Apple’s tax arrangements, until recently of interest to almost no-one, are now caught up in a debate about what has come to be known as BEPS – base erosion and profit shifting.
BEPS refers to a range of practices that artificially segregate taxable income from the activities that generate it and, in so doing, exploit different tax rules in various jurisdictions to reduce tax liability.
A US Senate investigation reported that Apple paid tax of just 2 per cent on US$74 billion of overseas income over a three-year period. It’s not the only company in US lawmakers’ sights; others include Boston Scientific, Western Union and Starbucks.
And the US is not alone in worrying about BEPS. The Organisation for Economic Co-operation and Development calculates that member countries’ company tax revenues rose steadily from an average 2.2 per cent of GDP in 1965 to 3.8 per cent in 2007. This trend reversed in 2008 and 2009, when the average dropped to 3.5 per cent and then 2.8 per cent. In 2010, it was still only 2.9 per cent.
A global recession has hit corporate profits, of course. But the OECD does not think that explains all of the fall and points to an increasing aggression in multinational companies’ tax minimisation activities in recent years.
Indeed, developed-world finance ministers now see BEPS as the single biggest threat to their budgetary health. They’ve begun looking for a cure. They met in Moscow at a G20 meeting in July to look at OECD recommendations designed to inoculate against BEPS.
The OECD says the “key pressure points” of BEPS include mismatches in entity and instrument characterisation, including hybrid mismatches. A hybrid mismatch occurs when the counterparties involved in a transaction are in jurisdictions that have different tax rules for the hybrid. One counterparty might be entitled to a tax deduction, while the other might not face any tax on its exposure. Entities that are resident in more than one jurisdiction can exploit such anomalies.
Other pressure points include the tax treatment of related-party debt financing, captive insurance and other intra-group financial transactions; transfer pricing and the artificial splitting of ownership of assets between legal entities within a group; the effectiveness of anti-avoidance measures and thin capitalisation rules; and the availability of preferential regimes, such as Ireland’s.
Measures to stem the flow
These issues have been around for some time. As Ernst & Young’s Daryn Moore notes, they’ve come to public attention because of government revenue shortage since the global financial crisis – and because, at the same time, multinationals have increased their BEPS practices.
Moore, Ernst & Young’s leader of international tax services for Oceania, adds that Australia already has projects underway to address these issues. This year’s Federal Budget heralded a review of the thin capitalisation rules.
The Government has also introduced transparency measures, such as a so-called ‘name and shame’ law that lets the Tax Office report on the tax paid by large companies. And it is reviewing the anti-avoidance provisions of the Tax Act.
The OECD, meanwhile, is calling for global harmonisation of tax rules. In a 15-step action plan presented to the G20 meeting in July, it looks at ways to address the challenges of the digital economy, where companies can have a digital presence in a country without being liable for taxation. It calls for measures to neutralise hybrid mismatch arrangements, as well as stronger rules to cover “controlled foreign companies”, or CFCs, though previous rules have been seen as ineffective.
While this call for global harmonisation will be resisted by countries not wishing to give up their tax
sovereignty, some commentators already want to go further. Essex Business School’s Professor Prem Sikka, for instance, advocates a “common consolidation” approach to taxing multinationals: all internal transfers and royalty payments have zero effect, a single global profit is calculated and taxed, and the tax revenue is apportioned to countries in accordance with an agreed formula that calculates where the wealth is created.
Apple still has its Irish subsidiaries and its iPhone sales. But governments are still short of tax revenue – so this debate is not going to go away.
