In February this year, the Organisation for Economic Co-operation and Development (OECD) released its report on base erosion and profit shifting (BEPS). Substantively, the report presented nothing new as it largely restated previous work in this space. It is notable, however, because it demonstrates clearly that BEPS has become an important political issue, both for OECD and non-OECD countries, and that there is likely to be momentum behind the OECD’s work in this space that was perhaps lacking prior to the financial crisis.

Key Findings

The report was published against the backdrop of a furore over a perceived lack of integrity in the international tax system. Overall, however, the report is relatively even-handed. It notes that much of the criticism derives from a relatively simplistic analysis of the issue by civil and governmental organisations, and admits that it is fair to ask whether the structures being criticised are in fact a function of incoherent policy-making by governments that provide incentives for BEPS. It also alludes to the duty of companies to their shareholders to mitigate their tax costs, which are likely to be one of the largest costs for any multinational business.

Empirical Evidence

The report concludes that there is no empirical evidence that proves either the existence or extent of BEPS. For example, whilst the statutory corporate income tax rates in OECD member countries dropped on average by 7.2 percentage points between 2000 and 2011 (from 32.6 per cent to 25.4 per cent), the corporate tax burden (as measured by the corporate tax-to-gross domestic product ratio) actually rose during this period, although this could be attributable to base-broadening measures, increases in incorporations of businesses and an overall increase in business profits.

The report is keen to stress the fact that there is plenty of circumstantial evidence supporting the existence of BEPS, including the levels of direct investment in tax haven countries, but that BEPS is only one factor affecting the tax yield in a given country.

Business Models

In the absence of any substantive empirical evidence on BEPS, the report therefore focuses principally on structural issues. In particular, the widespread phenomenon of the separation of business activities from profit-reporting locations is at the core of the report, and the report seems to view with suspicion the increasing prevalence of long global value chains that involve the fragmentation of production and of value-adding across borders.

The report also focuses specifically on e-business and intangibles. It voices strong concerns about the ease with which the risk and reward in respect of such assets can be located in jurisdictions that can bear no relationship to the associated profits, and which have the effect of reducing the overall effective tax rate of the multinational enterprise involved.

The report does, nevertheless, go on to conclude that the phenomenon of supply chain fragmentation is simply a function of the current rules on international tax having become outmoded. It sees this as a consequence of those rules having failed to keep pace with globalisation and the way in which multinational enterprises now do business.

Tax Incentives

The report also touches on the impact of state-sponsored tax incentives. It notes that these may lead to a multinational enterprise having a low effective tax rate in an entirely uncontroversial manner,e.g., where a government policy to encourage investment in a particular sector gives rise to a tax break. It also flags, however, the potential for distortion in a global economy where sovereign states compete with each other to attract inward investment by offering competitive tax systems. On this specific point, the report encourages a multilateral approach to the problem to avoid a "race to the bottom" and encourages states to look again at the OECD’s previous work on the characteristics of potentially harmful tax regimes.

Proposed Next Steps

The report is facilitative in nature and does not propose concrete solutions; its main purpose is apparently to keep the international discussions on BEPS going. It proposes the development of an action plan to address BEPS, which is expected to be presented to G20 leaders later in 2013.

What is any such plan likely to consist of ? The BEPS report identifies an extensive list of international tax principles that the OECD recommends be overhauled, including transfer pricing rules on intangibles. It also identifies an array of rules that countries could introduce unilaterally on a domestic level, such as controlled foreign company rules, anti-arbitrage rules and enhanced information exchange initiatives. Yet many of these kinds of rules already exist in sophisticated tax regimes, and even a simple overhaul of a pre-existing regime can take years. Revision of international principles at the OECD level frequently takes even longer. Recent experience in the area of transfer pricing on intangibles suggests that this area alone could keep international tax policy-makers occupied for years to come. All this suggests that the report’s proposition that a multilateral consensus on a suitable way forward could be reached at the international level within the next six months is, to say the least, ambitious.

The most likely scenario is that, in the short term, the BEPS action plan will simply be a restatement of the conclusions reached in the BEPS report, which will receive enhanced political backing in the form of G20 approbation towards the end of the year. In the medium to longer term, there are likely to be relatively focused changes that deal with transfer pricing on intangibles (already in fact underway) and taxation of e-business transactions, which may move towards a "place of consumption" principle.

Change may be slow in coming. Different countries retain their own tax systems and the power to change them, and the OECD can only recommend changes, it cannot require them. The OECD may seek to propose changes to its Model Tax Convention and the commentary thereon, but this will take time to filter into the existing treaty network, if it does at all (bearing in mind that the BRICS states—Brazil, Russia, India, China and South Africa—and other source-based economies do not adhere to the OECD principles). There does, however, seem to be a growing consensus that the existing international principles cannot deal properly with e-business transactions, which may lead to changes in this area appearing sooner.


It is perhaps tempting to dismiss the BEPS report as an attempt by the OECD to ensure it continues to be "relevant" in this space, given recent political and media pressure and vociferous criticism from the BRICS states of the underlying rationale for the current principles of international tax, in particular in the context of the arm’s length principle and its application to transfer pricing. Whilst the OECD is unlikely to seek wholesale revision of the international tax system that it has played a key role in establishing, the BEPS report does disclose something of a sea-change from a wider perspective. There is now clear political backing for some form of change to the international tax principles.

Even if the proposed timetable for reform is destined to fail, it seems clear that the idea of tackling BEPS has gained sufficient political momentum for real change to occur in due course. Multinational enterprises will therefore need to keep fully abreast of developments in order to ensure their supply chain structuring is compliant with whatever form the new rules take, and also to monitor the risk of double taxation where domestic law changes are made on a patchwork basis in an effort to tackle BEPS unilaterally.