International structuring, BEPS and abuse of law
In a previous post I wrote about the competitive advantage enjoyed by a hypothetical multinational company which sold intangible electronic goods.
Structuring
This hypothetical multinational operates such that it is able to get the best deal from a variety of different tax regimes at once (even assuming equivalent gross employee salaries in different countries) without any exotic tax planning. The shareholder is in one country, Country A (with comparatively low rates of taxation of dividends and low capital gains taxes). The staff are in country B (with comparatively low rates of taxation for employment income and low employer labour taxes). The customer is in country C (with comparatively low sales taxes). A company operating in such a way has a formidable business advantage over purely national rivals.
It is important to understand that the OECD's Base Erosion and Profit Shifting ("BEPS") initiative would not remove any of the advantages this company has secured for itself, because there is no BEPS going on here. Even though, by careful structuring, considerable tax is avoided and considerable competitive advantage gained.
BEPS
Let us take this a step further. What about if the hypothetical multinational exited its intellectual property from country A (where its shareholders were) to country D which has a patent box regime. And if the multinational then had tax-deductible royalties paid to the patent box in country D on the sales made in country C. And if the multinational then transferred those funds to a treasury company in country E which has a low tax rate on interest income. And if the multinational then used those funds partly to buy up the equity of its competitors in countries F,G & H and partly to make loans equal to the equity injections to those (now subsidiary) companies. And if those subsidiary companies in countries F,G and H then claimed tax deductions for interest which significantly reduced their profits.
This is where we could start to see BEPS coming into play. In fact there are already certain additional tax charges within the tax system of many states which tend to act as a more or less effective brake on such behaviour. There could be exit tax charges on the IP exit, withholding taxes on the royalties, stamp duty on the equity purchases, and withholding tax on the interest payments. BEPS is likely to increase the incidence of such charges. The difficulty we have here in the European Union is that Governments' ability to impose these additional tax charges at all is very limited. Under the Treaty of Lisbon companies largely enjoy the freedom of movement of capital, and the freedom of establishment, even if the primary motive for the exercise of the free movement is tax avoidance. Absent a wholesale renegotiation not only of the Lisbon treaty, but the principles on which it is based, there is little European governments can do about this.
Abuse
The techniques I have set out above are not to be confused with 'abusive' tax avoidance, which does not benefit from the protection of the EU treaty freedoms. The essence of the doctrine of abuse is a divergence between reality and form. For example, if the treasury company in country E in the example above was a 'brass plate' company with no employees, actually managed and controlled by an employee of the patent box company in country D, it would not have properly exercised its freedom of establishment, because its central management and control was elsewhere. The tax authority of country D could, should, and would argue it was resident in Country D and tax it accordingly.
This hypothetical multinational operates such that it is able to get the best deal from a variety of different tax regimes at once (even assuming equivalent gross employee salaries in different countries) without any exotic tax planning. The shareholder is in one country, Country A (with comparatively low rates of taxation of dividends and low capital gains taxes). The staff are in country B (with comparatively low rates of taxation for employment income and low employer labour taxes). The customer is in country C (with comparatively low sales taxes). A company operating in such a way has a formidable business advantage over purely national rivals.
It is important to understand that the OECD's Base Erosion and Profit Shifting ("BEPS") initiative would not remove any of the advantages this company has secured for itself, because there is no BEPS going on here. Even though, by careful structuring, considerable tax is avoided and considerable competitive advantage gained.
BEPS
Let us take this a step further. What about if the hypothetical multinational exited its intellectual property from country A (where its shareholders were) to country D which has a patent box regime. And if the multinational then had tax-deductible royalties paid to the patent box in country D on the sales made in country C. And if the multinational then transferred those funds to a treasury company in country E which has a low tax rate on interest income. And if the multinational then used those funds partly to buy up the equity of its competitors in countries F,G & H and partly to make loans equal to the equity injections to those (now subsidiary) companies. And if those subsidiary companies in countries F,G and H then claimed tax deductions for interest which significantly reduced their profits.
This is where we could start to see BEPS coming into play. In fact there are already certain additional tax charges within the tax system of many states which tend to act as a more or less effective brake on such behaviour. There could be exit tax charges on the IP exit, withholding taxes on the royalties, stamp duty on the equity purchases, and withholding tax on the interest payments. BEPS is likely to increase the incidence of such charges. The difficulty we have here in the European Union is that Governments' ability to impose these additional tax charges at all is very limited. Under the Treaty of Lisbon companies largely enjoy the freedom of movement of capital, and the freedom of establishment, even if the primary motive for the exercise of the free movement is tax avoidance. Absent a wholesale renegotiation not only of the Lisbon treaty, but the principles on which it is based, there is little European governments can do about this.
Abuse
The techniques I have set out above are not to be confused with 'abusive' tax avoidance, which does not benefit from the protection of the EU treaty freedoms. The essence of the doctrine of abuse is a divergence between reality and form. For example, if the treasury company in country E in the example above was a 'brass plate' company with no employees, actually managed and controlled by an employee of the patent box company in country D, it would not have properly exercised its freedom of establishment, because its central management and control was elsewhere. The tax authority of country D could, should, and would argue it was resident in Country D and tax it accordingly.