Report reveals BEPS's inability to stop profit shifting

Despite significant tax measures like the BEPS project and the Tax Cuts and Jobs Act in the US, multinational corporations moved approximately $1 trillion, or 40% of their profits, into tax havens in 2019, according to a report.

The TCJA and BEPS have only, according to the report's author and head of the secretariat at the Danish Ministry of Finance, caused profit-shifting to stagnate.

"For sure, they haven’t created a decrease in profit-shifting," claims Wier.

He claims that those who were adamant that profit-shifting would be eliminated by BEPS and the TCJA, which went into effect in 2015 and 2018 respectively, are proven wrong by this study.

"We can surely say that this has not been the case," adds Wier, whose report was released on November 3.

He asserts that given the OECD's persistence in pursuing the two-pillar approach, the outcomes might not have come as a huge surprise to them.

Profit-shifting grew between 1975 and 2019 but has since leveled off, according to a study published by the UN University World Institute for Development Economics Research (UNU-WIDER).

According to the research, there has been "no discernible decline in global profit-shifting or in profit-shifting by US multinationals" compared to 2015, four years into the BEPS process' implementation and over two years after the TCJA went into effect.

According to Wier, the main issue with the BEPS initiative is that it did not address the root causes of stress pricing and arm's-length pricing.

He claims that this applies to situations in which businesses have given their intellectual property (IP) rights to tax havens prior to going public. The value of the transactions and any profit distributions were then exceedingly difficult to estimate.

According to Wier, "If you go to the core of the issue, it’s really a fundamental system of trying to put an arm’s-length price on intellectual property that is not traded on any markets."

The authors of the research point out that they do not contend that the TCJA and the BEPS project have had minor effect, but rather that their combined efforts have not been adequate to stop the global flow of profits to foreign countries.

Wier claims that pillar two represents restrictions that go above and beyond the typical types of steps that have been done to reduce earnings, which is why he is interested to see if it will be implemented.

The premise that profit shifting and changes in where assets are stored are all bad for the global economy is not accepted by everyone, though.

According to Molvin Yiu Kin, associate principal of the Singapore-based consulting firm WTS Consulting, this line of thinking has a limited perspective on the advantages of globalization.

He asserts that once multinationals leave their home jurisdictions, the entire group becomes more profitable and contributes more to global growth.

"The pie has become bigger because of globalisation," according to Yiu Kin.

He claims that the growth of international corporations has also benefited home countries.

"Did the US or other home-jurisdiction firms have no fiscal growth over the years from corporate tax collection? Of course they did, and I think that’s one thing that needs some charting, " he continues.

In addition, he contends that when it comes to how profits are generated and reported, things are not always as simple as they may appear. He acknowledges that occasionally some businesses might be compelled to move profits for tax purposes, but that is not generally the case.

According to him, "Companies do move their businesses for non-tax reasons and for a good business rational."

He also challenges the notion of what today constitutes a tax haven, questioning, for instance, whether semiconductor businesses should view the US as a tax haven in light of the Chips and Science Act, which was passed in August of this year.

The historic two-pillar proposal, which was agreed upon by 137 nations at the OECD Inclusive Framework in October 2021, is the most comprehensive effort to limit profit-shifting by multinational firms.

It intends to ensure that major multinational corporations having revenues of at least €750 million ($745.9 million) in all the nations where they do business pay an international minimum effective tax rate of 15%.

This, according to Wier, stands in stark contrast to BEPS and the TCJA, which have not been able to completely stop the tendency of profit-shifting.

He contends that "these measures just do not have the same bite as pillar two."

He contends that tax policymakers may have been aware of the potential effects these measures would have on businesses, but they may have purposefully delayed putting in place the legislation required to significantly alter profit-shifting.

But pillar two is not going to be the panacea for all the problems caused by profit-shifting.

According to Wier, the global minimum tax rate of 15% would still be below the global average effective tax rate for countries outside tax havens, which is estimated to be at 20%

He claims that while there would still be a strong incentive to shift profits to low-tax jurisdictions, it will be far less strong.

In order to remove virtually all incentives for firms to shift income, he advocates raising the tax floor rate that businesses would pay under pillar two from 15% to 21%. US Vice President Joe Biden was compelled to make concessions despite his desire to obtain a 21% minimum rate.

Attempting to implement the two-pillar system has not proven easy. Due to vehement opposition from some nations and industries on both sides of the Atlantic, efforts to implement the restrictions have stagnated.

Poland has lifted its objections to the minimum rate, but Hungary has continued to oppose the EU's attempts to implement pillar two.

France and Germany have vowed to act independently by enforcing their own laws unilaterally or by finding ways to get around other nations.

To pass tax reforms affecting the entire EU, all member states must vote in unison.

The Biden administration attempted to enact a diluted version of the 15% minimum effective tax rate in the Inflation Reduction Act, but it failed to take into account important OECD provisions.

Yiu Kin questions if pillar two is appropriate in light of the magnitude of opposition from many nations.

According to him, "if countries are not really implementing it in its current form, then that means it might not be working."

He hypothesizes that the delays in adoption may be due to a perception among nations that they could lose out from pillar two.

There is a misperception, according to Wier, that all nations must support pillar two for it to move forward: "The OECD ensured that there are mechanisms to allow us to push forward without having low-tax countries on board."

"If the EU moves forward with the measures and the US doesn’t, then it just means that America is leaving a lot of tax revenue on the table," he continues.

Positive incentives that are part of pillar two allow countries that accede to the agreement to collect the global corporation tax shortfalls.

"As soon as some countries go in, more should want to follow," according to Wier.

The analysis also reveals a substantial shift in the balance of power in favor of multinational corporations: between 1975 and 2019, the profit share of global income increased from 15% to 20%.

The rise in corporate output contributions and the rise in the capital share of production were the main causes of this.

The paper states that "Corporate tax collection has stagnated relative to global income – that is, the global effective corporate income tax rate has declined by about a third."

The percentage of profits reported by businesses outside the country where their main office is headquartered has increased dramatically, from 4% in 1975 to 18% in 2019.

The study concludes that "This evolution may explain why the issue of how to tax multinational firms has become more salient in the first two decades of the 21st century."

The authors also discovered that from less than 2% in the 1970s to 37% in 2019, a greater proportion of business profits were transferred to tax havens. Accordingly, the amount of corporate tax that has been lost due to worldwide profit-shifting has increased from less than 0.1% to 10%.

Tax fairness will continue to be a hot button issue for the public and governments throughout the world as the Russia-Ukraine war rages and economic headwinds buffet markets.

Despite the fact that regulatory initiatives like BEPS and the TCJA failed to stop profit shifting, there is still reason for optimism because pillar two appears to have the highest possibility of doing so, despite certain apparent drawbacks.

By fLEXI tEAM