The OECD’s BEPS Project: The Emperor Has No Clothes

With all due respect, the OECD’s BEPS project was a fiasco, accomplishing little of any positive value and opening up a Pandora’s box with its focus on “value creation” in the context of transfer pricing. Despite all the “happy talk” coming out of the OECD and all the talk of a revolution in the global international tax system,1 there is nothing revolutionary in the BEPS project. One can’t help but be reminded of a line from Shakespeare: it is “full of sound and fury, signifying nothing.”2

The OECD’s BEPS project issued final reports on 15 Action items on October 5, 2015, and these were approved by the G20 in Antalya, Turkey, on November 16, 2015. The following is a review of what was accomplished by these final reports:

1. Action 1 (Address the tax challenges of the digital economy) — accomplished nothing, at least as far as income tax is concerned.3

2. Action 2 (Neutralise the effects of hybrid mismatch arrangements) – accomplished little.4

3. Action 3 (Strengthen CFC rules) — accomplished nothing.5

4. Action 4 (Limit base erosion via interest deductions and other financial payments) — accomplished little.6

5. Action 5 (Counter harmful tax practices more effectively, taking into account transparency and substance) — accomplished nothing other than to set some standards for “patent boxes” and the exchange of rulings.7

6. Action 6 (Prevent treaty abuse) — accomplished nothing.8

7. Action 7 (Prevent the artificial avoidance of PE status) — actually accomplished something.9

8-10. Actions 8-10 (Assure that transfer pricing outcomes are in line with value creation: intangibles, risks and capital, and other high-risk transactions) — made things worse by muddying the waters and basically allowing every tax authority to go off on its own aligning transfer pricing outcomes with “value creation” (whatever that means).10

11. Action 11 (Establish methodologies to collect and analyze data on BEPS and the actions to address it) — accomplished nothing.11

12. Action 12 (Require taxpayers to disclose their aggressive tax planning arrangements) — accomplished little.12

13. Action 13 (Re-examine transfer pricing documentation) — made things worse by requiring a country-by-country template which has no relevance to transfer pricing.13

14. Action 14 (Make dispute resolution mechanisms more effective) — accomplished nothing.14

15. Action 15 (Develop a multilateral instrument) — accomplished nothing.15

How did the project end up being such a huge waste of time for tax authorities, taxpayers, and tax advisors? Three factors appear to have been involved.

No Clear Focus

First of all, the project was off to a bad start when, in the fall of 2012, the OECD failed to zero in on exactly what the G20 was concerned about. Instead, once the G20 expressed some concern and asked the OECD to come up with an Action Plan, the OECD took off running. Apparently in an effort to impress the world (and perhaps keep the UN Committee of Experts on International Cooperation in Tax Matters at bay16), the OECD came up with a huge list of items, throwing in everything except the kitchen sink.17 Thus, the project never had a clear focus.

The OECD should have first sought to understand the principal G20 concerns, based on statements of leaders at G20 meetings and also statements of political leaders in their own national contexts, e.g., in the United Kingdom, France, and Germany. Concerns also could have been deduced from the hearings conducted by Senator Carl Levin’s Permanent Subcommittee on Investigations, which hearings appear to have been a principal impetus for the G20 concerns.18 Based on this context, one could ascertain that there were four real concerns: the digital economy, royalty deductions when the associated royalty income is subject to low or no taxation,19 PE avoidance, and improper transfer pricing.

The OECD should have focused on these four concerns, identified problems in the global international tax system that give rise to these concerns, and then come up with solutions to these problems. Once it identified the solutions, it should have then come up with an Action Plan for countries, not for the OECD.

Instead, the Action Plan that the OECD developed for itself was a jumbled assortment of different items with different purposes and no clear focus.20

BEPS Is anEmpty Term

A second major factor leading to the failure of the BEPS project is that the term “BEPS” is empty. What does it really mean? I always draw a complete blank when I hear the term. It stands for “base erosion and profit shifting” and we’re told by the OECD that profit shifting is a type of base erosion.21 Thus, we’re left with the term “base erosion.” But what does this mean? Beaches erode, not tax bases. Tax bases are reduced. Thus, we’re talking about base reduction. But much base reduction is clearly legitimate. In fact, everyone agreed, including the OECD, that what the lambasted multinationals were doing was perfectly legal. Thus, base reduction can be perfectly innocuous. As stated by Judge Learned Hand, “Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”22

Thus, if BEPS really means base reduction, what actually is the problem? Clearly, the OECD BEPS project was upset about certain types of base reduction but not others. But how do you distinguish between the two? The OECD BEPS project talked about “BEPS risks,” “BEPS issues,” “BEPS concerns,” “BEPS channels,” etc., but what exactly were these? If the project had defined “BEPS” as involving certain specific types of base reduction, then the term would have had some meaning. However, the OECD never did this; it simply referred to BEPS as some type of generic category of base reduction and thus it was never clear what exactly it was referring to. If someone asks you what is “BEPS,” what do you say?

Too Much Verbiage

A third reason the OECD BEPS project wasted the time of so many is simply because it produced so much verbiage. The final reports number in excess of 1,900 pages. Moreover, the OECD often uses vague verbiage and undefined jargon instead of using precise terms clearly connected to reality.23 In addition, ideas are often repeated at least three or four times. If the reports were much more precise and concise, it is likely they would be of more interest to tax administrations, particularly tax administrations whose native language is not English.24

I must confess that when reading an OECD report I often feel I am reading a passage from “Jabberwocky,” e.g., “`Twas brillig, and the slithy toves did gyre and gimble in the wabe.” I’m also reminded of a statement by Judge Learned Hand about the U.S. income tax:

In my own case the words of such an act as the Income Tax, for example, merely dance before my eyes in a meaningless procession … couched in abstract terms that offer no handle to seize hold of … [A]t times I cannot help recalling a saying of William James about certain passages of Hegel: that they were no doubt written with a passion of rationality; but that one cannot help wondering whether to the reader they have significance save that the words are strung together with syntactical correctness.25

For an organization that has so many tax experts, one would expect much more precise and tightly written reports.26 The OECD should be clarifying the tax waters, not muddying them.

Conclusion

In conclusion, the emperor has no clothes.

The problem with the global international tax system is that many of the basic rules of taxation used by most countries make no sense, e.g., sourcing rules and determining the “residence” of a corporation based on place of incorporation.27 In addition, the arm’s-length principle is totally unworkable and a huge waste of time. If the OECD really wants to revolutionize international taxation, it should focus on these issues. The sole redeeming value of the BEPS project is that its emphasis on “value creation” and the use of country-by-country reports might ultimately result in the general use of worldwide formulary apportionment.28