Base erosion and profit shifting

Definition

Base erosion and profit shifting (BEPS) refers to tax avoidance strategies used by multinational corporations to shift profits from high-tax jurisdictions to low or no-tax locations, thereby eroding the tax base of higher-tax countries. This practice raises concerns about fairness in taxation and the ability of countries to collect revenue necessary for public services. It often involves complex mechanisms like transfer pricing that can distort economic activity and lead to significant revenue losses for governments.

5 Must Know Facts For Your Next Test

1. BEPS is a major issue for governments worldwide, as it contributes to significant tax revenue losses, estimated at hundreds of billions annually.
2. The OECD (Organisation for Economic Co-operation and Development) has developed a comprehensive action plan to combat BEPS, encouraging countries to implement specific measures to close loopholes.
3. Common methods of BEPS include manipulating transfer pricing, using intellectual property rights, and leveraging complex corporate structures to shift profits.
4. Countries are increasingly collaborating on international agreements to address BEPS, such as the Multilateral Convention to Implement Tax Treaty Related Measures.
5. The fight against BEPS not only aims to secure tax revenues but also strives for a fairer global tax system that holds multinational corporations accountable.

Review Questions

• How do transfer pricing practices contribute to base erosion and profit shifting by multinational corporations?
  • Transfer pricing allows multinational corporations to set prices for goods and services exchanged between their subsidiaries in different countries. By manipulating these prices, companies can allocate more profits to subsidiaries located in low-tax jurisdictions while reducing profits in higher-tax areas. This practice directly contributes to base erosion and profit shifting by enabling firms to avoid paying their fair share of taxes where economic activities actually occur.
• Discuss the implications of base erosion and profit shifting on government revenues and public services.
  • Base erosion and profit shifting significantly impacts government revenues, as it leads to reduced tax collections in higher-tax jurisdictions. This loss of revenue can hinder governments' ability to fund essential public services such as education, healthcare, and infrastructure. As a result, governments may need to increase tax rates or cut services to compensate for the shortfall, ultimately affecting economic growth and social equity.
• Evaluate the effectiveness of international efforts to combat base erosion and profit shifting and suggest potential improvements.
  • International efforts, led by organizations like the OECD, aim to address base erosion and profit shifting through coordinated actions and agreements. While initiatives like the BEPS Action Plan have made strides in creating awareness and promoting transparency among nations, challenges remain due to varying national interests and compliance levels. To improve effectiveness, a stronger emphasis on enforcement mechanisms and stricter regulations could be established, alongside increased collaboration between countries to share information on corporate structures and tax strategies.

Related terms

Transfer pricing: The method used by multinational corporations to set prices for transactions between their subsidiaries in different countries, which can impact how profits are reported and taxed.

Tax havens: Countries or jurisdictions that offer low or no taxes, attracting foreign businesses and wealthy individuals seeking to minimize their tax liabilities.

Profit shifting: The practice of reallocating profits from one jurisdiction to another to reduce tax liabilities, often involving techniques like manipulation of intercompany transactions.