The BEPS Initiative: Redefining International Tax Planning?

Technology companies frequently possess an international tax footprint before expanding their domestic tax footprint.  That may soon change as the Organisation for Economic Cooperation and Development (OECD) and its G20 member countries undertake an ambitious agenda to fundamentally alter the international taxation system.  The OECD released its Action Plan Addressing Base Erosion and Profit Shifting (BEPS) last year and it’s now working diligently to deliver the first stage of findings in September 2014.

Historically, tech executives and their advisors have been motivated to transfer the company’s intellectual property offshore while its value was low to minimize the tax burden of this transfer and to establish an international tax structure which would lower the company’s effective tax rate.  These tax structures have allowed technology companies to compete and to sell products and services globally by shifting profits to low-tax jurisdictions.  The benefit of these complex international tax structures is now in jeopardy.

Companies have been able to take advantage of current tax laws that were enacted decades ago under the old bricks and mortar business model.  International tax statutes—much like national, state and local statutes — are insufficient for today’s digital economy.  Under today’s rules, a business could have economic activity in one country with the profits from this activity taxed in a completely different low-tax country.  This profit-shifting reduces a country’s overall tax base and impedes its ability to generate tax revenues.  The OECD’s BEPS program tries to align these activities so that a country can tax the profits from economic activities occurring within its borders.

The BEPS Action Plan addresses a laundry list of international tax issues: preventing artificial avoidance of permanent establishment, re-defining transfer pricing, preventing treaty abuse, addressing the tax challenge of the digital economy, neutralizing the effects of hybrid mismatches, strengthening CFC rules, limiting interest expense deductions, and arguing in favor of country-by-country reporting, among other things.

This focus on international taxation stems from the global financial crisis of 2008-2009 and the fiscal situations of many European countries.  These economic realities, coupled with international tax statutes that are inadequate for the digital economy, has spurred the OECD focus on international tax laws and existing international tax planning.  The United States is actively involved in this process.

European countries are already beginning to address some of the BEPS principles with legal or administrative decisions.  A Spanish court recently ruled that a nonresident company was subject to Spain’s income tax on income derived from sales through a website located outside of Spain of the theory of a “virtual” permanent establishment.  Ireland has enacted legislation which changes Irish company residence rules.  Under the old regime, an Irish company could be “stateless” in terms of its place of tax residence and this was used favorably by many multinationals in international tax planning.  The new legislation provides that if a company is not a tax resident of a treaty country, then it is automatically a tax resident of Ireland.  These examples, along with many of the OECD proposals, could result in country-by-country reporting for a business, regardless of its current international tax structure and agreements.

Given this uncertainty, tech companies should work with counsel that is closely monitoring the OECD BEPS Initiative.  A company should review its existing international tax planning and agreements to understand the current tax structure.  It should also internally audit sales and services to understand which countries it may have potential exposure and nexus in order to anticipate potential tax liabilities should existing international tax laws change.