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Tax Base Erosion and Profit Shifting (BEPS) and International Economic Law

Clinic: Graduate Institute, Fall 2013
Beneficiary: Mr. Sergey Ripinsky and Ms. Kendra Magraw, UNCTAD

Executive Summary

Read the full report here

There is a growing concern with regards to the significant losses of national tax revenues because of sophisticated tax planning by multinational enterprise (MNEs) aimed at shifting profits in ways that erode the taxable base. International legal systems created to regulate directly or indirectly such conducts of MNEs have so far proven ineffective in preventing tax base erosion and profit shifting (BEPS) from occurring. The purpose of this memorandum is to show the reason why this is the case.

As BEPS is the result of the conduct of private actors, MNEs in particular, it is bilateral taxation treaties that are directly relevant to this phenomenon. However, they leave legal loopholes that make strategic tax planning possible providing opportunity for BEPS; as the traditional concept of permanent establishment can easily be manipulated, it is no longer an effective nexus providing a basis for taxation; exemption rules, originally designed to prevent double-taxation, can be exploited in a way to lead to double non-taxation; the arm’s length principle, commonly underlying transfer pricing allocations, can be abused so as to separate income from the economic activity that produces it and allowing profits to be shifted to low tax environments. Consequently, other branches of international economic law, i.e. international investment as well as trade law, which are also directly or indirectly relevant to taxation, need to be explored.

International investment law, which regulates the conduct of host States, not investors, has by definition little chance to address BEPS. In addition to this, several limitations have been identified; as a lot of investment treaties exclude taxation issues from their scope of application, BEPS is placed outside the scope of investment law accordingly; to the extent that an investment treaty is applicable to taxation, it can be a regulatory measure to be scrutinized by investment arbitration, and thereby there exists a limited possibility that a measure against BEPS is alleged to constitute a violation of an investment treaty and/or contractual obligations resulting from ‘tax stabilization clauses’; conversely, the usefulness of counterclaims before investment arbitration, which theoretically has a potential to tackle BEPS in the context of investment law, will be limited in the light of current jurisprudence.