Preparing for the future of taxation
As countries throughout the world continue to implement BEPS – often in piecemeal and inconsistent ways – multinational companies will need to take a proactive approach to managing tax risks, which can have a significant, long-lasting impact on their business strategies and brand reputations. Below we identify key strategies to help companies navigate the new environment.


Think global The heightened cross-border cooperation in tax policy will place greater demands on multinational companies. While regional tax managers have typically overseen local audit activity, that may need to change as governments share information about audits. For example, the position taken on an indirect tax audit in one country may undercut the position taken on an income tax audit in another country. “Multinationals are going to be forced to manage their tax policy much more globally,” says Simone Musa, Chair of Baker McKenzie’s Global Tax Practice Group.

Be able to tell your story Companies will face heightened obligations related to their own data. “They are going to need good data about their operations, while also being able to manage that data efficiently and explain what it means in ways that authorities across multiple jurisdictions can understand,” says Kirsten Malm, a partner in Baker McKenzie’s San Francisco office. “Companies also need to ensure that the story they tell Wall Street neatly aligns with what they tell the authorities. And they will need people internally who understand how all of the information fits together.”

This is likely to become an even bigger issue going forward. For example, while CbCR information currently is intended to be shared only among tax authorities, certain NGOs and some politicians in the EU and Australia have called for public CbC reporting. In addition to aggressive transparency initiatives, technological advances are delivering new tools to tax authorities, intensifying the pressure on tax departments and adding to reputational risk.
Multinationals are going to be forced to manage their tax policy much more globally.
Simone Dias Musa,
Partner
Engage with stakeholders Multinational companies should be deeply involved with the ongoing debates over tax policy. This means staying current on what different countries are doing, linking into networks and sharing intelligence, and actively engaging with policy makers.
“The polarizing nature of the debate can put companies in a difficult position with respect to their tax strategies,” says Paardekooper. “They need to be compliant, but they wonder if there is any other moral higher ground that they should adhere to in order to be seen as a good taxpayer.” From a business standpoint, active engagement with the OECD and other stakeholders can lead to improved policies and help to ensure the consistency and proper applicability of the BEPS measures.


Assess the impact of BEPS on your operating structure The new BEPS guidance will have a significant impact on operating model structures of multinational companies. According to the OECD’s status report, BEPS measures already are putting pressure on corporate structures such as “cash box” structures, cost-plus sales and marketing compensation, IP / patent boxes, contractual allocation of residual profit, and treaty shopping structures.22
Companies should assess whether their existing supply chains and IP ownership models are compliant with the new BEPS guidance on tax transparency and substance. Companies may also want to consider reassessing the transfer pricing method selection and PE exposure for sales organizations. After BEPS, aligning substance and structure is key when it comes to permanent establishment and transfer pricing risks.


Understand where value is created in your business More broadly, understanding and identifying the key tax and legal considerations for each part of the supply chain is critical as tax, transfer pricing and legal issues are present at every stage from research, design and planning to buying, manufacturing, distributing and selling. An assessment of the suitability and sustainability of the transfer pricing policy and resulting allocation of profits within a group should consider:
+ The economically significant functions, assets and risks
+ Which party or parties perform the functions, own and operate the assets and assume the risks and
+ How non-routine returns are created, such as through the development and use of unique intangibles or the assumption of significant entrepreneurial risk.
The challenges ahead
While 2017 was heralded as the year of BEPS implementation, some of the biggest issues are still under discussion, including the digital economy. “While the OECD clearly stated in the BEPS Project that it is not possible to ring-fence the digital economy, some jurisdictions are suggesting that a ring-fence would be appropriate to impose special and different taxes on digital enterprises. As could be expected, this creates significant uncertainties for companies,” says Gary Sprague, a Baker McKenzie partner based in Palo Alto.21
Multinationals are likely to see more activity in this area as domestic political pressures force the tax policy agenda.
Amid cooperation, competition continues
At the same time, the cooperative spirit underpinning the BEPS Project and other initiatives has not done away with the cross-border competition that’s been fundamental to tax policy for decades. Corporate tax rates remain a fundamental differentiator for countries trying to attract foreign investment (or keep domestic companies at home) and those rates have been declining since 1980 in both advanced and developing economies.
This picture is unlikely to change in the near term. The BEPS Project does not address headline corporate tax rates, which ultimately drive tax competition (although it does address certain tax incentive regimes, including the so-called patent or IP boxes).
And while countries such as Germany and France have called for greater harmonization of rates in the EU, particularly in the wake of Brexit, small member states – Ireland, the Netherlands, Belgium, and Luxembourg – have been more aggressive about using tax policy as a tool to compete for foreign direct investment. And in its 2018 Budget, even France is proposing to reduce its corporate tax rate from 33.33% to 25%.
Apart from competition to attract investment, countries also can be seen as competing to increase their share of taxable income. Countries such as Israel, Turkey and Italy (proposed) have jumped the gun on BEPS Action 1, which is focused on addressing the tax challenges of a digital economy, and adopted a virtual permanent establishment (PE) standard, creating a new form of PE based on a significant digital presence in another country’s economy. The UK Diverted Profits Tax (“DPT”) and the Australian Multinational Anti-Avoidance Law (“MAAL”) seem to be intended as tools to tax profits arising offshore from investments made offshore, which is a change from the normal nexus standards for determining tax liability.
Still other countries (e.g., India through its “equalization levy”) have implemented or at least debated new rules to impose a unique tax on the digital goods and services sector. While these unilateral actions are not part of BEPS, the project may have provided inspiration and perhaps cover for governments to propose the more radical changes.20
The cross-border cooperation reshaping tax policy
The scope of the OECD/G20 Inclusive Framework on BEPS is unprecedented. It involves more than 100 countries and jurisdictions and includes the implementation of 15 action plans covering various dimensions of the operating landscape for multinational companies from the digital economy to dispute resolution.18 Nations are moving forward quickly to establish the necessary legal framework to implement the BEPS package of measures with the aim of curtailing corporate tax planning strategies that reduce tax liability by shifting profits to locations where companies have little or no economic activity.
Several of these measures are notable for their focus on transparency and heightened cross-border cooperation. For example, the BEPS Project’s Action 13 aims to develop rules for transfer pricing documentation to enhance transparency for tax administrations and provide the information needed to conduct effective transfer pricing risk assessments and audits. Under the three-tier system for documentation, multinational companies must deliver to tax administrations a detailed disclosure of where they record profits and sales, employ staff, hold assets and pay and accrue taxes.
This disclosure – known as “Country-by-Country Reporting” (CbCR) – “represents a break with past tax policy,” says Mary Bennett, a Baker McKenzie partner based in Washington, DC and former head of the OECD’s tax treaty, transfer pricing and financial transactions division. “It imposes a new obligation on multinationals to generate detailed information on their global operations for the digestion of every country in which they do business around the world. And it’s going to involve extensive information sharing among governments.”

Another indicator of the global push for transparency and greater cross-border cooperation among tax authorities is the BEPS framework for the compulsory and spontaneous exchange of information about tax rulings (BEPS Action 5). By mid-2017, exchanges of about 6,000 tax rulings had already taken place between tax administrations around the world, with thousands more underway.19 The effect of this compulsion is clear – transactions or arrangements that may present BEPS concerns will be reported to tax administrations in other relevant countries.
Together, CbCRs and automatic information exchanges provide immediate transparency about the multinational’s operations and tax liabilities globally. Since the CbC reports provide information without an appropriate commercial context, the information may increase the risk of tax disputes. Indeed, there is already evidence that BEPS is spurring audit activity, with companies facing identical audits in multiple countries.
While BEPS is at the center of the push for transparency, political momentum is spurring related tax activity and cooperation across various country blocs. For instance, in July 2017, the BRICS countries – Brazil, Russia, India, China, and South Africa – announced a landmark tax cooperation agreement. And the European Council has resurrected a project to study the imposition of the Common Corporate Consolidated Tax Base in the EU, which essentially would substitute formulary apportionment for the arm’s length principle to allocate the tax base for transactions within the EU.
While the success and timing of any specific effort is difficult to predict, the directional trend is clear. Tax policymakers are looking for new tools to respond to a digitized and internationalized economy and a certain level of global cooperation is helpful to advance national aims.
Uncertainty about globalization has itself been globalized, with populations throughout the world questioning whether the mostly unfettered flow of goods, services, information, and people is a net positive or a net negative. The discontent in some countries is intimately linked to growing distrust of two pillars of virtually every economy: government and multinational companies. At the nexus of the relationship between government and multinational companies is the public policy that is frequently a source of debate: taxation. There is a sense among many people that globalization benefits large companies and not average citizens, with some asserting that companies are not paying their “fair share” of taxes (even if their tax positions are lawful).
Against this backdrop, one of the most noteworthy global economic policy developments in decades – the OECD’s base erosion and profit shifting (BEPS) Project – is dramatically altering the international tax system by encouraging governments to close loopholes, improve transparency and “better align rights to tax with economic activity.”17 While cross-border tax cooperation has always existed, the BEPS Project encompasses more countries and more issues. As a result, multinationals are facing the biggest changes to how and where they’re taxed in more than 50 years, according to Baker McKenzie partner Caroline Silberztein.
At the same time, countries are still finding ways to compete as they seek to attract investment and increase tax collections. This activity is creating greater uncertainty for international tax planning strategies and raising the stakes when it comes to compliance. Changing business models, the rise of the digital economy, technological advances such as automation, and national tax reform – particularly in the US – are further complicating the tax policy landscape. Below we highlight the conflicting forces reshaping tax policy and the resulting risks and opportunities for multinationals, which extend well beyond the tax department.
Sources
17 OECD, Action Plan on Base Erosion and Profit Shifting, OECD Publishing, 19 July 2013; http://dx.doi.org/10.1787/9789264202719-en

18 http://www.oecd.org/tax/automatic-exchange/country-specific-information-on-country-by-country-reporting-implementation.htm

19 http://www.oecd.org/tax/beps/inclusive-framework-on-BEPS-progress-report-july-2016-june-2017.pdf

20 Gary Sprague, “Nexus Rules and Theories of Market-Based Taxation in the BEPS Project (and Beyond).” Bloomberg BNA International Tax (Feb. 15, 2017); https://www.bna.com/nexus-rules-theories-n57982083828

21 Gary Sprague, “The Broader Consequences of the EU Debate on Taxing the Digital Economy,” Bloomberg BNA Tax Management International (Nove. 10, 2017)

22 http://www.oecd.org/tax/beps/inclusive-framework-on-BEPS-progress-report-july-2016-june-2017.pdf
Companies need to ensure that the story they tell Wall Street neatly aligns with what they tell the authorities. And they will need people internally who understand how all of the information fits together.
Kirsten Malm,
Partner
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