Base Erosion and Profit Shifting (BEPS): An International Phenomenon

Base Erosion and Profit Shifting (BEPS): An International Phenomenon

Base Erosion and Profit Shifting (BEPS) refers to tax planning strategies used by multinational enterprises that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, thereby eroding the tax base and significantly reducing their tax burden. These practices lead to substantial tax revenue losses in the states where economic activities actually take place, which undermines tax fairness and the financing of public goods.

BEPS Initiative: BEPS 1.0 and BEPS 2.0

The Organisation for Economic Co-operation and Development (OECD), together with the G20 countries, launched the BEPS initiative to counteract these practices.

This initiative can be divided into two phases:

1. BEPS 1.0 (Allocation of new taxing rights for market jurisdictions): In 2015, 15 action points were published, comprising a series of binding measures to prevent tax abuse. These points aim for transparency, the reform of tax rules, and the closing of loopholes in international tax law.
2. BEPS 2.0 (Introduction of minimum taxation): This second phase specifically addresses the taxation of digital business models (Pillar 1) and the introduction of a global minimum tax (Pillar 2). The measures of Pillar 1 aim to redistribute taxing rights between countries, while Pillar 2 provides for a minimum tax of 15% for multinational enterprises to ensure fair taxation and prevent the erosion of the tax base. Learn more here.

Links to the respective 15 Action Points (Measures)

Addressing the tax challenges of the digital economy (Action Point 1)

Hybrid mismatch arrangements (Action Point 2)

Designing effective controlled foreign company rules (Action Point 3)

Limiting base erosion involving interest deductions and other financial payments (Action Point 4)

Countering harmful tax practices more effectively, taking into account transparency and substance (Action Point 5)

Preventing the granting of treaty benefits in inappropriate circumstances (Action Point 6)

Preventing the artificial avoidance of permanent establishment status (Action Point 7)

Aligning transfer pricing outcomes with value creation (Action Points 8 to 10)

Measuring and monitoring BEPS (Action Point 11)

Mandatory disclosure rules (Action Point 12)

Transfer pricing documentation and Country-by-Country Reporting (Action Point 13)

Making dispute resolution mechanisms more effective (Action Point 14)

Developing a multilateral instrument (Action Point 15)

EU Measures to Combat Aggressive Tax Planning

The EU implements measures in the form of directives (ATAD, CBCR, MDR). Within the framework of the BEPS initiative and beyond, the European Union has adopted or proposed several directives to combat aggressive tax planning and prevent the erosion of the tax base. Here is an excerpt of the central measures:

Anti-Tax Avoidance Directive (ATAD I and II):

• ATAD I was adopted in 2016. This directive contains rules to prevent base erosion and profit shifting. It includes a series of measures to combat tax avoidance, including:
  • Interest limitation rules: This regulation prevents companies from reducing their tax burden through excessive interest payments to associated enterprises in low-tax jurisdictions.
  • Exit taxation rules,
  • A General Anti-Abuse Rule (GAAR)
  • Controlled Foreign Company (CFC) rules: Profits of subsidiaries in low-tax countries are attributed to the parent company and taxed in its state of residence to prevent profit shifting.
• These measures aim to prevent the shifting of profits to low-tax jurisdictions and protect the tax base of the Member States.
• ATAD II extends ATAD I and specifically addresses the neutralisation of hybrid mismatch arrangements that exploit differences in the tax treatment of financial instruments or entities between different jurisdictions. It thus includes measures against hybrid arrangements. ATAD II aims to stop the use of hybrid financial instruments and structures that are treated differently in different countries, leading to double non-taxation.

CBCR (Country-by-Country Reporting)

The EU requires multinational enterprises to provide country-by-country reporting to create transparency regarding the distribution of profits and taxes paid in various countries. These reports are intended to help tax authorities better identify tax avoidance practices.

Objectives and Implementation:

• Objective: Through country-by-country reporting, tax authorities should gain better insight into the global structures and tax practices of multinational enterprises to identify and prevent tax avoidance.
• Implementation: The EU has mandated CBCR for large multinational enterprises with a consolidated turnover of at least 750 million euros. These companies must submit their reports to the tax authorities, who may also exchange this information with other states.

MDR (Mandatory Disclosure Rules)

The EU has introduced mandatory disclosure rules (MDR), which require intermediaries such as tax advisors and lawyers to report potentially aggressive tax arrangements before they are implemented.

DAC 6 (Directive on Administrative Cooperation in the field of taxation):

• This directive, which came into force in 2018, aims to increase transparency by requiring tax advisors and other intermediaries to report certain cross-border tax arrangements to the tax authorities. DAC 6 specifically targets tax arrangements designed to minimise the tax burden or circumvent tax obligations. The directive allows tax authorities to take early action against potentially harmful tax arrangements.
• This reporting obligation primarily affects intermediaries such as tax advisors, lawyers, and financial service providers involved in the planning and implementation of such structures.
  • Intermediary (§ 138d Abs. 1, § 138f Abs. 7 AO - Fiscal Code): An intermediary is an individual or company that markets, designs, organises, or makes available for use a cross-border tax arrangement for third parties, or manages its implementation by third parties. Reporting obligations exist under certain conditions, such as if the intermediary is resident in Germany, has a permanent establishment in Germany, or is entered in the commercial register. An auxiliary intermediary differs from the main intermediary in that they do not play a significant role in the design, marketing, or implementation of the tax arrangement but rather perform a supportive or advisory function. The responsibility for reporting lies primarily with the main intermediary; the auxiliary intermediary is only obligated if the main intermediary does not fulfil their reporting duty or is not identifiable. (Art. 3 No. 21 Sent. 2 EU Directive)
  • Relevant Taxpayer / User (§ 138d Abs. 5 AO): The relevant taxpayer is any person or organisation to whom a reportable cross-border arrangement is made available, who is ready to implement this arrangement, or who has already taken the first step towards implementing it.
  • Reportable Cross-Border Arrangement: This refers to tax arrangements that meet certain criteria and could potentially be used aggressively for tax avoidance. The reporting obligation applies to intermediaries and, in certain cases, to taxpayers if no intermediary is involved.
  • Important aspects are:
    • Reporting Obligations: Intermediaries must report cross-border tax arrangements that meet certain hallmarks to the national tax authorities.
    • Hallmarks: The directive defines specific hallmarks that indicate potentially aggressive tax planning. These include structures aimed at avoiding or reducing tax payments without economic substance.
    • Automatic Exchange of Information: The reported information is exchanged between Member States to ensure that all relevant tax authorities are informed about potential aggressive tax arrangements.
• Workflow of the DAC 6 Reporting Process
  • Identification of the new arrangement (after 24.06.2018):
    • First, a cross-border tax arrangement is identified that may be reportable. An arrangement is reportable if it fulfills certain "hallmarks" defined by law. These hallmarks indicate potentially aggressive tax planning.
  • Examination of the reporting obligation (Tax type & cross-border tax arrangement):
    • After a reportable arrangement is identified, it is checked whether the arrangement is actually mandatory to report. This examination includes the analysis of the hallmarks and the conditions under which the arrangement is implemented.
      • The Main Benefit Test for certain hallmarks examines whether the main purpose or one of the main purposes of a cross-border arrangement is to obtain a tax advantage. This could, for example, be a reduction of the tax burden, tax avoidance, or the use of tax loopholes.
      • The Main Benefit Test is applied in combination with specific "hallmarks." These hallmarks are specific features or characteristics of a tax arrangement that could indicate aggressive tax planning. If an arrangement meets such a hallmark and the Main Benefit Test is positive, the arrangement must be reported.
      • The test requires a subjective assessment of the arrangement, as it must be checked whether a tax advantage can be considered the main advantage of the arrangement. This assessment can be complicated as it is based not only on obvious results but also on the intentions of the parties involved.
    • If the arrangement is reportable, intermediaries and/or taxpayers must initiate the necessary steps for reporting to the BZSt (Federal Central Tax Office). If the arrangement has a genuine economic purpose and the tax advantage is only a side effect, the Main Benefit Test might be negative, meaning the arrangement might not be reportable.
  • Jurisdiction and Obligation of the Intermediary: Generally, the intermediary who markets, organises, or manages the implementation of the arrangement is reportable. The intermediary must check if they are resident in an EU Member State, have a permanent establishment there, or are subject to the reporting obligation for other reasons.
    • Reporting by the Intermediary: The intermediary is obliged to report the reportable arrangement within 30 days after the day the arrangement is made available, provided, or after the first implementation step occurs. The report includes details about the arrangement, the parties involved, and the tax types affected.
    • Auxiliary Intermediary: If the main intermediary does not carry out the reporting or is not identifiable, the reporting obligation falls to the auxiliary intermediary. They are obliged to report if they have knowledge of the reportable arrangement.
    • Reporting Obligation of the Relevant Taxpayer: In cases where no intermediary is involved (e.g., "in-house" arrangements), the relevant taxpayer themselves is responsible for reporting. This also applies if the intermediary cannot report due to professional confidentiality obligations and has informed the taxpayer of this.
  • Automatic Exchange of Information: The information reported by intermediaries or relevant taxpayers is collected by national tax authorities and automatically exchanged between EU Member States. This ensures that all involved countries are informed about potential aggressive tax arrangements and can react accordingly.

Taxation of the Digital Economy (Pillar One)

Pillar 1 of the BEPS initiatives was developed to address the challenges of taxing the digital economy. It focuses on how large multinational enterprises, especially digital groups, should be taxed in the countries where they operate, even if they have no physical presence there.

Traditional tax systems are based on the concept that a company can only be taxed in a country if it has a physical permanent establishment there. However, digital business models, such as those operated by major tech companies, make it possible to generate significant revenue in a country without having a physical presence. This results in these companies paying little or no tax in many market jurisdictions (the countries where the users or customers are located).

Pillar 1 aims to change existing rules for allocating taxing rights and give market jurisdictions more rights to tax the profits of multinational groups, particularly when they generate high profits through digital business models but have no physical presence.

Key Elements of Pillar 1:

1. New Nexus Principle:
   • Nexus is a criterion that establishes a company's tax liability in a specific country. Under Pillar 1, this principle is expanded so that market jurisdictions receive the right to tax profits if a company has significant economic activities in their country through digital services or the sale of goods and services, even if there is no physical presence.
2. Profit Allocation:
   • A central component of Pillar 1 is the introduction of a new method for allocating the profits of large multinational enterprises. This method takes into account where the turnover is generated and ensures that a portion of the profits is allocated to the market jurisdictions where the users or customers are located.
3. Scope:
   • Pillar 1 primarily affects very large multinational enterprises, typically those with a global turnover of more than 20 billion euros and a profitability of over 10%. These companies are expected to pay tax on profits where their users or customers are located.

The goal of Pillar 1 is to ensure a fairer distribution of taxing rights and to give market jurisdictions more influence over the taxation of companies that generate high turnover in their territory without being physically present. This is intended to prevent profits from being shifted to countries with low tax rates without being taxed in the market jurisdictions.

Pillar 1 is part of the broader efforts by the OECD and G20 to adapt global tax rules to the challenges of the digital age and ensure that multinational enterprises are taxed appropriately and fairly, regardless of where they operate their business.

Minimum Taxation Directive (Pillar Two):

• This Minimum Taxation Directive, proposed within the framework of BEPS 2.0, aims for the introduction of a global minimum tax of 15% for large multinational enterprises. The goal is to ensure that companies bear a fair tax burden regardless of their seat, making the shifting of profits to low-tax jurisdictions less attractive. Minimum taxation is intended to prevent multinational enterprises from minimising their tax obligations through aggressive tax planning.
• The directive, based on global OECD/G20 decisions, provides that multinational enterprises with a turnover of more than 750 million euros are subject to an effective minimum tax rate of 15%. This ensures global minimum taxation of 15% for large multinational enterprises.
• It includes:
  • Global minimum tax of 15%: Multinational groups with an annual turnover of over 750 million euros must ensure that their profits are taxed at least at 15% worldwide.
  • Top-up Tax: If the effective tax rate in a country is below 15%, a top-up tax is levied to compensate for the difference. This regulation aims to tax profits generated in low-tax jurisdictions retrospectively.
  • Implementation through national laws: In Germany, a corresponding draft for a Mindestbesteuerungsrichtlinie-Umsetzungsgesetz (MinBestRL-UmsG - Minimum Tax Directive Implementation Act) was submitted.
• The following adjustments to the Handelsgesetzbuch (HGB - Commercial Code) are based on this foundation, for example:
  • § 274 Abs. 3 HGB:
    • It is determined that when accounting for deferred taxes, differences resulting from the application of the Minimum Tax Act or a comparable foreign law must not be taken into account.
  • § 285 Nummer 30a HGB:
    • Introduction of the obligation to explain the actual tax expense or tax income resulting from the Minimum Tax Act or a foreign minimum tax law in the notes to the annual financial statements. If these laws are not yet in force, companies must present the expected impact on the corporation.
  • § 314 Abs. 1 Nummer 22a HGB:
    • Similar reporting obligations as in § 285 HGB, but applied to consolidated financial statements. The actual tax expense or tax income must be explained in the notes to the consolidated financial statements, as well as the expected effects if the laws are not yet in force.

The current issue of taxing the digital economy within the framework of BEPS Pillars 1 and 2 can be presented as follows:

1. New business models with high profit margins: Digital companies generate high profits, often without a physical presence in the countries where they offer their products or services. This poses a challenge for traditional tax systems oriented towards physical presence (permanent establishments).
2. Lack of territorial connection points: According to § 49 EStG (Income Tax Act), income from foreign companies is generally only taxed in Germany if they have a domestic permanent establishment. Digital companies offering services cross-border often do not meet this condition, so their profits cannot be taxed in the market jurisdictions.
3. Nexus Principle: Pillar 1 of the BEPS initiatives introduces the concept of an expanded nexus principle. This means that market jurisdictions receive the right to tax profits even if a company has no physical presence in their country. This ensures that profits are taxed where the economic activity takes place—that is, where the users or customers are located.
4. Minimum Taxation (Pillar 2): To prevent tax avoidance through the shifting of profits to low-tax countries, Pillar 2 introduces a global minimum tax of 15%. This ensures that all companies, regardless of their location, are subject to minimum taxation, thereby reducing the attractiveness of low-tax jurisdictions.

These measures aim to achieve a fairer distribution of taxing rights and ensure that digitally active companies also pay their fair share of taxes, even if they have no physical presence in the market jurisdictions.

Through these and other measures, the EU demonstrates its commitment to the fight against aggressive tax planning and tax avoidance. The introduction of transparency rules, the fight against hybrid arrangements, and the establishment of minimum taxation are essential steps towards maintaining tax justice and ensuring that multinational enterprises make their fair contribution. These measures strengthen trust in the tax systems of EU Member States and contribute to the stability of public finances.

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Note
**This article is for general information purposes and was carefully prepared by the Lexo.Tax editorial team. Personal tax advice can only be provided within the framework of membership with Lexo.Tax – and exclusively within the legally permissible scope according to § 4 Nr. 11 StBerG (Tax Consultancy Act).