Base Erosion and Profit Shifting
BEPS stands for Base Erosion and Profit Shifting (“BEPS”). BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to locations where there is little or no real activity but the taxes are low, resulting in little or no overall corporate tax being paid (double non-taxation). BEPS planning strategies are not per se illegal (most are not!). However, as it can result in double non-taxation, countries miss out on tax income. Furthermore, it allegedly can create an unequal playing field for companies, as large multinationals have the capacity to set up BEPS planning strategies while companies who operate in one country only mostly lack this capacity.
To tackle the BEPS issue described above, the Organization of Economic Co-operation and Development (“OECD”) presented the (anti) BEPS Action Plan in 2013. The BEPS action plan consisted of 15 action points that aim to tackle tax avoidance strategies that exploit gaps and mismatches in tax rules between different countries to artificially shift profits to low or no-tax locations around the world. The aim of the BEPS actions is to realign taxation with economic substance and value creation, while preventing double (non)taxation.
As to realize its goals, the OECD drafted three pillars that should tackle BEPS: coherence, substance and transparency. While plenty of focus today is on substance, in our view, this is merely an evolutionary aspect in respect of transfer pricing. The real potential game changer, according to us, is that increasingly the focus is on “rationale”.
Indeed, the realm of transfer pricing accordingly has been augmented from “who does what?” (substance) to include “why?” (rationale) and “how?” (focus on ex-ante pricing considerations vs. ex-post testing). The increased importance of rationale can be best evidenced by counting how many times reference is made to it (as ‘options realistically available’) in the first chapter of the post-BEPS OECD TP Guidelines on the core concept of the arm’s length principle, compared to the prior version: 9 versus 1, an increase of 800%!
For this reason we have updated the set-up of our transfer pricing documentation package, to include the story-telling required to explain the rationale, not (only) because we like story-telling, but it may be your best defense in view of effectively managing the burden of proof.
The three BEPS pillars (adjusted by us) and their corresponding action items are shown in the table below:
“A” stands for arm’s length