Base Erosion and Profit Sharing

In another global monumental tax policy development this week, the G20 has agreed on a plan to tackle the practice of corporations shifting profits internationally to reduce their tax burden, referred to as “base erosion and profit sharing” (“BEPS“). In the St. Petersburg Declaration, the G20 endorsed the action plan proposed by the OECD (the “G20/OECD BEPS Project“) that will require the sharing of corporate tax information internationally with a view to ensuring that profits are not shifted to low-tax jurisdictions.

The OECD has been mandated by G20 to draw up a progress report on the G20/OECD BEPS Project by October of this year. The aim is to have a standard model for the sharing of corporate international tax information with measures to curb the practice of BEPS, together with a Model Competent Authority Agreement by February, 2014. The Global Forum on Transparency and Exchange of Information for Tax Purposes, an OECD forum, will establish a mechanism for monitoring and reviewing the implementation of the new standard model. By the end of 2015, it is expected that countries will automatically exchange corporate tax information.

The Declaration contains an action plan to address BEPS, including proposed measures to ensure that the global tax system can cope with challenges presented by the digital economy by identifying existing legal impediments. Once impediments have been identified, options to overcome legal difficulties in international tax corporate sharing and monitoring in the digital economy will be proposed for implementation. The G20 will also consider the development of treaty provisions and recommendations for neutralizing the effect of hybrid instruments and entities, along with the strengthening of existing controlled foreign corporation rules.

The action plan also proposes the creation of best practices for the design of rules to prevent base erosion through the use of interest expense, and points to the necessity of effective transfer pricing guidance on the pricing of related party financial transactions.

It also deals with consideration of intangibles, risks and capital, and high-risk transactions from a tax perspective. Part of the aim is the creation of rules to eliminate BEPS in respect of the movement of intangibles among G20 members, the transfer of risks among, or the allocation of excessive capital to, G20 members, and transactions which would not, or would only very rarely, occur between third parties.

Disclosure appears to be a key feature of the G20/OECD BEPS Project. The proposal being considered would require corporate taxpayers to provide governments with information on their global allocation of income, economic activity and taxes paid. And individual taxpayers would be required to disclose  aggressive tax planning arrangements. Much of this aspect of the proposal will likely be inconsistent with national privacy laws.

The G20 Summit, not surprisingly, also addressed a number of issues related to commodities derivatives trading, energy infrastructure developments,  climate change and anti-corruption, much of which made its way into the G20 Declaration as an action plan of sorts for the G20 nations over the next two years.

Regulation of Opaque Commodities Derivatives Market

The G20 called on its members to ensure the regulation and supervision of commodities derivatives trading, as recommended by the International Organization of Securities Commissions. Like carbon markets, the commodities derivatives market functions in what we call an opaque trading environment. It’s opacity and complexity makes it challenging to regulate. It also makes it susceptible to fraud.

Ironically, the opacity of the commodities derivates market is what makes it attractive to funds and despite pending regulation on the horizon, there has been a massive increase in trading in commodity derivatives over the past decade that far outstrips the growth in commodity production. Regulation and supervision has not kept pace with market development.  At the end of 2012, the OTC commodities derivatives market stood at USD$2.6 trillion in notional value, according to the Basel-based Bank for International Settlements, while the wider OTC derivatives market represented USD$633 trillion. The sheer amount is large enough to move markets and big enough to concern regulators.

Countries have individually implemented some regulations to address commodities derivatives trading but they are not consistent with each other and extraterritoriality issues prevail in respect of implementation.

There is a need for global regulation to ease compliance on financial institutions and ensure harmonization but there remain issues on the most effective route to take to achieve it as a matter of law.

Anti-Corruption, Money Laundering & Immigration 

The G20 also addressed the nexus between corruption and money laundering and recognized that corrupt officials must, by necessity, launder the proceeds of crime, usually internationally.  In that vein, they tasked the Financial Action Task Force with revising the 2012 Recommendations to address the gap in beneficial ownership arrangements (as exists with private corporations and trusts) in the context of money laundering curbs.

The G20 will also change immigration policy to vet foreign nationals for corruption as part of the immigration process, which will include vetting for verification of source of funds to ensure the funds are not proceeds of crime. There was also agreement to review existing immigrants in all member countries to determine if some members had been admitted with unverifiable funds or who may be corrupt, and an agreement to share that information internationally and to remove those foreign nationals from the destination country and return them to their homeland for prosecution. Finally, the G20 members agreed to mutual assistance in returning assets improperly removed from a country by corrupt officials.

Energy Infrastructure Regulation

The G20 members acknowledged that they will need to make sizable investments in energy infrastructure and to develop low carbon energy infrastructure, particularly in clean and sustainable electricity, in order to improve global economic performance in energy. The need to achieve legally reliable market functioning was also identified in the energy sector vis a vis sustainable energy.  It was recommended that G20 members participate, and take action in respect of the Energy Sustainability Working Group’s goals. The ESWG is a working group that is advocating for additional laws around energy infrastructure for, among other things, consumer protection of the process and transparency of energy procurement, although it is certainly not limited to those issues in terms of proposed regulatory reform.

UNFCCC Protocol & Climate Finance

The G20 reiterated its commitment to implementing the outcomes under the 1992 UN Framework Convention on Climate Change (“UNFCCC“) with a view to having a new protocol by 2015 that would be legally binding on all the parties. The Declaration stayed away from referring to implementation of Kyoto Protocol except to say that it may be referred to for the purposes of accounting and reporting of emissions. In addition to supporting the UN towards a new global protocol on climate regulation, the G20 will focus its efforts on climate finance over the next 12 months. Climate finance has also become the focus of the efforts of Executive Secretary of the UNFCCC, Christiana Figueres, and in particular the deployment of climate finance for emerging market economies and developing nations, the aim of which is to overcome barriers to effective climate finance worldwide.