BEPS creates significant challenges for U.S. companies
The OECD (Organisation for Economic Co-operation and Development) issued its long-awaited, final 15-point action plan
under the Base Erosion and Profit Shifting (BEPS) project. BEPS was originally launched by the OECD to examine the effects on member countries by multinational companies (MNCs) that were artificially reducing their overall global tax liabilities by exploiting differences in cross-border tax rates and rules, and through aggressive transfer pricing practices to generate “stateless” income.
The OECD has produced thousands of pages of analyses and recommendations to combat BEPS, and in response, many countries already are reforming or otherwise implementing new laws, guidelines, policies, practices and procedures. While these developments threaten both U.S. MNCs and the U.S. revenue base, they disproportionately affect small and medium-sized companies doing business internationally. Many of the most dynamic middle market companies in the U.S. are least equipped to handle the burdens created by the BEPS movement. Grant Thornton believes U.S. lawmakers can take significant actions to address these issues and enhance the global competitiveness of dynamic middle-market U.S.-based MNCs.
BEPS Observation #1: U.S. MNCs will pay more foreign tax at the expense of U.S. receipts
The fiscal stresses on many European countries have driven those nations to seek more revenue and aggressively adopt many BEPS recommendations. U.S. MNCs with foreign operations will see their foreign tax bills increase under these measures, and what’s worse, it will come at the expense of the U.S. tax base. U.S. MNCs can generally reduce their U.S. tax with a credit for foreign taxes paid, so any increase in foreign taxes means a decrease in U.S. taxes. The new revenue for European countries will in many cases actually be paid for by U.S. taxpayers.
Grant Thornton recommendation: Tax reform is needed now
BEPS further demonstrates the disconnect between the U.S. system for taxing MNCs with that of nearly all our trading partners. We urge Congress to pursue tax reform to lower business rates and shift to a territorial system that would exempt foreign earnings from tax.
The tax code should also provide incentives for the development and retention of intellectual property (IP) here in the U.S, and any incentives must include all businesses, no matter how they are organized. Tax reform is the only way to avoid subsidizing taxes collected outside the U.S. and to provide a competitive tax system for U.S.-based multinationals.
BEPS Observation #2: Compliance costs will increase
The U.S. system for taxing international business and investment is one of the most complex tax systems in the world. The effort to address every potential source of avoidance or evasion has made it not only harsher in application but costlier in its compliance requirements than those of many other major economies. Absent tax reform, BEPS-related compliance costs in the U.S. could exceed those overseas.
The BEPS project has now produced thousands of pages of analysis and recommendations that are leading to major legislative changes across the world, with the versions implemented in each country varying in significant and problematic ways. Taxpayers will be forced to simultaneously comply with multiple, conflicting tax regimes. As a result, MNCs will face both an increased tax burden and cost of compliance – the depth of which is not yet fully understood. In addition to country-by-country reporting, cost increases are sure to include the less apparent costs associated with necessary changes to financial accounting systems, the “leakage” of confidential or propriety competitive information and inevitable tax controversies in multiple jurisdictions.
Grant Thornton recommendation: Tap the brakes
Congress has appropriately taken a measured approach to BEPS recommendations and has not yet moved to implement legislation. However, Treasury and the IRS have proposed regulations that would require country-by-country reporting consistent with the BEPS recommendations. These regulations raise significant concerns and could be costly for companies. It is also unclear whether the proposed regulations signal a wider embrace of BEPS-inspired reforms. We encourage lawmakers to adopt a more moderated response that first includes a thorough analysis of the potential impact of any changes on U.S. competitiveness on the global economic stage in order to determine appropriate next steps.
BEPS Observation #3: Rewriting the link between value creation and tax
MNCs with operations and intercompany transactions across countries must typically assign income based on a transfer pricing analysis that allocates income as if transactions were occurring between unrelated parties. Historically, transfer prices under this “arm’s length” standard were assigned based on variables such as the functions performed, risks borne, geographic markets, economic conditions, and the assets employed.
BEPS recommendations on transfer pricing ostensibly preserve the current arms-length standard, but in reality rely heavily on the number of actual “boots on the ground.” The BEPS measures are meant to combat apparent tax schemes to shift income to jurisdictions with low tax rates and operations with little apparent substance. However, relying solely, or primarily, on boot counts to determine transfer prices will likely encourage U.S. MNCs to move more highly skilled white and blue collar jobs out of the U.S. to build substance in low tax jurisdictions. The jobs that will leave are not limited to manufacturing jobs in the Midwest, but include everything from high tech jobs leaving Silicon Valley to financial jobs leaving Wall Street.
Grant Thornton recommendation: Reassert our role as a transfer pricing thought leader
In 1988, Treasury produced a whitepaper that became a foundation for a new set of global transfer pricing rules. The rules and broader regimes have since evolved in a failed effort to keep up with advances in IP, technological capabilities, resources, and the globalization of economies and commerce. BEPS is the latest, and perhaps most divergent, move away from many of the principles upon which our rules are based, and it fails to meet the challenges posed by the new world economy. We recommend that the Congress require Treasury to perform a comprehensive study that reexamines our foundational transfer pricing principles with a specific focus on intellectual property, modern business models, truly global supply chains, and workable safe harbors for small and midsized MNCs.
The results might allow us to again move the global conversation in a direction that levels the playing field for U.S. MNCs.
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