Double Non-Taxation and OECD’S BEPS Action Plan

1311_NonTaxNoTaxDouble non-taxation has recently made the news and created public discussions on tax moral with cases like Apple, Starbucks, Microsoft, Amazon, Google, Vodafone and others. The problem of double non-taxation has been a concern by tax authorities all over the world. As we all know, no two tax systems are exactly the same. The right to tax lies with a jurisdiction on an entity by entity basis having some connection to that jurisdiction, i.e. residency. The interaction of domestic tax systems can sometimes lead to an overlap and double taxation. The interaction can however also leave gaps which results in an item of income not being taxed anywhere, so called double non-taxation. In particular the effects of increasing globalization and the digital economy create opportunities for corporations to exploit the possibilities of double non-taxation. The WTO estimates that 60% of global trade is between related corporations. Aside from exceptional cases of illegal abuse most companies comply with the legal requirements of the jurisdictions involved.
Example: Trading and/or service profits are captured by a Hong Kong entity which are claimed as non-taxable offshore sourced profits on the basis that actual work is performed by travelling employees or agents of the Hong Kong entity in China. If the activities performed in China do not constitute a permanent establishment in China it is possible to legitimately achieve an outcome where the profits are taxed neither in Hong Kong nor in China.

In the past years the focus has been not only to avoid double taxation but also double non-taxation. Newer DTAs include already anti avoidance provisions especially towards aggressive tax planning structures. These rules and regulations however only exist on a national level and greater international harmonization will be required. National governments recognized this and call on international cooperation to tackle base erosion and profit shifting.

As a result, the OECD has defined a 15 point action plan on base erosion and profit shifting (BEPS) which is to be implemented within 2 years:

Address the tax challenges of the digital economy
Neutralise the effects of hybrid mismatch arrangements
Strengthen Controlled Foreign Corporation (CFC) rules
Limit base erosion via interest deductions and other financial payments
Counter harmful tax practices more effectively, taking into account transparency and substance
Prevent treaty abuse
Prevent the artificial avoidance of Permanent Establishment (PE) status
Develop rules to prevent BEPS by moving intangibles among group members
Develop rules to prevent BEPS by transferring risks among, or allocating excessive capital to, group members
Develop rules to prevent BEPS by engaging in transactions which would not, or would only very rarely, occur between third parties
Establish methodologies to collect and analyse data on BEPS and the actions to address it
Require taxpayers to disclose aggressive tax planning arrangements
Re-examine transfer pricing documentation
Make dispute resolution mechanisms more effective
Analyse the tax and public international law issues related to the development of a multilateral instrument
The action plan attempts to curb issues that give rise to BEPS and promises to encourage the updating of international tax rules from the single principle of avoiding double taxation to avoiding double taxation and eliminating BEPS by closing loopholes for double non-taxation. An important part is of this action plan is a revision of transfer pricing guidelines and development of a coordinated approach to documentation.

The proposed action plan may have substantial effect on corporate structures using offshore structures where little to none business activities take place. As mid-shore jurisdictions Hong Kong and Singapore are less open to criticism from high tax jurisdictions and bilateral tax relations are governed by DTAs.