As political leaders of the G20 countries gathered recently in Brisbane, Australia to tackle Islamic State terrorism, Ebola, and other frontline challenges confronting the world, their finance experts met behind the scenes to review reports on addressing base erosion and profit shifting (BEPS) and deepen the growing international consensus. But what is BEPS and what does it have to do with Nigeria? Should we be paying attention? What changes can we expect?
Base erosion and profit shifting is by far the most comprehensive attempt by international tax authorities to address gaps in global tax rules which have enabled some of the world’s most profitable companies pay a less-than-proportionate share of income taxes. Finance ministers have fingered multinational entities for contriving complex cross-border business structures, aided by an army of well-greased accountants and advisers, just to escape tax. The multinationals reject the charge, saying they have done nothing but followed the rules to legally reduce their tax cost. The media is also in on the act. Only recently, confidential tax rulings granted by the tax administration of Luxembourg, a small European duchy, to over 300 global companies were exposed by a syndicate of investigative journalists. Hardly in modern history has the debate on international taxation been this free-for-all.
Significant proceedings were held by a committee of finance experts at the recently concluded G20 summit to review progress under a two-year BEPS Action Plan which would culminate in late 2015. Already as part of that plan, automatic exchange of information between G20 countries and with other territories should begin from 2017. The speed of this international consensus-building effort is unprecedented.
Whatever happens in Vegas doesn’t stay in Vegas
Globalisation has all but erased the geographical lines of trade as we know it. Business has become so integrated beyond national borders it is often difficult to imagine the world before the internet. Companies now generate huge amounts of income from remote markets without a physical presence. As a key performance indicator, multinationals aim to reduce their global effective tax rate, which is the proportion of income taxes paid out of profits. The lower the income taxes paid, the greater the profits available for investors.
Crucially, however, tax rules have not developed in step with these changes. Due to disparities in tax laws of different countries, many global companies are able to shrink their effective tax rate by moving profits from a country where the income-generating activity takes place (often a high tax environment) to a country with a more favourable tax regime through a series of related-party payments such as interest, dividend and royalty. This arbitrage, adjudged artificial by tax authorities, erodes taxable profits in countries and deprives them of a perceived fair share of tax revenue.
The ongoing tax dispute between Amazon, the US-based internet retailer, and the European Commission on the former’s tax agreement with Luxembourg authorities reflects this sentiment. As reported by the BBC, Brussels contends that most of Amazon’s European profits “are recorded in Luxembourg but are not taxed in Luxembourg”. The EU is also investigating the tax planning structures of Apple, Starbucks, and several other multinationals. These disputes have attracted public attention and transported global corporate taxation into mainstream discussion.
So what is BEPS?
The BEPS project is an initiative of the Organisation for Economic Cooperation and Development (OECD), working at the behest of G20 leaders, to address perceived shortcomings in international taxation. It aims to harness a global collective approach in combating cross-border tax avoidance because individual-country and bilateral responses have not been very effective. Working through a 15-point Action Plan established in June 2013, it seeks to, among other things, close legal loopholes that allow double non-taxation; align taxation with commercial substance; counter harmful tax practices; strengthen tax treaty provisions; deepen transparency and information sharing; and develop a multilateral legal instrument to amend bilateral treaties. BEPS goes beyond the tax morality debate by attempting to create bold, legally enforceable tools.
The project builds on the OECD’s 1998 report on Harmful Tax Competition: An Emerging Global Issue which at the time highlighted the new challenges of globalisation and how using preferential tax regimes to attract geographically-mobile investment among states would ultimately erode national tax bases and undermine the international tax system. That report advocated the need for a multilateral response. Fifteen years after, the clouds have begun to gather. The OECD is already engaging participants from Asia, Africa, Central Europe, the Middle East, Latin America, and the Caribbean. It is this worldwide consultation among important stakeholders including tax authorities, businesspeople, and advisers that distinguishes BEPS from previous endeavours.
How BEPS can affect Nigeria
Nigeria is not immune to the effects of base erosion and profit shifting. As with many developing economies hungry for imported capital and technology, Nigeria is subject to foreign investor demands to provide an attractive rate of return. Critically, in this time of falling international oil prices and austerity measures, the need to protect an existing but lean tax base has never assumed greater significance.
Although the impact areas may be as varied as they come, below are some implications for taxation in the country:
(i) Tax matching. BEPS frowns at the idea of related parties claiming a tax deduction on interest and other financial payments in one country, while enjoying a tax-exemption or deferral on the corresponding income in the other country (termed “double non-taxation”). In such mismatch situations, OECD proposes changes to domestic laws that will deny a tax deduction for the expense; make the income taxable; or deny payment for tax deduction if it is also deductible in another country. This poses a number of questions for Nigeria – in particular whether investment incomes received by Nigerian companies from foreign sources (in many instances, tax-exempt under Nigerian law) will continue to enjoy tax deduction in the country of origination. Conversely, whether Nigeria may be persuaded to overturn these tax exemptions in order to secure the foreign tax deduction.
(ii) Preferential regimes and use of tax havens. Multinationals have historically used related-party entities in favourable tax countries to legally own income-generating assets or financings that ultimately suffer nominal or zero corporate tax. A number of Nigerian companies use tax havens to register high-value assets (aircraft, rigs) or route financing structures (captive insurance, loans), enjoying both a local tax deduction on costs and tax exemption on repatriated return on capital. These corporate structures, which are typically administered by third-party nominees with a letterbox, may not be sufficient to justify current tax treatments in the future.
Izinegbe Aibangbee
