous R&D tax incentives in one country and benefit in another from low tax rates on the income from exploiting intangible assets.
IP tax planning models such as these successfully result in profit shifting which in most instances may lead to base erosion of the tax base. Corporate tax havens have some of the most advanced IP tax legislation in their statute books.
Intra group debts are another common way multinationals avoid taxes. Intra-group debts are particularly simple to use, as they do not involve third parties and "can be created with the wave of a pen or keystroke". They often do not require any movement of assets, functions or personnel within a corporate group, nor any major change of its operations. Furthermore, intra-group debts provide significant flexibility for manipulations, as explained in a paper released by the United Nations. The popularity of using intra-group debts as a tax avoidance tool is further enhanced by the fact that in general they are not recognized under accounting standards and therefore do not affect consolidated financial statements of MNEs. It is not surprising that the OECD describes the BEPS risks arising from intra-group debt as the "main tax policy concerns surrounding interest deductions" (emphasis added).
Most BEPS activity is also most associated with U.S. multinationals, and is attributed to the historical U.S. "worldwide" corporate taxation system. Before the Tax Cuts and Jobs Act of 2017 (TCJA), the U.S. was one of only eight jurisdictions to operate a "worldwide" tax system. 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; post the 2017 TCJA, this happens in the U.S. via the FDII-regime).
Research in June 2018 identified Ireland as the world's largest BEPS hub. Ireland is larger than the aggregate Caribbean tax haven BEPS system, excluding Bermuda. The largest global BEPS hubs, from the Zucman–Tørsløv–Wier table below, are synonymous with the top 10 global tax havens:
Zucman–Tørsløv–Wier. Missing Profits of Nations. Table 1: Shifted Profits (2015) Profits shifted($2015 bn) Jurisdiction Headline corporate tax rate(all firms) (%) Effective corporate tax rate(foreign firms) (%) 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 42 Puerto Rico 37.5 3 39 Hong Kong 18 18 24 Bermuda 0 0 13 Belgium 25 19 12 Malta 35 5
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). One of the authors of this research was also quoted as saying, "Ireland solidifies its position as the #1 tax haven.... U.S. firms book more profits in Ireland than in China, Japan, Germany, France & Mexico combined. Irish tax rate: 5.7%."
Tools
Research identifies three main BEPS techniques used for "shifting" profits to a corporate tax haven via OECD-compliant BEPS tools:
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, which are the main global BEPS hubs, have extensive networks of bilateral tax treaties. The U.K. is the leader with over 122, followed by the Netherlands with over 100. 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.
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 five 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.
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 the tools are OECD-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 BEPS hubs (or Conduit OFCs) need 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). That 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. They call themselves "knowledge economies".
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. Tax investigators call such jurisdictions "captured states", 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.
Agendas
The BEPS tools used by tax havens have been known and discussed for decades in Washington. 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, existing users, which include Google and Facebook, were given a five-year extension to 2020. 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). None of these new BEPS tools have been as yet proscribed by the OECD. Tax experts show that disputes between higher-tax jurisdictions and tax havens are very rare.