OECD plans for gathering data on ‘base erosion’ at a disappointingly early stage, expert says

International plans for gathering and analysing data on the extent to which multinational companies are artificially shifting their profits to low-tax jurisdictions are at a disappointingly early stage, an expert has said.

Heather Self of Pinsent Masons, the law firm behind Out-Law.com, also said that the global governments involved in the Organisation for Economic Cooperation and Development (OECD) were wrong to treat the need for accurate data as “just another action item” on their checklist of measures to tackle international tax avoidance through base erosion and profit shifting (BEPS).

Self said that it was important for the OECD to be able to understand “the magnitude of the problem” that its BEPS project was trying to solve before producing its formal recommendations for global governments later this year. However, its new ‘discussion draft’ on item 11 (84-page / 1.9MB PDF) from its 2013 ‘Action Plan’ showed that this work was still at a “very early stage”, she said.

“I find it staggering that so much resource is being put into solving a problem without defining the size and scale of the problem first,” she said. “There are perceptions that BEPS is a major issue, but a distinct lack of evidence – and therefore a risk that any ‘solution’ is worse than the problem.”

The OECD is currently working on a single set of international tax rules which would prevent multinational companies from artificially shifting profits to low-tax jurisdictions. In July 2013, it set out 15 ‘actions’ to address the practice and set deadlines for implementation. The work is due to be completed by the end of 2015.

Among the measures that will be addressed by the OECD as part of the project are so-called ‘hybrid mismatch’ arrangements, which allow companies to claim tax relief for the same expense in two jurisdictions or which allow companies to claim tax relief in one jurisdiction without a corresponding tax charge in another. Its final recommendations will also prevent the abuse of tax treaties, ensure that transfer pricing rules do not allow companies to avoid being taxed in the jurisdictions where they make their profits and propose rules to prevent “excessive” income deductions.

Self said that while some of the policy objectives of the OECD’s project, such as the prevention of so-called ‘double non-taxation’, were uncontroversial and clearly designed to tackle abuse of the mismatches between different countries’ tax regimes. However, plans to “update the tax system for the digital world” could risk the introduction of disproportionate or damaging measures without effective data on the extent of the problems needing addressed, she said.

“Merely shifting taxable profits from one jurisdiction to another will not necessarily generate additional tax that would otherwise have been lost to avoidance,” she said.

“Updating the definition of ‘permanent establishment’ and transfer pricing arrangements for intangibles, such as intellectual property, are big areas for the OECD. To the extent that this is leading to non-taxation, then there is a BEPS problem: but in many cases compliance burdens will be increased for little extra tax overall,” she said.

One particular set of recommendations that are of “real concern” Heather Self saidare those relating to ‘action 4’ on the OECD’s plan: the deductibility of interest. In its discussion draft on interest, published in December 2014, the OECD suggested that excessive tax deductions for interest payments should be restricted, whether on a group-wide basis, by reference to a fixed ratio or through some combination of these two solutions. However, Self said that the introduction of a “one size fits all” approach without a proper understanding of the extent of the problem could lead to double tax in many cases, particularly where long-term infrastructure projects were involved.

“Hence data on the extent of the BEPS problem is a key requirement to ensure proportionality in the solutions – and it’s very disappointing that the work in this area is at such an early stage,” she said.

“I also think it is the wrong approach to treat this as just another action item on the plan. This needs input from a different group of stakeholders – governments, analysts, economists and others, rather than tax experts – and would surely have been better as a separate data-gathering exercise,” she said.

The OECD’s discussion draft assesses the effectiveness of existing data sources, sets out potential indicators of the scale and economic impact of BEPS and proposes two complementary approaches to estimating the scale of BEPS. It also identifies specific areas where input is required in order to move the monitoring and data-gathering aspects of the BEPS work forward, and asks for comment by 8 May 2015.