GLOBTAXGOV

The BEPS Project is regarded as a multilateral solution to prevent base erosion and profit shifting, but is the BEPS solution truly multilateral?

By Irma Johanna Mosquera Valderrama

In principle, the adoption of the OECD-BEPS Inclusive Framework by more than 113 countries (March 2018) demonstrates the level of support from developing and developed countries, including EU countries, to the adoption of the international standards of the BEPS Actions. But one interesting question that requires further research is: Are these standards truly international or do the regional and unilateral solutions play a role in the way that these standards are implemented in the countries?

For instance, I have observed while analysing the implementation of the BEPS in the Netherlands since 2015 until now, that at EU level the Dutch government is in favour of the implementation of the BEPS Actions through the EU Directives. For the Dutch government, the EU Directives are hard law measures that can safeguard the principles of equality and certainty for the taxpayer (Documents of the Second Chamber of Parliament, 2017-2018, no. 794). The Netherlands is currently in the process of transposing the Anti-Tax Avoidance Directives (ATAD 1 and ATAD 2) into its domestic legislation. The legislative proposals are expected to be submitted to the Second Chamber of Parliament before the summer of 2018 (ATAD 1) and by 2019 (ATAD 2). Since these Directives go beyond the BEPS Actions by introducing measures such as exit taxation and a general anti-avoidance rule (GAAR), it is expected that the implementation of the BEPS Actions in the Netherlands will have some regional EU elements. Non-EU countries, therefore, should be aware of these developments.

Furthermore, the current discussion at OECD level and at EU level on the digital economy will generate a similar question: are EU countries following the EU proposal for a virtual permanent establishment or will EU countries follow the OECD-BEPS Project, mainly its Action 1 and Action 7?

Some challenges are expected as a post written by Wouter Lips in the GLOBTAXGOV blog shows: “International tax policy making is messy and complicated and made in multiple rivaling policy arenas (OECD, EU-level, US, UN, national legislations, …) at the same time”.

In this discussion, countries are also taking unilateral measures that may conflict with their international commitments. For instance, Italy has chosen to adopt a new definition of permanent establishment that will also affect e-commerce and the digital economy.  In a post in the GLOBTAXGOV blog, Enza Sonetti rightly asks how this new definition of permanent establishment will be reconciled with the choices and reservations made by Italy in the BEPS Multilateral Instrument?

 International tax lawmaking

These developments also add to the complexity of the implementation of BEPS. In a recent article that I wrote in the framework of the GLOBTAXGOV project, I showed that countries are taking different approaches to the implementation of BEPS. One question that should also be considered is how the different implementation of BEPS by the countries and developments in the EU will influence international tax lawmaking. This question will be further researched in the GLOBTAXGOV project.

In order to enhance cooperation between GLOBTAXGOV blog and the Leiden law blog, this blogpost has been also published at the Leiden law blog  http://leidenlawblog.nl/articles/multilateral-solutions-as-regional-solutions

Enza Sonetti – 17/4/2018

Italian Budget Law has amended the domestic definition of Permanent Establishment (PE) to prevent artificial avoidance of PE status and make national legislation consistent with OECD’s Final Report on BEPS Action 7 and the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI). The new definition has come into force on January 2018 and it is expected to have a considerable impact on Permanent Establishment status but its application to Italy’s existing tax treaties may be complicated due to the reservations to MLI submitted.

The new version of art. 162 of Italian Consolidated Text on Direct Taxation, extends the PE concept and covers hypothesis in which a foreign company has a significant business in Italy even though it has no physical establishment there. The amendment refers indeed, to the significant and continuous economic presence within Italian territory of a subsidiary that is set up in a way not to result as physically present in Italy. It is evident, thus, how this new concept will affect e-commerce and digital economy and help to avoid the presence of hidden PE.

Moreover, the Budget Law has modified the negative list provided by art. 162 that specifies the cases in which a fixed-base does not constitute a PE: Italy, in this respect, has decided to adopt a case by case approach as the character of preparatory or auxiliary activities that would exclude the existence of a PE, needs to be verified with reference to parent company’s activity. On the other hand, pursuant to art.13 of MLI and to tackle tax avoidance strategies, has been introduced an anti-fragmentation rule aiming to prevent artificial fragmentation of activities that, considered together or aggregated would constitute a PE.

The reform has also reviewed the notion of the dependent agent, designing a detailed definition more consistent with Final report on Action 7. According to this new definition, a person constitutes a PE if he acts on behalf of a non-resident corporation and habitually executes contracts or is involved in the conclusion of contracts without any possibility to make substantial changes to them. To tax law purposes a PE exists also if the agent is controlled by a foreign company or both are under the control of a third party that owns more than 50% of voting rights in the other.

The amendments introduced, implement the principles set in Final Report on Action 7 but need to be coordinated with MLI to which Italy, has expressed the right of not applying the entirety of articles 12 and 14 of the Convention to its Covered Tax Agreements. Therefore, they represent a relevant but a unilateral step towards the rationalisation of international tax governance and show the contradictions of autonomous strategies. Italy indeed expands the national definition of PE but on the other hand, expresses reservations and option to MLI that may provoke the unwelcome effect of not taxing incomes deriving from a different or new type of PE that should instead fall within the scope of the Convention.

ABOUT THE AUTHOR

Dr. Enza Sonetti received a joint- PhD (2017) in Legal Strategy for SMEs from Suor Orsola Benincasa University of Naples and in Law and Political Science from the University of Barcelona. She currently works at AGM Abogados SL-Barcelona . Her research interests are focused on European Tax law, SMEs taxation, cooperative compliance systems, factors influencing taxpayers’ behaviour and tax penalties.

Wouter Lips- 16/4/2018

Problems and inadequacies of applying the common OECD tax standards to an increasingly digitalized economy have been predicted for nearly 20 years ¹. Yet, The Base Erosion and Profit Shifting (BEPS) outcomes did not provide satisfactory answers to these challenges and the OECD interim report does not give much hope of a breakthrough in 2020. The EU Commission in March released a proposal for a virtual permanent establishment as a long-term common solution, that many appreciate as good rational policy. Yet few people think the proposal has an actual chance of succeeding, pointing to the US who will very likely object to a measure that seems aimed at “their” digital multinationals. Meanwhile, the Commission also proposed an “interim” measure, a three percent tax on the turnover of digital companies with a turnover exceeding 750 million euros, which in absence of permanent agreement could become quite permanent.

International tax policy making is messy and complicated and made in multiple rivaling policy arenas (OECD, EU-level, US, UN, national legislations, …) at the same time. The eventual policy makers, (ECOFIN ministers), themselves often are not tax technical experts – they are often not experts in many subjects they cover – and do not have time to become so. Therefore they rely on limited resources and imperfect information when deciding policy. Moreover, both left- and right-wing politicians have interest beyond choosing the most adequate or equitable tax policy: being seen “doing something” about tax scandals, returning favors to business lobbyist, protectionist tendencies, ideological interests, etc… Economist Herbert Simon ² dubbed this situation “bounded rationality”, where individuals’ rational decision-making ability is impaired by time, resource and cognitive factors. In this view, decision makers prefer satisfactory solutions to optimum ones.

Political scientists have been trying to capture the complexity of policy making in light of limited resources, multiple arenas and bounded rationality. These frameworks act as lenses that provide richer explanations of the messiness of politics than rationalist behavior of functionalist explanations can.

One such lens political scientist use is the Multiple Streams Framework developed by John W. Kingdon ³. Kingdon tried to explain why some ideas made it to the top of the policy-makers agenda while others didn’t. Some ideas could be out there for decades without ever getting enacted, while sometimes out-of-the blue a new policy could be agreed upon in a matter of weeks.

Kingdon divided the agenda setting process into three independent “streams”. The first one he identifies is the problem stream. It consists of the issues policy makers pay attention to. Policy makers naturally have limited attention spans and not every issue stays at the forefront of their thoughts. International tax policy for example sees a surge in the problem stream after each tax scandal, and then slowly returns under the radar.

The second one, policy stream, consists of all the rivaling ideas that are floating around in the “policy primeval soup”. These ideas can be developed by policy administrations, think thanks, NGO’s, academia,… In digital tax policy, a wide range of ideas float around: The Common Consolidated Tax Base, virtual PE, Destination-based Cash flow taxes and border-adjustment taxes, extended profit splits… An idea like unitary taxation has been around since the 1930’s and pops up every now and again. Most recently by the report of the independent commission for the reform of international corporate taxation ⁴, yet it does not seem its time has come already.

The political stream is the third relevant stream. Kingdon defined movements in this stream mainly as domestic administrative and legislative turnovers, but changing political constellations apply to international or multilateral politics as well. The election of Emmanuel Macron as president of France, and his good relationship with Angela Merkel has clearly given a higher profile to tax policy in the EU for example.

Another important concept for Kingdon is coupling. The three streams move independently and with different dynamics, but there are instances in which they coincidently align. In such cases, a window of opportunity arises in which skillful policy entrepreneurs (which can be policy makers, but not always) can couple the three streams to move their favored policy to the top of the agenda.

Take FATCA for example. The idea of automatic exchange of information has been kept alive in the US during the 2000s in the policy stream by politicians such as Senator Carl Levin and NGO’s such as Global Financial Integrity. In 2009 a democratic congress and democratic presidency made for a favorable political stream. The Financial Crisis, the UBS banking scandal and Sen. Levins’ hearings opened up the problem stream. This meant a window of opportunity existed during 2009-2010 for automatic exchange of information. An example of skillful policy entrepreneurship is the tacking-on of FATCA on the HIRE employment restoration act. A separate FATCA law would have meant scrutiny in the Ways and Means committee where it would have led to much more resistance. Making it a part of the HIRE act meant it was handled in the Appropriations committee, out of the eye of the tax experts in congress, strongly improving its eventual chances of enactment.

So what can Kingdon teach us about the likability of the EU digital proposals passing? First of all, we have to identify the policy arenas where this process plays out. The most obvious is the EU itself. The second arena where these policies will have to be decided is the OECD task force on digital economy in 2020. A third relevant policy arena are the EU-US external relationships. The digital tax proposals are seen by the US as a GAFA (Google, Amazon, Facebook, Apple) cash grab, and not every EU country is prepared to let relations with the US sour over tax policy.

When weighing both policy proposals in the policy stream, the digital revenue taxation route is generally not seen as a viable or adequate solution for the problems of digitalization and corporate taxation. Nevertheless, several countries have recognized them as temporary solutions, as the OECD interim report⁵ indicates. The virtual PE concept has also been floating in policy circles for quite some time. It was hinted at during BEPS for example, and it is discussed frequently in the OECD digital economy public consultation submissions. This indicates that stakeholders are anticipating and debating the introduction of such changes to the PE definition.

In the political stream, both proposals however are facing rabid opposition in all three arenas. Within the EU, there is heavy opposition from Ireland, Belgium, The Netherlands and Denmark against the interim measures. While a bloc of Central European countries fear that the thresholds in the virtual PE proposals might mean that small countries will get cut off from their fair share of the tax⁶. While the leadership of Macron has given a new dynamic to corporate taxation of digital giants in the EU, it is unknown if this opposition can be overcome.

In the OECD arena, the interim report and presentation released in March ’18 clearly delineated three groups of countries who basically “agreed to disagree” on the desirability of interim measures⁵, while a long-term proposal is to be delivered in 2020. In this forum, no consensus is present at the moment either. The US is staunchly against both proposals. Under the Obama administration, there already was irritation at what was perceived as the EU singling out US Multinationals⁷ . The Trump administration, which has a far more zero-sum view on economic matters, will be undoubtedly aggravated and might even retaliate. Germany fears this last scenario might play out in trade and tariff disputes⁶.

Whether or not entirely true, the framing of the digital tax proposals as cash grabs is very tenacious. While Pierre Moscovici is being very staunch in his communication that non-EU digital firms will also be targeted, French ministers have been on record applauding the “GAFA”-tax.  The inability to change this framing can be seen as bad policy entrepreneurship on the EU’s side.

However, within the EU politically, the interim tax proposal has one edge over the virtual PE proposal: it can still be done unilaterally or through enhanced cooperation if nine countries agree to it. One Commission official even went on record saying that if there is not agreement in the Council of Ministers on the temporary measures by the end of 2018, there will be a move towards enhanced cooperation” ⁸. We will probably see at least some countries within the EU go through with a form of revenue tax for digital economy, even in absence of EU agreement.

With regards to the problem stream, it is difficult to predict windows of opportunities and how long they will keep open. Right now, there seems to be an opening. We’re still in the wake of the paradise papers scandal, and the recent Facebook scandal have a lot of politicians worried about the adverse effects of digital giants on societies. A digital revenue tax in the eyes of policy makers could also function as a symbolic measure to show the primacy of politics and that even mega-companies are subject to the law. Because of Fear of populism and Brexit, pro-EU politicians also need a victory to show a rationale for the EU. A tax on digital companies that seem to exist above nation states, may fit that need.

It’s impossible to predict if this opportunity will still exist two years down the road, when the long-term proposal has to be agreed upon in the OECD. There is however a distinct possibility that it won’t and that taxation of the digital sector will be off the public agenda for other items of the day. In that case, it seems unlikely that EU negotiators will want to spend much political capital against the US to push the long-term proposal of a virtual PE.

In conclusion, while policy-wise a revenue tax is hands down a worse outcome than the proposal of a digital PE, the political constellation is far more favorable to the first idea. While right now, a window of opportunity due to the three streams coupling seems to exist, and France is showing leadership on the issue, it might not be down the road. It seems that the revenue tax proposal has a chance of being realized, at least in some large EU countries. This moment might be long gone when it’s time for the long-term proposals to be negotiated within the OECD, while opposition from the US is likely to remain rampant.  As many commenters predict, the interim proposal will very likely become quite permanent.

Literature

1. Mclure C. Implementing state corporate income taxes in the digital age. Natl Tax J. 2000;53(4):1287-1305.
2. Simon H a. Rational Decision-Making in Business Organizations. In: Nobel Memorial Lecture, 8 December, 1978. ; 1978. doi:10.2307/1808698.
3. Kingdon J. Agendas, Alternatives and Public Policies. Second Edition. Essex: Pearson; 2014.
4. Faccio T, Picciotto S, Brockmeyer A, et al. Alternatives to the Separate Entity / Arm ’ s Length Principle. 2017;ICRIT.
5. OECD. OECD/G20 Base Erosion and Profit Shifting Project Tax Challenges Arising from Digitalisation – Interim Report 2018.; 2018. doi:10.1787/9789264293083-en.
6. Plucinska J, Vinocur N, Smith-Meyer B. Europe’s digital tax map: Where countries stand. Polit EU. 2018. https://www.politico.eu/article/europe-digital-tax-map-where-countries-stand-analysis-deep-divisions/. Accessed April 16, 2018.
7. US Department of the Treasury. The European Commission’s Recent State Aid Investigations of Transfer Pricing Rulings. White Pap. 2016.
8. Kirwin J. EU to Impose Two New Taxes on Digital Giants. Bloomberg. 2018. https://www.bna.com/eu-impose-two-n57982088898/. Accessed April 16, 2018.

ABOUT THE AUTHOR

Wouter Lips   is a PhD candidate, funded by the Flanders Research Network, and a member of the Ghent Insitute for International Studies at Ghent University. His PhD project focuses on the political economy of the G20 tax agenda with regards to automatic exchange of information and BEPS.

This presentation addressed the role of National Governments in Global Tax Governance: How to achieve fairness and equality? Some of the issues addressed during this presentation are:  Canada as a country member of the G20 and the OECD has an active role in the setting of international tax standards for developed and developing countries and therefore, the questions that need to be addressed are: What can Canada do to contribute to enhance fairness and equality in the international tax standards developed by the OECD and G20? What can Canada do to contribute to address the concerns of developing countries? Link to the conference:http://mcgill.ca/misc/events/2018-annual-conference

My presentation is available online.  Mosquera McGill Canada Taxes and Fairness February 2018

This blog is part of the ERC research project GLOBTAXGOV. This blog aims to set up an alternative platform for discussion among scholars, governments, international organizations, research institutions regarding the setting of international tax standards by the OECD, G20 and the EU. This blog will be fed by experts in governance, tax law, and international relations. This blog also aims to exchange experiences to establish a dialogue in tax governance and to disseminate the project GLOBTAXGOV.