On November 24, 2016, a multilateral instrument (the 'instrument') to modify bilateral tax treaties was adopted by more than 100 countries. This instrument has the effect of modifying more than 2000 tax treaties in force in the world today. Implementation of the instrument by the adopting countries would radically revolutionize international taxation of multinational corporations ('MNCs'). The goal is to close loopholes for base erosion of profits from different countries where MNCs do business or utilize as tax shelters.
The term Base Erosion and Profit Shifting (BEPS) refers to tax planning strategies that misuse the loopholes in tax rules to shift profits to jurisdictions which impose little or no tax. Often times, economic activities are not carried out in these low tax jurisdictions. Such tax planning strategies effectively reduce the overall tax burden of MNCs compared to domestic companies which pay the full amount of their taxes. The impact of BEPS for developing countries is significant because of their heavy reliance on corporate income taxes. The previous OECD Model Tax Convention favored residence countries which comprise the developed countries of the world. The current instrument marks a shift to increased source taxation to avoid shifting of profits from where economic activities are carried out. This would favour developing countries in Africa which are largely capital importing countries and rely heavily on corporate income taxes.
In 2015, the UN conducted a study to examine the reactions of developing countries to the OECD’s BEPS project. In their reactions, they identified different strategies employed by MNCs to shift profits from their jurisdictions. Some of these practices include: non-recognition of income for the value of local marketing activities, non-commercial levels of debt funding of foreign-owned entities which give room for interest deductions as a means of shifting profits, shifting of profits to jurisdictions which permit secrecy of company operations, deliberate avoidance of a permanent establishment status especially for companies which do not require a physical presence (the problem of the digital economy), and treaty shopping amongst others.
In the UN study, one of the obstacles identified by developing countries in tackling BEPS was lack of information and transparency which made it difficult to determine where income was reported. Other obstacles identified include: a lack of comparable data to utilize in transfer pricing cases, lack of expertise and resources to analyze available data and to apply relevant measurement and risk assessment tools, and lastly, inadequate legislation and a deficient legal structure.
The OECD has provided 15 action plans to enable both developed and developing countries tackle BEPS both domestically and internationally. The instrument provides the means for implementing tax treaty related measures to prevent BEPS. The substance of these measures are contained in Action 2 (dealing with the use of hybrid instruments and structures), Action 6 (dealing with tax treaty abuse), Action 7 (dealing with avoidance of permanent establishment status) and Action 14 (dealing with dispute resolution).
The impact of the BEPS project may not be felt if other avenues for tax leakages exist. At this point, African countries must also focus on strengthening tax abuse strategies domestically through legislations, improving administrative capacity to deal with aggressive tax planning, and evaluating the over-generous granting of incentives such as tax holidays.
The signing of the instrument will take place on June 5, 2017. For details on how this instrument impacts African countries, please look out for more updates on this site in the coming days.