A Critical Evaluation of the OECD's BEPS Project

1. A Critical Evaluation of the OECD’s
BEPS Project
by Ramon Tomazela
Reprinted from Tax Notes Int’l, July 20, 2015, p. 239
Volume 79, Number 3 July 20, 2015
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2. A Critical Evaluation of the OECD’s BEPS Project
by Ramon Tomazela
Aggressive tax planning has become a sensitive po-
litical issue, especially in light of the initiatives of
the OECD and the European Union to tackle harmful
tax practices and aggressive tax avoidance. The OECD
base erosion and profit-shifting project represents an
attempt to eliminate the double nontaxation stemming
from BEPS, which reflects the view that the interna-
tional standards may not have kept pace with changes
in the global corporative business environment.1
This article analyzes the most fundamental issues
raised by the OECD proposals to amend the interna-
tional tax rules. It focuses on key issues of tax policy
essential for creating a new international tax standard
to overcome the challenges posed by the economic de-
velopment.
Critical Analysis
Action 1 of the BEPS project addresses the tax chal-
lenges of the digital economy. A major issue involves
companies that manage to have a significant business
presence in the economy of another country without
being liable for taxes there because of the lack of
nexus under the concept of permanent establishment.
The digital economy is the only business field that re-
ceived an action plan dedicated to its main challenges.
Generally, digital-based activities may give rise to
two types of difficulties:
• identification of the states with jurisdiction to tax,
which requires a new concept of nexus for activi-
ties developed without any physical presence; and
• development of mechanisms for the allocation of
taxable basis for each state with jurisdiction to
tax.
The second issue will likely be the more difficult to
solve because the allocation of taxable profit in the
digital economy raises complicated economic issues.
Standard transfer pricing methods may lead to inaccu-
rate results, while more sophisticated methods may be
too complex and costly to be applied consistently for
all transactions in the digital economy, especially by
developing countries.2
Action 2 of the BEPS project is intended to neutral-
ize the effects of hybrid mismatch arrangements, which
exploit differences in the tax treatment of an entity or
instrument under the laws of two or more tax jurisdic-
tions to produce a mismatch in tax outcomes, thus re-
ducing the overall tax burden of the parties con-
cerned.3 In attempting to resolve the issue, the OECD
sets out recommendations for domestic rules to align
the tax treatment of payments made under a hybrid
financial instrument or payments made to or by a hy-
brid entity with the tax outcomes in the other jurisdic-
tion.
The OECD initiative against hybrid mismatches is
addressing a problem caused by the lack of coordina-
tion among tax systems around the world. The absence
1
OECD, ‘‘Addressing Base Erosion and Profit Shifting’’
(2013), at 47.
2
Julien Pellefigue, ‘‘Transfer Pricing Economics for the Digi-
tal Economy,’’ 22 Int’l Transfer Pricing J. 95-100 (2015).
3
OECD, ‘‘Neutralising the Effects of Hybrid Mismatch Ar-
rangements’’ (2014), at 29.
Ramon Tomazela is a master of laws candidate
in tax at University of São Paulo, a visiting tax
law professor at the Brazilian Tax Law Insti-
tute, and a tax associate at Mariz de Oliveira e
Siqueira Campos Advogados in Brazil. E-mail:
rts@marizsiqueira.com.br
In this article, the author analyzes the poten-
tial impact of the OECD base erosion and
profit-shifting project on the international tax
regime in order to help identify the project’s
key challenges. Attempting to fix the interna-
tional tax regime without implementing more
radical changes via tax legislation shows that
the BEPS project may be insufficient to resolve
all issues posed by economic development and
the business environment.
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3. of tax neutrality between the treatment applicable to
equity and debt in the different countries is precisely
the reason why numerous tax planning schemes can be
successfully created with hybrid instruments.
Similarly, the use of hybrid entities is possible only
by virtue of the discrepancies in national systems in
relation to the tax classification of legal entities. The
autonomous methods used by countries for the tax
classification of companies or partnerships allow —
and even stimulate — the use of hybrid entities as a
powerful instrument for cross-border tax arbitrage.
Thus, to accept the anti-hybrid rule proposed by the
OECD, it seems necessary to analyze the subject from
an international perspective to establish a direct link
between the deductibility of the remuneration derived
from the hybrid instrument at the subsidiary level and
the taxation of the corresponding amount at the parent
level. That is required because the use of some types of
financial instruments or legal entities is not illegal or
abusive in itself, which is why general antiavoidance
rules do not provide a comprehensive mechanism to
counter the use of hybrid mismatch arrangements.
A GAAR may recharacterize a financial instrument
based on its economic substance, regardless of its legal
form, but it does not provide a comprehensive response
to cases of hybrid mismatch arrangements.4 Therefore,
the underlying reasoning of the OECD proposal on
linking rules, intended to link tax treatment of a hybrid
entity or hybrid instrument in one jurisdiction with
that applied in another jurisdiction, may rely exclu-
sively on the concept of inter-nation equity, which is at
least debatable because countries do not consistently
observe it.
The linking rules proposed by the OECD find po-
tential support in the single tax principle, whereby in-
come from cross-border transactions should be subject
to tax once and only once.5 More specifically, the link-
ing rules may be considered a mechanism to achieve
the matching principle in the international tax field
beyond the scope of tax treaties.
It is well known that in a tax treaty context, with-
holding taxes are reduced in the source state based on
the assumption that the corresponding income is sub-
ject to tax in the residence state. It follows that the
preservation of the matching principle is the primary
reason for not entering into tax treaties with tax ha-
vens, in which the income is not properly taxed.6
Based on the single tax principle and its tenets (effi-
ciency, equity, and prevention of revenue loss), the
matching principle could be extended beyond the tax
treaty context7 to establish a direct link between the
deductibility of the remuneration derived from the hy-
brid instrument at the subsidiary level and the taxation
of the corresponding amount at the parent level.
Thus, the preservation of a direct link between de-
duction and taxation, in a broader cross-country con-
text, may be accepted as a result of the single tax prin-
ciple. However, if that is the foundation for tackling
international tax arbitrage, it must be recognized, for
consistency’s sake, that countries should also offer
proper solutions for all cases of double taxation, even
outside a tax treaty context. It implies that double taxa-
tion should no longer be considered a simple result of
the parallel exercise of taxing rights by sovereign coun-
tries, but rather as a violation of the single tax prin-
ciple.
That approach is highly doubtful, taking into consid-
eration that even in the context of EU law, the Court
of Justice of the European Union has consistently held
that fundamental freedoms offer no remedy against the
problem of double taxation,8 which is a consequence
of the parallel exercise of taxing rights and of member
states’ fiscal sovereignty.9 If that is the case even in the
single market created under community law, then it is
much more difficult to recognize the single tax prin-
ciple as a customary international law.
Also, taxpayers may choose financial instruments
with hybrid features for various nontax reasons. The
combination of equity and debt characteristics in a fi-
nancial instrument can be motivated by several eco-
nomic, financial, commercial, and legal reasons10 that
bear no relation to tax-reduction strategies. In general
the development of hybrid financing has been moti-
vated primarily by the opportunity to combine the
qualities of both equity and debt instruments, rather
than to exploit cross-border tax arbitrage. Thus, given
the existence of nontax reasons for using hybrid finan-
cial instruments or hybrid entities, domestic linking
rules should at least allow taxpayers the opportunity to
prove that tax avoidance was not the primary reason
for the structure in order to protect bona fide transac-
tions.
Beyond that, it is possible to criticize the narrow
scope of action 2 of the BEPS project, which focuses
on tax arbitrage marked by the presence of a hybrid
4
Christoph Marchgraber, ‘‘Tackling Deduction and Non-
Inclusion Schemes — The Proposal of the European Commis-
sion,’’ 54 European Tax’n 133 (2014).
5
Reuven S. Avi-Yonah, ‘‘International Tax as International
Law — An Analysis of the International Tax Regime,’’ Cam-
bridge Tax Law Series (2007), at 8-10.
6
See Avi-Yonah, ‘‘Commentary (Response to Article by H.
David Rosenbloom),’’ 53 Tax L. Rev. 168-171 (2000).
7
Id. at 171.
8
CJEU, Kerckhaert, C-513/04 (2006), and Damseaux,
C-128/08 (2009).
9
Katharina Daxkobler and Eline Huisman, ‘‘Levy & Sebbag:
The ECJ Has Once Again Been Asked to Deliver Its Opinion on
Juridical Double Taxation in the Internal Market,’’ 53 European
Tax’n 400 (2013).
10
Eugene F. Brigham and Michael C. Ehrhardt, Financial
Management: Theory & Practice (2008), 742-766.
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4. element, leaving out many other cross-border transac-
tions used by multinational companies to exploit differ-
ences among tax systems. Even in relation to hybrid
financial instruments, action 2 of the BEPS project
wasted a prime opportunity to solve the problem re-
garding the classification of income derived from hy-
brid financial instruments in the OECD model tax con-
vention.
Indeed, qualification conflicts for income from hy-
brid financial instruments may lead to double taxation
or to double exemption, both of which are incompat-
ible with the objectives of tax treaties. To avoid those
consequences, the first step would be to delete the ref-
erence to domestic law in article 10(3) of the OECD
model treaty, which creates an overlap between the
definitions of dividends and interest, so that the treaty
concept of dividend would be regarded as closed and
exhaustive. There is no justification for the adoption of
different approaches for dividends and interest, and
that distinction contributes to qualification controver-
sies. Another alternative would be the inclusion of a
provision addressing hybrid financial instruments in tax
treaties, such as a tiebreaker rule to decide whether the
remuneration should qualify as dividend or interest.
When it comes to the action 3 discussion draft of
the BEPS project, whose goal is to strengthen con-
trolled foreign corporation rules, it seems that even a
further tightening of existing rules to cover any pos-
sible loopholes may not suffice to curb the allocation of
untaxed income abroad. It is not difficult to envisage
that it will probably stimulate inversions.11 Although
taxpayers may choose to invert for various nontax rea-
sons connected with competitive factors, it is undeni-
able that the reduction of the overall tax burden and
the circumvention of CFC rules play a significant role
in changing tax residence.
After the inversion, the parent company may prevent
the application of CFC rules, no matter how strict the
tax treatment applicable to low-taxed foreign income.
In the new jurisdiction, the parent company may also
make use of loopholes and base erosion techniques,
which might not have been otherwise possible in its
original home country because of strict rules against
artificial tax avoidance schemes. It shows that simply
hardening CFC rules will not necessarily achieve the
results intended by the OECD.
Provisions against inversions, such as that in section
7874 of the U.S. Internal Revenue Code, may also be
circumvented, even though to achieve that objective,
multinational companies must bear the risk of con-
sumer boycotts, brand erosion, and scrutiny by tax au-
thorities. The solution of redefining the tax residence
of the parent company based on the residence of
shareholders is likely to be ineffective or costly to ad-
minister, especially for multinational companies whose
shares are publicly traded on different stock ex-
changes.12
Also, from a political standpoint, it is doubtful
whether the U.S. Congress is willing to accept the re-
peal of the check-the-box rules, used in many tax-
planning structures to treat an intermediate company
as a transparent entity for tax purposes and, as a con-
sequence, turn passive income into active income to
avoid the application of the CFC rules (subpart F).
Most European countries have a participation ex-
emption for foreign dividends and capital gains, which
reinforces the view that the strengthening of CFC rules
might not be accomplished, especially because within
the EU framework, far-reaching CFC rules are difficult
to reconcile with the freedom of establishment and the
free movement of capital, which may restrict their ap-
plication by EU member states.13 Thus, a stringent
CFC rule may be incompatible with EU law, as recog-
nized by the OECD itself.
The action 4 discussion draft of the BEPS project
focuses on the limitation of base erosion via interest
deductions and other financial payments. In general,
the establishment of limitations on interest deduction is
not a new issue. Many countries already have thin
capitalization or similar rules to avoid the erosion of
tax bases using interest payments made to related par-
ties or lenders domiciled in low-tax jurisdictions.
Conceptually, one can ask whether restrictions on
interest deductions are incompatible with the ability-to-
pay principle as the debtor’s ability-to-pay principle is
decreased by the interest payment. If the interest ex-
pense is not deducted from the taxable profits, it im-
plies that the debtor — not the creditor — has in fact
been taxed. From a tax treaty perspective, domestic
rules restricting interest deduction may breach arm’s-
length principles in articles 9(1) and 11(6), as well as
the nondiscrimination clause in article 24(4) of the
OECD model treaty. Despite that, it seems that the
controversy on the compatibility of domestic rules on
interest restrictions with tax treaty provisions may be
solved by including a saving clause in the OECD
model and in future multilateral tax treaties, which has
not been proposed so far.14
What is not so clear, however, is how to work
around EU law, which may set important restrictions
on actions suggested by the OECD. Indeed, OECD
proposals in this area may restrict the exercise of fun-
damental freedoms or conflict with the nondiscrimina-
tion principle, which may prevent their implementation
11
See Avi-Yonah, ‘‘Globalization, Tax Competition, and the
Fiscal Crisis of the Welfare State,’’ Harvard L. Rev. 33-34 (2000).
12
Id. at 36.
13
Edward D. Kleinbard, ‘‘Stateless Income’s Challenge to Tax
Policy,’’ Tax Notes, Sept. 5, 2011, p. 1021.
14
Emilio Cencerrado Millán and María Teresa Soler Roch,
‘‘Limit Base Erosion via Interest Deduction and Others,’’ 43 In-
tertax 58 (2015).
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5. by EU member states. Because the partial implementa-
tion of BEPS actions — only outside the EU — may
jeopardize the efficiency of the BEPS project as a
whole, EU law should also be taken into account in
developing possible solutions for action 4.15
Action 5 of the BEPS project deals with countries’
harmful tax practices, which is the other side of the
problem, because the erosion of tax bases and the shift
of profits cannot be attributed only to the behavior of
taxpayers engaged in cross-border activities. It is curi-
ous that action 5 is the sole action plan to focus on
competition among countries to improve their econo-
mies and attract foreign investments by granting tax
benefits, which is at the core of all international tax-
planning structures used by multinational companies.
That lack of focus weakens the transparency and ap-
peal of the BEPS project, which might be seen as a
mere instrument to raise tax revenues and overcome
the economic crisis.
The truth behind the BEPS project will be revealed
only after analyzing its effect on national tax legislation
to regulate harmful tax competition. Apart from that
conceptual issue, action 5 of the BEPS project can be
seen as a new attempt to achieve the objectives out-
lined in the 1998 OECD report on harmful tax compe-
tition by strengthening the substantial activity require-
ment and introducing compulsory, spontaneous
exchange of rulings on preferential tax regimes.
However, considering the vagueness and generality
of the goals, it is possible to predict that the outcomes
of action 5 will be highly dependent on countries’ po-
litical will. Also, as far as harmful tax competition is
concerned, a proposal based on a collective action
should not be limited to only OECD and G-20 coun-
tries, as in the BEPS project. A comprehensive solution
is necessary to reach consistent and long-lasting results.
An interesting example involves the numerous pat-
ent box regimes available in Europe to attract research
and development activities and mobile income. The
OECD developed the nexus approach, under which the
proportion of income that may benefit from an intel-
lectual property regime is the same proportion as that
between qualifying expenditures — that is, R&D ex-
penditure incurred by the taxpayer in the development
of IP assets — and overall expenditures.16
In theory, the nexus approach requires direct nexus
between the income receiving the favorable tax treat-
ment and the expenditures incurred to generate it.
However, attempting to link the income with an intan-
gible asset through a previously incurred expense can
be complicated and cumbersome because the income
derived from a specific product may be connected with
several intangible assets (patents, trademarks, know-
how). It follows that the nexus approach fails to recog-
nize the complexities of tracing expenses to income-
generating assets and that the use of estimations to
solve the issue will be completely arbitrary.17
Action 6 of the BEPS project addresses treaty shop-
ping.18 Among its recommendations, the OECD
pleaded for including in the title and preamble of tax
treaties a statement that the contracting states intend to
avoid the creation of opportunities for nontaxation or
reduced taxation through tax avoidance and treaty
shopping.
Strictly speaking, that amendment is unnecessary. It
is widely accepted that ‘‘the principal purpose of
double tax conventions is to promote, by eliminating
double taxation, exchanges of goods and services, and
the movement of capital and persons,’’ as stated in
paragraph 7 of the OECD commentary on article 1 of
the OECD model.
Thus, considering that the purpose of a tax treaty is
to promote economic relations between contracting
states, and that its provisions will be interpreted in
good faith and in light of its object and purpose (Vi-
enna Convention article 31, paragraph 1), it is indisput-
able that interposed companies, without an effective
economic presence in the residence state, should not
have access to treaty benefits. That follows from the
proper interpretation of the term ‘‘resident’’ in article 1
of the OECD model treaty, which defines the subjec-
tive scope of a tax treaty given its object and purpose
of promoting the economic relationship between the
contracting states.
Besides being unnecessary, the amendment will
probably also be ineffective on most occasions. For
countries that adopt the exemption method to elimi-
nate double taxation, the risk of double nontaxation
will continue to exist in the application of tax treaties
that do not have a subject-to-tax provision. In that case,
including in the treaty’s preamble a clear statement
against double nontaxation will not be completely ef-
fective because the mere intention of the contracting
states cannot override the result of the application of
other treaty provisions and their interaction with do-
mestic law. The same holds true for exemption granted
by domestic law (‘‘participation exemption’’) despite
the adoption of the credit method in the relevant tax
treaty.
The OECD also recommended including a limita-
tion on benefits provision and a more general antiabuse
rule based on the principal purpose test (PPT) to get
the most out of both rules, which have their strengths
15
Eric C.C.M. Kemmeren, ‘‘Where Is EU Law in the OECD
BEPS Discussion?’’ 23 EC Tax Rev. 190 (2014).
16
OECD, ‘‘Countering Harmful Tax Practices More Effec-
tively, Taking Into Account Transparency and Substance’’ (2014),
at 29-32.
17
Manfred Naumann, ‘‘International Tax Competition and
Patent Boxes,’’ Kluwer International Tax Blog (Mar. 18, 2015).
18
OECD, ‘‘BEPS Action 6: Preventing the Granting of Treaty
Benefits in Inappropriate Circumstances’’ (2014), at 10.
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6. and weaknesses. The combination of LOB and PPT
rules in the OECD model is justified under the argu-
ment that the LOB rules do not address some forms of
treaty shopping (conduit financing arrangements) and
other types of treaty abuse.19
What may be questioned, though, is the conve-
nience of subjecting access to treaty benefits to a strict
anti-treaty-shopping rule, which requires the taxpayer
to satisfy a combination of subjective and objective
tests. The combination of both tests, a non-mandatory
alternative proposed by the OECD, may be too con-
straining in some situations, discouraging foreign in-
vestments in the country. It remains to be seen how the
OECD will combine those kinds of alternatives in the
multilateral tax treaty proposed in action 15.
The inclusion of antiavoidance rules in tax treaties
is the most effective way to combat treaty shopping,
given that in most countries, tax treaties provisions
override domestic legislation, including antiavoidance
rules, which in general do not enjoy a special status.
Most OECD countries think that domestic law anti-
avoidance provisions are generally compatible with tax
treaties, even in the absence of any specific treaty pro-
vision recognizing that possibility.
That approach relies on the idea that GAARs affect
only facts that give rise to tax liability under domestic
law, a subject not addressed in tax treaties and there-
fore not affected by them. However, the recharacteriza-
tion of a transaction by domestic antiavoidance rules
may lead to double taxation, an outcome the tax treaty
specifically tried to avoid. In that situation, the applica-
tion of antiavoidance provisions may not be in accord-
ance with the objective and purpose of tax treaties.20
Thus, because the OECD’s argument that domestic
GAARs do not conflict with tax treaties21 is uncon-
vincing, the inclusion of antiavoidance rules is an ap-
propriate alternative for combating treaty shopping.22
The problem is that LOB provisions are extremely
complicated, which may give rise to conflicts and liti-
gation in their concrete application by tax authorities.23
Other than the U.S. and a few other countries with
experience with LOB provisions, such as India and
Japan, many countries might struggle with the lack of
administrative capacity to apply them as an instrument
to challenge treaty-shopping structures.24
Regarding the PPT, the provision drafted by the
OECD follows the wording used in many domestic
antiavoidance rules and in some U.K. tax treaties.25
What is appalling here is the high degree of subjectiv-
ity granted to tax authorities in determining whether
the taxpayer’s main purpose is to take advantage of
treaty benefits, because the OECD provides no guid-
ance on how to distinguish between principal and an-
cillary purposes.26
The objective facts and circumstances analysis does
not necessarily reveal the intention or the principal pur-
pose of the taxpayer, which may create difficulties for
its practical application. Also, treaty entitlement should
not be denied based only on the principal intention of
obtaining treaty benefits, given that tax treaties are
signed precisely to foster transactions that would not
have occurred in their absence.27
Just like all other features of a tax system, the tax
treaty network is one of the important business reasons
to allocate economic activities in a specific country.28
Thus, what should be investigated is the taxpayer’s
level of economic presence in the resident state, what-
ever the principal purposes pursued by the taxpayer.
Moreover, because the provision is vague and subjec-
tive, it could create legal uncertainty for foreign inves-
tors, hindering their ability to rely on the tax treaty in
structuring legitimate transactions.29
Also, the conjugation of PPT along with the LOB
provision might endanger the legal certainty brought by
the objective tests provided in the latter, which should
work as a safe harbor for taxpayers that meet its condi-
tions. Indeed, if the taxpayer complied with the re-
quirements in the LOB provision, treaty entitlement
should be granted because its legitimate connection
with the residence state has been proved.
However, with the inclusion of a PPT clause, tax
authorities may argue that the taxpayer is not entitled
to the benefits provided by the tax treaty because of
the lack of a nontax reason, despite its genuine eco-
nomic link with the residence state. It shows that the
OECD’s suggested approach may not be the best alter-
native to address treaty-shopping cases not covered by
the LOB provision, because of the serious risk of over-
lap.
19
Evgenia Kokolia and Evgenia Chatziioakeimidou, ‘‘BEPS
Impact on EU Law: Hybrid Payments and Abusive Tax Behav-
iour,’’ 55 European Tax’n 5 (2015).
20
Marjaana Helminen, ‘‘The International Tax Law Concept
of Dividend,’’ Series on International Taxation (2010), at 105-
106.
21
Paragraphs 9 and 22 of the commentary on article 1 of the
OECD model convention (2010), at 60-61; 70.
22
Jonathan Schwarz, Schwarz on Tax Treaties (2013), 261.
23
Qunfang Jiang, ‘‘Treaty Shopping and Limitation on Ben-
efits Articles in the Context of the OECD Base Erosion and
Profit Shifting Project,’’ 69 Bulletin for Int’l Tax’n 148 (2015).
24
Luc De Broe and Joris Luts, ‘‘BEPS Action 6: Tax Treaty
Abuse,’’ 43 Intertax 146 (2015).
25
For example, the India-U.K. and Spain-U.K. tax treaties; see
supra note 22, at 261.
26
Id. at 132.
27
Id.
28
See Kemmeren, supra note 15, at 191.
29
Michael Lang, ‘‘BEPS Action 6: Introducing an Antiabuse
Rule in Tax Treaties,’’ Tax Notes Int’l, May 19, 2014, p. 655.
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7. Given that, and considering that the traditional LOB
provision is not broad enough to combat all forms of
treaty shopping, it would be preferable to extend the
LOB provision to cover conduit arrangements. A spe-
cific anti-conduit provision can be found in the U.K.-
U.S. tax treaty, as well as in U.S. law (IRC section
7701(l) and Treas. reg. section 1.881-3), which could
both serve as a reference for the OECD.
According to the OECD, the action 7 discussion
draft of the BEPS project is meant to prevent the artifi-
cial avoidance of the PE threshold. Use of the word
‘‘artificial’’ is questionable in this case, because the tax-
payers either avoided the characterization of the PE or
used the exceptions to the general PE definition in ar-
ticle 5 of tax treaties. That is a clear example of how
the actual wording of tax treaties was not maintained
in pace with changes in the business environment. For
that reason, redefining the PE concept to extend it to
situations in which business activities are carried on
without physical presence (nonphysical PE) could help
address tax planning structures commonly used in the
digital economy.
Other key aspects for the success of action 7 rely on
the redefinition of dependent agent PE to tackle com-
missionnaire structures that have been exploited re-
cently based on a lack of authority to conclude agree-
ments on behalf of the principal, as well as the repeal
of exceptions for preparatory and ancillary activities
and facilities used for storage, display, or delivery of
goods (the main example is probably the Amazon case).
The main conceptual issue here is to determine
whether the PE has a substantial relationship with the
source state to justify its tax jurisdiction, because a
merely occasional relationship is insufficient to allocate
taxing rights. The amendment of the PE definition
should not work as an unlimited force of attraction
derived from the mere supply of goods and services. In
general, the expansion of the dependent agent PE pro-
vision would reflect the economic reality of corporate
structures and business models designed to minimize
the tax burden, thus contributing to the fair allocation
of taxing rights between residence and source coun-
tries. Also, any amendment on concept of dependent
agent PE should be accompanied by specific orienta-
tion for the profit attribution under the authorized
OECD approach (article 7(2) of the OECD model).30
The discussion draft on actions 8, 9, and 10 of the
BEPS project are designed to align transfer pricing out-
comes with value creation. The development of guid-
ance on transfer pricing for intangible assets address an
essential issue that raises many practical problems.
However, the proposals released so far appear to indi-
cate that no meaningful progress will be achieved in
the allocation of profits.
Conceptually, the BEPS project was the perfect op-
portunity for the OECD to consider the convenience of
keeping the transfer pricing rules based on the arm’s-
length principle or changing to a different approach.
The arm’s-length concept ignores the essence of the
business model used by multinational enterprises. In-
deed, MNEs tend to act as one entity in the world
market in order to gain competitive advantages through
significant scale economy and synergy effects, but this
residual profit is not properly allocated between associ-
ated enterprises.31
Apparently, actions 8, 9, and 10 of the BEPS project
represent a final attempt to fix the transfer pricing rules
and maintain the arm’s-length principle as the interna-
tional standard — before implementing a more radical
change toward formulary apportionment, which is
based on the assumption that the multinational group
is a single entity. The allocation factors commonly sug-
gested for formulary apportionment are assets, payroll,
and sales, which are considered proxies for profit allo-
cation.
One may argue that formulary apportionment is not
very effective in addressing the challenges of the digital
economy, because at least two allocation factors (assets
and employees) are not directly connected with where
the consumers are located (consumer market) and
where the sales are carried out. Only the sales factor is
designed to represent the demand side and the contri-
bution of the market. However, if that is the case, a
valid alternative would be to modify the formula and
attribute double weight to the sales factor, although it
may create a stimulus to export transactions. Another
common criticism is that the three-factor formula does
not cover intangible assets.
Even so, the truth is that values of intangibles are
indirectly included in the formula, because intangible
assets are generally produced by laboratories that have
physical assets (assets) and scientists and researchers
(payroll). Also, considering that the entire group as a
unitary entity shares intangibles assets, it is almost im-
possible to allocate intangible assets in one physical
location, making it appropriate to not consider them
directly in the formula.32
Focusing on an alternative in line with the arm’s-
length principle, the BEPS project clearly tried to
strengthen the functional analysis, whose practical re-
sults remain to be seen. It will probably be difficult to
achieve significant results by applying a functional
analysis to complex businesses, with the development
30
Alfred Storck and Alexander Zeiler, ‘‘Beyond the OECD
Update 2014: Changes to the Concepts of Permanent Establish-
ments in the Light of the BEPS Discussion,’’ in The OECD-
Model-Convention and its Update 2014 (2015), at 262.
31
Hubert Hamaekers, ‘‘Arm’s Length — How Long,’’ in Inter-
national and Comparative Taxation — Essays in Honour of Klaus Vogel
(2002), at 38-39.
32
See Avi-Yonah, supra note 6, at 111-113.
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8. of electronic commerce, Internet, and modern commu-
nications combined with the easy transference of in-
tangibles assets, risks, and functions.
In any event, the OECD’s effort to maintain the
arm’s-length principle deserves to be acknowledged,
because a switch to formulary apportionment would
depend on countries agreeing on a predetermined for-
mula and its characteristics to avoid double taxation.
The achievement of an international political consen-
sus on that issue is an extraordinarily difficult obstacle
to overcome.
Leaving aside conceptual questions, despite the par-
ticipation of G-20 countries as associated members and
of the possible invitation of other countries on an ad
hoc basis, developing countries might struggle with the
lack of administrative structure, technical instruments,
and human resources to approach the transfer pricing
issues raised in the BEPS project. It might also be diffi-
cult to introduce mechanisms to enhance cooperation
among tax administrations, such as advance pricing
agreements, mutual agreement procedures (MAPs), and
tax arbitration.33 Ideally, the OECD should have con-
sidered that in its transfer pricing recommendations.
The analysis of the action plans on data and com-
pliance reporting, although sensitive for many taxpay-
ers, is beyond the scope of this paper. The action 11
draft establishes methods to collect and analyze data
on BEPS, the action 12 draft requires taxpayers to dis-
close their aggressive tax planning arrangements, and
the action 13 report addresses transfer pricing docu-
mentation. A core aspect that may be highlighted is the
growing importance of improving the relationship be-
tween taxpayers and tax authorities as a way to pro-
mote the voluntary fulfillment of tax obligations and
the reduction of aggressive tax planning. Apart from
focusing on collecting information to enable tax au-
thorities to actively run inspections, the OECD should
find alternatives to enhance the relationship between
taxpayers and tax authorities as a longer-term goal.
The discussion draft on action 14 of the BEPS proj-
ect covers dispute resolution mechanisms and alterna-
tives to make them more effective, which is essential in
the BEPS context where the risk of double taxation
may increase significantly. It is unrealistic to believe
that the outcome of the BEPS project will be neutral,
without creating an overlap in the exercise of tax juris-
diction by the countries involved. For that reason, al-
though it may not be the ideal way to develop interna-
tional case law on tax treaty interpretation, arbitration
is a reasonable solution for the problems that taxpayers
will probably face in the BEPS project, because it
avoids a unilateral outcome in tax litigation.34
Action 15 of the BEPS project intends to develop a
multilateral instrument to modify bilateral tax treaties
in a quick, consistent, and coordinated way. However,
the success of a multilateral agreement depends on the
efforts among signatory countries to reach consensus
— not an easy task. Negotiating a multilateral tax
treaty will probably be lengthier and more complicated
than negotiating a bilateral treaty.
To develop a workable multilateral treaty, the coun-
tries concerned must accept provisions that ultimately
will be applied to all parties. It is doubtful, however,
whether it will be possible to attain a leveling out of
different ideas on the BEPS project for purposes of ne-
gotiating a multilateral tax treaty. Besides, the idea of a
multilateral treaty is particularly challenging because
international treaties usually depend on the approval of
the legislative power to enter into force within each
legal system, regardless of the discussion on monism
or dualism. Thus, even if the delegation responsible for
the tax treaty negotiation agrees with a specific solu-
tion, congressional representatives will not necessarily
share that opinion.
Finally, it is useful to remark that a multilateral
MAP will be feasible only if binding decisions are
handed down in an acceptable time frame. The experi-
ence with the EU arbitration convention35 and the av-
erage duration of OECD MAP procedures36 shows
that it is not easy to reach a binding decision within a
reasonable time.37
Conclusions
The BEPS project targets only specific problems in
the international tax regime without offering a compre-
hensive solution. The OECD clearly wants to fix prob-
lems caused by the failure of international tax rules to
keep pace with changes in the global corporative busi-
ness environment.
However, the problem is that the BEPS project rep-
resents a mere attempt to change the current interna-
tional tax regime in specific ways without implement-
ing more radical changes toward a tax regime for the
future. In practice, the success of the OECD measures
largely depends on whether countries will embrace the
outcomes of the BEPS action plans even against their
national interest. ◆
33
Ana Paula Dourado, ‘‘The Base Erosion and Profit Shifting
(BEPS) Initiative Under Analysis,’’ 43 Intertax 3 (2015).
34
See Dourado and Pasquale Pistone, ‘‘Some Critical
Thoughts on the Introduction of Arbitration in Tax Treaties,’’ 42
Intertax 160 (2014).
35
Convention 90/436/EEC on the elimination of double
taxation in connection with the adjustment of profits of associ-
ated enterprises (1990).
36
OECD MAP statistics 2013, available at http://
www.oecd.org/ctp/dispute/map-statistics-2013.htm.
37
CFE Fiscal Committee, ‘‘Opinion Statement FC 15/2014
on Developing a Multilateral Instrument to Modify Bilateral Tax
Treaties (BEPS Action 15),’’ 55 European Tax’n 4-5 (2015).
VIEWPOINT
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