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Taxing multinationals: Arm’s length principle is essential, say OECD officials

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The OECD’s action plan to tackle base erosion and profit shifting is unlikely to include a root and branch reform of the international tax system, but last week’s report to G20 finance ministers suggests that recommendations may include uniform international rules on controlled foreign companies and the deductibility of interest.

OECD tax officials said in a recent article that the arm’s length principle was ‘an essential element’ of a fair allocation of taxing rights between countries. And discussions with OECD representatives last month indicated that the intention is ‘not to abandon the traditional arm’s length standard [for transfer pricing] but rather to make refinements to the existing regime’, according to Ernst & Young. Some tax campaigners have called for fundamental reform and a system of ‘unitary taxation’.

The firm reported that the business and industry advisory committee to the OECD met OECD representatives in March, after publication of the report Addressing Base Erosion and Profit Shifting.

OECD secretary-general Angel Gurría warned in February that the use of aggressive tax strategies by some multinationals was eroding the tax base of many countries and threatening the stability of the international tax system.

But Ernst & Young’s client briefing indicated that OECD representatives acknowledged an ‘inherent link’ between tax competition by countries for business and opportunities for profit shifting.

‘OECD representatives also expressed the view that claims by some groups that the current international tax system is “completely broken” were overstated and indicated an intention to focus attention on what are seen as particular problem areas in an effort to improve the operation of the rules,’ the firm said.

With regard to interest, OECD representatives ‘expressed the view that countries cannot allow unlimited interest deductions and that rules are needed to address excess leverage’.

On transfer pricing, the focus would be on intangibles, treatment of risk and potential re-characterisation of transactions.

Senior OECD tax officials have said that helping to develop rules that support the efficient operation of global markets is one of the OECD’s key objectives. Writing in the OECD Yearbook, Pascal Saint-Amans and Raffaele Russo said: ‘This involves providing a policy framework that achieves a fair allocation of taxing rights between countries. The arm’s length principle and the elimination of double taxation are essential elements of that framework, but so is the elimination of inappropriate double non-taxation, whether that arises from borderline strategies put in place by aggressive taxpayers or from tax policies introduced by national governments.’

The aim of the base erosion and profit shifting (BEPS) project is to bring international tax rules into the 21st century, the OECD declared in last week’s report to G20 finance ministers.

‘[The] OECD is actively working to develop an action plan to respond to BEPS. The action plan will be delivered to G20 finance ministers in July 2013 and will set out a roadmap and process for further work,’ it said.

Three focus groups are working to develop the action plan, which will ‘provide concrete solutions to realign international standards with the current global business environment’.

The OECD’s work is also being informed by engagement with business and civil society. ‘In general, business recognises that there is a need to restore trust in the international tax system by revisiting the tax rules,’ the OECD said.

‘Business emphasised that the current rules work effectively in most areas but other areas require an adjustment to the rules, in particular where the substance and taxation of transactions has diverged.

‘Business has acknowledged the importance of economic substance and called on the OECD to establish a common definition of economic substance, proposed the creation of a joint OECD/business group to work on issues relating to the digital economy, supported the establishment by the OECD of uniform international rules on controlled foreign companies and on interest deductibility, and offered to work on a business code of tax conduct as part of the BEPS agenda.’

The report also noted that trades union representatives had called for greater transparency, including country by country tax reporting. NGOs had expressed strong support for the BEPS report and presented a report titled No More Shifty Business, which was signed by 58 NGOs.

Writing in the French newspaper Le Figaro last week, Gurría said: ‘The G20 has asked us to review international tax rules in order to put SMEs and multinationals on a level playing field.

‘Combating the erosion of tax bases and the shifting of profit has become a priority now that taxpayers’ trust in the effectiveness and fairness of their tax systems depends on it. Eliminating double taxation of transnational investment is necessary for growth and employment.

‘While this objective must be maintained, it is also necessary to do away with “double non-taxation” and the shifting of profits to tax-free jurisdictions where no real activity takes place. In July, I shall present the G20 with an action plan to put an end to such practices.’