There is a growing concern with regards to the significant losses of national tax revenues because of sophisticated tax planning by multinational enterprise (MNEs) aimed at shifting profits in ways that erode the taxable base. International legal systems created to regulate directly or indirectly such conducts of MNEs have so far proven ineffective in preventing tax base erosion and profit shifting (BEPS) from occurring. The purpose of this memorandum is to show the reason why this is the case.
As BEPS is the result of the conduct of private actors, MNEs in particular, it is bilateral taxation treaties that are directly relevant to this phenomenon. However, they leave legal loopholes that make strategic tax planning possible providing opportunity for BEPS; as the traditional concept of permanent establishment can easily be manipulated, it is no longer an effective nexus providing a basis for taxation; exemption rules, originally designed to prevent double-taxation, can be exploited in a way to lead to double non-taxation; the arm’s length principle, commonly underlying transfer pricing allocations, can be abused so as to separate income from the economic activity that produces it and allowing profits to be shifted to low tax environments. Consequently, other branches of international economic law, i.e. international investment as well as trade law, which are also directly or indirectly relevant to taxation, need to be explored.
International investment law, which regulates the conduct of host States, not investors, has by definition little chance to address BEPS. In addition to this, several limitations have been identified; as a lot of investment treaties exclude taxation issues from their scope of application, BEPS is placed outside the scope of investment law accordingly; to the extent that an investment treaty is applicable to taxation, it can be a regulatory measure to be scrutinized by investment arbitration, and thereby there exists a limited possibility that a measure against BEPS is alleged to constitute a violation of an investment treaty and/or contractual obligations resulting from ‘tax stabilization clauses’; conversely, the usefulness of counterclaims before investment arbitration, which theoretically has a potential to tackle BEPS in the context of investment law, will be limited in the light of current jurisprudence.
In a similar vein, international trade law imposes obligations on Member States, but does not impose any obligation on private actors. It thus has by definition little chance to address BEPS; GATT has little scope to tackle BEPS as it does not deal with measures that affect taxation on income of MNEs; rather, provisions on transfer of payments could allow MNEs to use tax avoidance schemes to shift their profits from one tax jurisdiction to another lower tax rate jurisdiction.
Therefore, international soft law with its non-binding nature, which aims at the harmonization of regulation of taxation treaties as well as domestic legislation, also needs to be explored. However, in its current state, it leaves legal loopholes allowing double non-taxation to take place due to the incoherence of controlled foreign company rules as well as the excessive deductibility of interests; international cooperation on taxation matters and exchange of information between tax authorities is to date insufficient to capture the overall fiscal scheme and strategic tax planning of MNEs; current soft laws, including the OECD Model Tax Convention, cannot be compatible with modern global market.
Based upon these findings, this memorandum will suggest several proposals for amelioration of the existing system. On the whole, filling gaps in current bilateral taxation treaties would be the most effective and realistic way to address BEPS as it is these treaties that primarily and directly deal with taxation. To accelerate such improvement of taxation treaties by States, coherent international soft law standards, including standardized, best practice, rules on arm’s length principle, controlled foreign company as well as exemption rules, need to be elaborated. International cooperation on tax matters between tax authorities of different States is moreover essential in uncovering the sophisticated tax planning taken by MNEs resulting in BEPS.
In addition to these suggestions, as a complementary proposal, it will be pointed out that counterclaims before investment arbitration offer room for amelioration. In line with an investment treaty, which permits countermeasures based upon non-fulfillment of domestic obligation, the system could be adjusted to enable counterclaims alleging tax avoidance by investors, and eventually to prevent BEPS from occurring to that extent.