The global economy has become increasingly globalised and digitalised, creating challenges for the international tax system. Consensus agreement on the two-pillared Base Erosion and Profit Shifting (BEPS) 2.0 project which seeks to address these challenges could be reached by summer 2021.
With political and technical challenges outstanding, consensus on the OECD Inclusive Framework on Base Erosion and Profit Shifting (BEPS) has not been reached in 2020 as initially intended. Instead, virtual public consultation meetings on the Pillar One and Pillar Two blueprints will be held in January 2021 and the Inclusive Framework on BEPS has indicated that it will move swiftly to ensure that the project will conclude in mid-2021.
Companies may engage in Base Erosion and Profit Shifting in an effort to erode taxable income and reduce tax liability. One example of BEPS activity is moving profits from a high tax jurisdiction to a comparatively low tax jurisdiction. The OECD estimates that the revenue lost to BEPS totals between $100 billion and $240 billion each year.
The initial Inclusive Framework on BEPS is an OECD project aimed at mitigating this tax avoidance. Led by the OECD Secretariat, it is a collaboration between 135 countries to determine considerable changes to tax policies and practices, providing coherent international tax rules and transparency.
Traditionally, the allocation of taxable profits and associated taxing rights was based where goods and services were produced, which often corresponded with where substantive economic activity occurs. However, a combination of globalisation and digitalisation has meant that production and consumption are often completely detached.
Beginning in early 2019, the BEPS 2.0 project aims to mitigate the tax challenges posed by a digitalised economy. The ongoing project was initially delayed by the Covid-19 pandemic and complicated by the Trump administration’s decision to pause US participation. The US may reengage under the Biden presidency. In the absence of the US, the EU could unilaterally change its own tax regime and adopt a digital tax. However, any unilateral approach has the potential to create tax divergence and uncertainty between countries.
The rationale informing the second iteration of the BEPS negotiations is the allocation of shares of taxable profit based on the geographical location of a company’s substantive value-added activity and the implementation of a global minimum effective tax rate. The 2.0 project is primarily focused on the challenges of taxing digital companies and seeks to establish a “consensus-based solution” that aligns efforts to address the challenge of the digital economy.
This could have significant repercussions for Ireland as a country with one of the highest rates of corporation tax revenue from foreign-owned firms. For instance, in 2019, one-fifth of the overall tax base (€11 billion) was generated by corporation tax.
The two pillars of the current BEPS proposals are described in the Inclusive Framework cover Statement as offering a “solid basis for future agreement”. These pillars are:
- Redefining profit allocation rules: Relocating a share of profit from where a company is headquartered to where commercial activity takes place.
- Implementing global minimum effective tax rules: Taxing profits currently taxed below a minimum rate.
In 2016, the first round of BEPS negotiations produced 15 actions for governments to implement to ensure that profits were taxed where economic activity took place and added value generated. Multinational companies responded by relocating intellectual property assets from no-tax jurisdictions to low-tax jurisdictions. Ireland was a beneficiary.
If implemented, BEPS 2.0 is likely to result in an increase in global tax revenue as some corporation taxing rights migrate from low tax jurisdictions to high tax jurisdictions. According to the OECD Secretariat’s projections based on the current set of unagreed pillars there could be an annual increase of between $60 billion and $100 billion in tax revenues or 4 per cent of global corporate tax revenues. Countries which have become hubs for multinational corporations, such as Ireland, are likely to see tax revenue decrease.
Likewise, given the tax incentives in Ireland to decrease the effective tax rate (such as the R&D tax credit), a reduction in tax differentials between jurisdictions could render Ireland’s current corporation tax regime less attractive to multinationals. On the other hand, if the global minimum corporation tax rate is higher than the Irish rate, it could produce an increase in revenue. Though this is tempered by the fact that a higher rate could also make Ireland a less attractive option for FDI.
It is not yet clear whether the level for the minimum effective tax rate would be set globally or on the basis of individual jurisdictions. Currently, Ireland’s effective corporation tax rate in Ireland is 12 per cent, just below the statutory rate of 12.5 per cent on traded profits.
In his Budget 2021 speech, Minister for Finance Paschal Donohoe TD reaffirmed commitment to Ireland’s 12.5 per cent rate of corporation tax and indicated that he would publish an update on Ireland’s Corporation Tax Roadmap. The roadmap, he said, would take into consideration the reports published by the OECD BEPS Inclusive Framework in October 2020.
“Further work is needed at international level before final agreements can be reached,” he said, adding: “What is certain, however, is that change is inevitable.
“Agreement at the OECD would present challenges for Ireland as changes to the international tax framework would see a reduction in the level of profits taxable here. Failure to reach agreement at the OECD would also have negative consequences for the Exchequer.”
Donohoe asserted that work to determine the direction of the global and European tax landscape will conclude in 2021. In this context, the Minister outlined that he was amending legislation to ensure that all tangible assets acquired after budget day (13 October 2020) are fully included within the scope of balancing charge rules. Taking immediate legal effect, the new rules “will ensure that our tax regime for intellectual property, together with the broader corporation tax regime, remains competitive, legitimate and sustainable”.
Previously, speaking at the 2019 Global Tax Policy Conference hosted by Harvard Kennedy School and the Irish Tax Institute, Donohoe had warned that change was coming to the international tax system. Then, he indicated that as a small, open economy, a consensus based international tax framework is vital for Ireland.
“Further work is needed at international level before final agreements can be reached. What is certain, however, is that change is inevitable.”
— Minister for Finance, Paschal Donohoe TD
Emphasising the need to avoid unilateral action and instead achieve certainty and stability through a sustainable and globally agreed solution, Donohoe noted that the BEPS Inclusive Framework is “unquestionably the right forum for these discussions”. Unilateral taxes, the Finance Minister suggested, are likely to exacerbate global trade tensions and damage cross-border trade and investment.
Examining the Pillar One proposals, Donohoe outlined several desirable criteria. These include: following the principle of aligning tax rights with value creation; minimising disruption to international corporate tax framework; basing it on existing transfer pricing rules; ensuring that the majority of profits remain taxable in exporting countries; and avoiding disproportionate impact.
On the Pillar Two proposals, the Minister asserted that he does not support measures which are aimed at ending “legitimate and fair tax competition”. “Competitiveness is not just a prerogative of large countries,” he said. Any solution must be “underpinned by a sound, intellectually principled basis” and also “be workable in practice”, he warned.
In late November 2020, the European Council approved conclusions for a “comprehensive assessment of the main tax policy issues to be addressed over coming years”. Within these conclusions, the Council emphasised that “fair and effective taxation systems in member states are central to the sustainable recovery of the EU” in the aftermath of the Covid-19 pandemic.
Welcoming progress made by the OECD Inclusive Framework on BEPS, the Council reiterated its support for efforts to reach consensus agreement on an update to the international corporate tax framework.
The European Council will assess global agreement on BEPS in March 2021 and has asked the European Commission to “engage on that basis in the relevant preparatory work in the Council on the way forward in line with EU law, in order to address the tax challenges of the digital economy, including in the absence of international consensus by mid-2021”.