BEPS Action Plans and Their Implications for International Tax Planning: The Why and How (With Case Studies).
Olatunji ABDULRAZAQ
Founder, Taxmobile.Online || Principal Partner, AOA Professional Services
The OECD’s Base Erosion and Profit Shifting (BEPS) Action Plan was launched in response to growing concerns about the ability of multinational enterprises (MNEs) to exploit loopholes in the global tax system. These strategies, such as profit-shifting and tax avoidance through low-tax jurisdictions, resulted in countries losing significant tax revenues. The BEPS Action Plan, consisting of 15 targeted actions, aims to close these loopholes and ensure that taxes are paid where economic activities occur and value is created.
In this newsletter, I explain why these actions were necessary and how they work to address the key concerns of tax authorities worldwide, while highlighting case studies that demonstrate the real-world impact.
Why BEPS Action Plans Were Necessary
1. Loss of Revenue for Governments: Many countries, especially high-tax jurisdictions, were losing significant tax revenues due to profit-shifting strategies employed by MNEs. Tax authorities found that corporate profits were being shifted to low or no-tax jurisdictions, even though the economic activities creating the profits were located elsewhere. This resulted in unfair competition and weakened national tax bases.
2. Mismatches in Global Tax Rules: The global tax system had not kept pace with the realities of an increasingly digital and globalized economy. Differences in tax treatment between jurisdictions created opportunities for tax arbitrage, allowing MNEs to exploit mismatches for tax benefits.
3. Lack of Transparency: The complexity of global operations made it difficult for tax authorities to gain a clear picture of how MNEs were allocating profits. This lack of transparency allowed MNEs to engage in aggressive tax planning strategies with minimal risk of detection.
4. Unfair Competition: By taking advantage of tax loopholes, some companies were able to reduce their tax burden significantly, creating an uneven playing field for businesses that operated solely within higher-tax jurisdictions and complied with local tax laws.
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How the BEPS Action Plans Address These Issues
1. Addressing the Tax Challenges of the Digital Economy (Action 1)
Why: The rise of the digital economy allowed companies to generate significant revenues in countries without a physical presence, making it difficult for those countries to tax the profits effectively.
How: Action 1 seeks to address the unique challenges posed by digital businesses, including introducing digital service taxes (DST) and expanding the definition of taxable presence.
Case Study: Google and France’s Digital Service Tax
France implemented a 3% DST in 2019 to tax digital giants like Google, Facebook, and Amazon, which generate significant revenues in the country without having a physical presence. This tax was designed to ensure these companies paid their fair share of taxes on their digital activities in France.
Why It Matters: This shift ensures that countries can tax digital revenues generated within their borders, regardless of physical presence. MNEs must now account for DSTs and rethink their tax structures to comply with new digital tax regulations.
2. Neutralizing the Effects of Hybrid Mismatch Arrangements (Action 2)
Why: Hybrid mismatch arrangements exploit differences in tax treatment between jurisdictions, resulting in double non-taxation or double deductions.
How: Action 2 seeks to neutralize the effects of hybrid mismatches by disallowing deductions for payments that result in double non-taxation and aligning tax treatment between jurisdictions.
Case Study: Starbucks and the Dutch Hybrid Mismatch
Starbucks used hybrid arrangements in the Netherlands to shift profits and reduce its tax burden in the UK. The European Commission's BEPS-related reforms and subsequent scrutiny led to a restructuring of these practices, ensuring that profits were taxed where value was created.
Why It Matters: MNEs using cross-border financing structures must ensure that hybrid instruments are not being used to generate tax benefits that violate BEPS principles. This requires a careful re-evaluation of tax planning strategies.
3. Limiting Base Erosion Involving Interest Deductions (Action 4)
Why: Excessive interest deductions allowed MNEs to shift profits by loading high-interest debt in high-tax jurisdictions and receiving tax deductions for those payments.
How: Action 4 limits the deductibility of interest expenses, ensuring that companies cannot use excessive debt to erode the tax base. Many countries have introduced limits on the percentage of EBITDA that can be deducted as interest.
Case Study: IKEA’s Interest Deduction Scheme
IKEA was accused of using intra-group loans to shift profits and reduce its tax burden in high-tax countries through interest deductions. As a result of BEPS Action 4, IKEA and similar companies had to adjust their financing structures to comply with new limitations on interest deductibility.
Why It Matters: MNEs must now ensure that interest deductions are in line with earnings, preventing the erosion of the tax base through excessive leverage.
4. Countering Harmful Tax Practices (Action 5)
Why: Preferential tax regimes, such as those for intellectual property (IP), allowed MNEs to benefit from low tax rates without substantial economic activity in those jurisdictions.
How: Action 5 ensures that preferential regimes, such as patent boxes, are only available to companies that have substantial business activities in the jurisdiction benefiting from the tax regime.
Case Study: Apple’s IP Regime in Ireland
Apple utilized Ireland's favorable IP tax regime to significantly reduce its tax burden. However, the European Commission found that Apple’s structure resulted in most of its profits escaping taxation. Action 5 has forced Ireland to align its tax rules with BEPS principles, requiring substantial economic activity for preferential tax treatment.
Why It Matters: MNEs must demonstrate genuine business operations in jurisdictions offering preferential tax rates for IP, ensuring that profit-shifting strategies no longer exploit such regimes.
5. Preventing Treaty Abuse (Action 6)
Why: Treaty shopping allowed companies to exploit tax treaties between countries to avoid paying taxes, often by routing investments through low-tax jurisdictions.
How: Action 6 introduces measures like the Principal Purpose Test (PPT) or Limitation on Benefits (LOB) provisions to ensure that treaty benefits are only available to businesses with substantial operations in both treaty jurisdictions.
Case Study: India-Mauritius Tax Treaty Abuse
For years, companies routed investments into India through Mauritius to take advantage of a favorable capital gains tax regime. In response to BEPS Action 6, India renegotiated its treaty with Mauritius, introducing limitations that prevent treaty abuse. Companies now need to prove a substantial presence in Mauritius to benefit from the treaty.
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Why It Matters: MNEs must ensure that tax benefits claimed under treaties are backed by substantial business operations. The focus is now on substance over form, and treaty shopping is no longer a viable strategy.
6. Preventing the Artificial Avoidance of Permanent Establishment (PE) Status (Action 7)
Why: Companies avoided taxable presence, or permanent establishment (PE), in countries where they generated profits by structuring their operations to avoid triggering PE status.
How: Action 7 expands the definition of PE and targets strategies such as contract splitting and dependent agent arrangements, which were used to avoid creating a taxable presence.
Case Study: Amazon’s Avoidance of PE in the UK
Amazon routed sales through its Luxembourg-based entity while maintaining a significant presence in the UK, avoiding PE status. As a result of BEPS Action 7, countries like the UK have updated their rules to ensure companies with substantial activities in their jurisdiction are taxed accordingly.
Why It Matters: MNEs must evaluate their business operations to ensure compliance with new PE rules, which make it more difficult to avoid taxable presence.
7. Aligning Transfer Pricing Outcomes with Value Creation (Actions 8-10)
Why: Transfer pricing rules allowed companies to shift profits to low-tax jurisdictions by overpricing or underpricing intra-group transactions, even when no actual value was created in those jurisdictions.
How: Actions 8-10 ensure that profits are aligned with where actual economic value is created, especially concerning intangible assets, risk, and capital allocation. These actions require that profits follow value-creating activities such as R&D, marketing, and risk management.
Case Study: GlaxoSmithKline’s Transfer Pricing Dispute
GlaxoSmithKline (GSK) was involved in a transfer pricing dispute with the US IRS, which argued that the company had shifted profits from its US operations to its UK headquarters. The case was settled for $3.4 billion. Under BEPS Actions 8-10, such strategies are subject to greater scrutiny, ensuring that profits are allocated based on real economic activity.
Why It Matters: MNEs must ensure that transfer pricing aligns with actual business operations and value creation, requiring robust documentation and functional analysis to support their pricing decisions.
8. Country-by-Country Reporting (Action 13)
Why: The lack of transparency made it difficult for tax authorities to assess whether profits were being properly allocated between jurisdictions. Country-by-country reporting (CbCR) enhances transparency by requiring MNEs to disclose their global activities and profits.
How: Action 13 introduces country-by-country reporting, which requires MNEs to provide tax authorities with a breakdown of their operations, taxes paid, and economic activities in each jurisdiction.
Case Study: LuxLeaks and Corporate Tax Avoidance
The LuxLeaks scandal exposed how multinational companies, including major brands, benefited from secret tax rulings in Luxembourg to reduce their tax liabilities globally. In response to such revelations, the BEPS Action 13 introduced CbCR, providing greater transparency on multinational tax practices.
Why It Matters: MNEs must now prepare detailed reports on their global operations, ensuring consistency and accuracy in tax reporting across all jurisdictions. This increases transparency and allows tax authorities to compare profits declared and taxes paid with actual economic activity in each country. Discrepancies can lead to audits, tax adjustments, and reputational damage.
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Conclusion: Why and How BEPS Action Plans Reshape International Tax Planning
The BEPS Action Plan has fundamentally reshaped the landscape of international tax planning. Why the action plans were necessary stems from the increasing complexity of the global economy, digitalization, and the need for fairness and transparency in the global tax system. Governments around the world were losing substantial tax revenues, and the playing field for businesses was uneven. How these action plans address these issues is by providing clear guidelines and introducing global tax measures to curb aggressive tax avoidance practices.
Multinational enterprises (MNEs) must now:
Prioritize Substance: Companies must ensure that profits are taxed where actual business activities and value creation occur. Tax structures that rely on low-tax jurisdictions without substance are now under severe scrutiny.
Adapt to Increased Transparency: With country-by-country reporting and the elimination of hybrid mismatches, MNEs are facing increased transparency requirements. Consistency in reporting global profits, activities, and taxes is essential.
Reconsider Transfer Pricing Strategies: Transfer pricing must align with the real economic functions performed by group entities. This means carefully documenting how value is created and how profits are allocated within the group.
Monitor Changes in Tax Treaties: The prevention of treaty abuse requires companies to engage in genuine economic activities in countries where tax treaties are leveraged. Tax planning strategies relying on treaty shopping are becoming obsolete.
Comply with New PE Rules: Avoiding permanent establishment status by artificially fragmenting business operations is no longer an effective strategy. MNEs must carefully assess whether their operations in a jurisdiction trigger tax liabilities under the new PE rules.
Reconsider Financing Structures: MNEs must review their financing structures, particularly concerning the use of debt, to ensure compliance with new limits on interest deductibility.
Real-World Impact
Case studies such as those involving Google in France, Starbucks in the Netherlands, Apple in Ireland, and GlaxoSmithKline’s transfer pricing disputes show that BEPS actions are not just theoretical measures—they are having real, tangible impacts on global tax planning. MNEs are being forced to adjust their tax structures to meet the new global standards, resulting in greater alignment of profits with value creation, increased tax compliance, and transparency.
In the post-BEPS era, MNEs need to shift away from aggressive tax avoidance strategies and focus on building tax structures that are robust, compliant, and sustainable in the long term. This new tax reality requires careful planning, constant monitoring of global tax changes, and a commitment to transparency and fairness in international taxation.
By addressing the why and the how, the BEPS Action Plan ensures that the international tax system is better equipped to handle the challenges of the 21st-century global economy. Multinational companies must now navigate this new framework, focusing on substance, transparency, and compliance to succeed in the evolving tax landscape.
Olatunji Abdulrazaq CNA, ACTI
Founder/CEO, Taxmobile.Online