Michael Danilack, deputy commissioner of the Internal Revenue Service (IRS), recently gave his views on the potential negative impact that the OECD’s base erosion and profit shifting (BEPS) project could have on the US.
The negatives
Danilack listed a number of harmful consequences that could arise from BEPS:
· Increase in cross-border disputes and litigation costs;
· Increase in aggressive tax audits, which will put additional pressure on competent authorities who are already strapped for resources;
· Foreign governments collecting more taxes from US companies could result in IRS having to issue more tax credits, undercutting US corporate tax collections; and
· A general decline in US tax revenue.
There are a number of positions contained in the OECD’s Discussion Draft on Transfer Pricing Intangibles that counterbalance measures the IRS has already introduced and frequently brings to bear on audits of intangible transfers.
“The forthcoming revisions to Chapter 6 and the Special Measures to be introduced may make it far more difficult for the IRS to prevail when taking extreme positions vis-a-vis the value of "platform contributions" (intangible assets transferred intercompany in the context of cost-sharing arrangements), and the compensation to which non-US cost-sharing participants are entitled by virtue of the functions they perform, the assets they contribute and/or the risks they assume,” said Elizabeth King of Beecher Consulting Group.
Because transfers of intangible assets are often a cornerstone of multinational groups’ tax planning efforts, and a focal point of IRS scrutiny, “this attempt to fight fire with fire might have significant adverse consequences for US tax coffers”, said King. “Alternatively, the result may be more frequent incidents of double taxation.”.
If the OECD endorses formulary apportionment on a broad scale while the IRS remains committed to the arm’s-length standard, disputes as to how multinational firms’ income should be allocated across tax jurisdictions would almost certainly be more frequent and more intense.
The positive approach
When comparing the US and Europe it is evident that their tax systems are fundamentally different. Most of Europe faces major problems with corporate tax because of permanent establishment (PE) rules. PE is at the core of how EU governments tax corporate entities. The US, on the other hand, is moving towards a market based tax system, which some feel is a much more realistic approach.
“The EU are finding themselves in an uncomfortable position, locked down with PE rules which have very little to do with how business is carried out in the 21st century,” said Joe Huddleston, executive director of the Multistate Tax Commission.
An uptake in aggressive audit activity is putting pressure on businesses, making it increasingly less attractive to do business in Europe.
“If there is any impact it would be positive. US businesses will find it less and less attractive to shelter money by holding it in other countries. It will encourage US businesses to stay in the US and encourage EU members to invest in the US,” said Huddleston.
Final considerations
While a case can be made that the increase in aggressive tax auditing in Europe could drive business to the US, BEPS in its current state seems to pose more negatives than positives for the US and other countries. There is no denying that BEPS requirements are costly and will force-up reporting and compliance expenses.
