BEPS Inclusive Framework, the urgency for developing countries

BEPS Inclusive Framework, the urgency for developing countries

The interest of this article is to test the importance of Base Erosion and Profit Shifting (BEPS) project initiated by Organization for Economic Co-operation and Development (OECD) and G20 for developing countries. This article will give hints on the integrity of BEPS project from its history, development progress, recommendation provided and current update.

Historically, the discussion on emerging case of BEPS had already started before 2012. In 2012, G20 Los Cabos summit tasked OECD to develop BEPS action plans. The OECD defines base erosion and profit shifting (BEPS) as tax planning strategies that exploit gaps in the architecture of the international tax system to artificially shift profits to places where there is little or no economic activity or taxation. A year after, in 2013, G20 St Petersburg summit approved the BEPS project proposed by OECD to be discussed and developed. After two years of discussion, BEPS package was agreed at the 2015 G20 Antalya summit, where 14 BEPS action plans already published with four minimum standards to be implemented.

If we go back further, OECD issued model tax convention with the latest update in 2014. Compared to United Nation model on tax treaty, it is clear that OECD MTC is clearly prone to the interest of developed countries, as typical for most of its members. On the other side, UN model on tax treaty give broader possibility for developing countries to extend its tax base to increase their tax revenue.

BEPS package in 2015 came with 14 actions to be resolved, and solutions is expected from long series of discussions, working parties, meeting and other variety of meeting between international tax experts and tax authorities of countries. Although being discussed with lengthy process, there are possible shortcomings overview of the BEPS package in respect of developing countries:

1.      The package recommends that it is impossible to ring fence the digital economy on BEPS Action 1 and they will keep on working on digital economy until 2020 by having Tax Force on Digital Economy (TFDE). This is a way to hide the lack of power to reveal the truth over political will of digital business exporter country. The integrity of BEPS package could also distorted for diverse interest of its member. (Morris, 2017)

2.      Each country keep their way of taxing, there is no effort on making the tax rules more congruent and coherent. An often mentioned as an example of hybrid mismatch is the use of Check the Box rules of IRS, but no slight intention or a sense of questioning the continuity of this tax philosophy.

3.      There is inconsistency on defining source versus resident country and active versus passive business income. Two country where two subsidiaries in a group reside, could be resident country in a cross border transaction and become source country in another cross border transaction. It means, this concept is quite aleatoire for a trade in a group.

4.      There is lack of intention to update the definition of Permanent Establishment (PE). The updates taken is the BEPS package is just trivial, not answering the most important part while the current definition of PE is way out of date relative to the current business reality. Lack of substantial improvement on definition of PE where developing economies could tax the economic activities in their regions (Avi-Yonah, 2007).

Several months after BEPS package were being finalized, BEPS Inclusive Framework (BEPS IF) was then proposed by the OECD, endorsed by G20 in February 2016 and launched in Committee on Fiscal Affair (CFA) meeting in Kyoto, 30 June 2016. Every jurisdiction that participates in the BEPS Inclusive Framework will have equal voice in reviewing and monitoring the implementation of the BEPS measures. The OECD/G20 BEPS Inclusive Framework’s mandate is to (Progress Report 2017/2018):

a.       Finalize the remaining technical work to address BEPS challenges, including with respect to the tax challenges of the digitalized economy;

b.      Ensure the implementation of the 4 BEPS minimum standard;

c.       Gather data to monitor the other aspects of implementation; and

d.      Support jurisdictions in their implementation of the BEPS package.

Willingness of developing countries to embrace the Base Erosion and Profit Shifting (BEPS) proposals could be clearly seen as there are 117 countries registered as member of BEPS IF as updated in August 2018.

From the flash observation of history, shortcoming overview of BEPS package and BEPS IF mandate, here are initial intuitions that could be researched further:

1.      BEPS is hardly being consistent in trying to answer the question posed on its basic objective, of which to ensure that profits are taxed where economic activities are carried out and value is created. Shifting strategy could be seen normal as a process on getting through the international tax problems, nevertheless the political pressure on its development is vivid. The BEPS Inclusive Framework is expected to provide measures to protect a country’s tax base, yet it seems as a second priority after the minimum standard since TFDE is only expected to result in 2020.

2.      Every participants in BEPS IF will be given an equal voice, so the advertisement said. Still, there is no such thing as having an equal voice in the development of standard setting and BEPS implementation monitoring. The four minimum standard has already decided, what kind of voice is expected to influence implementation? Valderrama mentions that there has not been a true decision-making process in BEPS IF (Mosquera, 2017). BEPS project could be used as a good excuse for bureaucrats of developing countries to travel abroad without enough bullets to address and argues in BEPS discussions meeting. In this case, what voice shall be considered equal?

3.      Asymmetry of information between BEPS IF project and participants could cause adverse selection and moral hazard.

BEPS IF is like saying, “Well, for all countries in the world that have not paid any attention on the hazardous effect of BEPS to your tax revenue, this is the time for you to join us! We will develop together the best international taxation policy to protect your tax base from evil multinational companies, and you all will have equal footing in it”.

“But hey, here is the thing that we have developed and we consider as very important and has ultimate truth to be implemented by all of us, the four actions of minimum standards. You have to implement this minimum standard in your country!”

When one party has more or better information than the other party, the adverse selection will occur. Country who has better information in BEPS IF and based on their information, it is better for the country not to be included in BEPS IF, then the list of registered member will be adversely selected. Only those who don’t understand BEPS IF will join, while possibly having little exposure in it.

On the other hand, countries that usually involved in unfair tax scheme, will join this framework, to make sure they are safe formally in doing their business as usual. This is called moral hazard. As an example, from the Forum on Harmful Tax Practices 2017 Progress Report (OECD, 2017), countries are classified on the preferential regime applied and the status of the regime. Interestingly, this review report could not address the comprehensive regime that could be exploited by a country. Netherland is only addressed on its innovation box regime and the status is not harmful.

This article assess the integrity of the BEPS IF for international taxation policy of developing country. The main conclusion is that the integrity of the BEPS IF to protect tax base of developing countries should be revisited. Moreover, the OECD should take into account the differences in fundamental of tax structure between developed and developing countries (Valderrama, 2008). Different tools in tax structure will lead to different most effective policy for each country. In the bright side, this BEPS IF has reawaken developing countries about the importance of their resources and how should they protect it to best interest of their people. Further research could be done by curtailing the four minimum standard, whose interest exactly are they for? The research could be induced by comparing economic exposure of each minimum standards actions on developed and developing countries.