International tax planning by multinationals: Simulating a tax-minimising intercompany response to the OECD's recommendation on BEPS Action 4

Kayis-Kumar, Ann (2016): International tax planning by multinationals: Simulating a tax-minimising intercompany response to the OECD's recommendation on BEPS Action 4. Published in: Australian Tax Forum: a journal of taxation policy, law and reform , Vol. 31, No. 2 (1 July 2016): pp. 363-394.

Abstract

In October 2015, the OECD/G20 presented their final report on the Base Erosion and Profit Shifting (BEPS) Project. This article presents a unique analysis of the OECD/G20’s recommendation on Action 4 by utilising tax optimisation modelling to simulate and examine a hypothetical multinational enterprise’s (MNE’s) behavioural response to this recommendation.

The literature to date has primarily focused on the “debt bias”, which arises from the distortion in the tax treatment between debt and equity financing. The BEPS Project is no exception, despite acknowledging that the “mobility and fungibility of money makes it possible for multinational groups to achieve favourable tax results”, the focus has remained on the debt bias. Prior work by the author introduced a broader conception of funding biases; specifically, the tax‑induced cross‑border “funding bias”. The funding bias includes intercompany licensing and leasing activities in addition to debt and equity financing.

These four forms of fungible intercompany financing are built into the tax optimisation model developed by this article. This model presents a unique contribution to the literature by simulating complex cross‑border intercompany tax planning strategies. This facilitates a formal analysis of one of the most significant challenges presented by the mobility and fungibility of capital, namely, anticipating how an MNE structures its internal affairs in a tax‑minimising manner given the current tax regime — and designing improvements to tax laws accordingly.

The model developed by this article shows that the OECD’s fixed ratio rule is more effective than the current regime of thin capitalisation rules at protecting the tax revenue base from the most tax‑aggressive MNEs. However, the model also indicates that it is ultimately more effective to equalise the tax treatment among otherwise fungible intercompany funding activities. This outcome is consistent with the principle of tax neutrality, which suggests that, ceteris paribus, all like income should be treated alike for tax purposes. This shows that rules eliminating the “underlying disease” (the tax incentive for thin capitalisation) are more effective at targeting BEPS than rules which mitigate the “symptom” (such as thin capitalisation rules or the OECD’s fixed ratio rule).

• Item Type: MPRA Paper
• Language: English
• Keywords: OECD; BEPS; Thin capitalisation; Interest limitation rules; Optimisation modelling; Mathematical modelling
• Subjects: C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling; C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C61 - Optimization Techniques ; Programming Models ; Dynamic Analysis; F - International Economics > F0 - General; K - Law and Economics > K3 - Other Substantive Areas of Law > K34 - Tax Law

References

Avi-Yonah RS, ‘Corporations, Society, and the State: A Defense of the Corporate Tax’ (2004) 90(5) Virginia Law Review 1193.

Balakrishnan K, Blouin J and Guay W, ‘Does Tax Aggressiveness Reduce Financial Reporting Transparency?’ (Working Paper, Wharton School, University of Pennsylvania, 20 September 2011).

Bärsch SE, Taxation of Hybrid Financial Instruments and the Remuneration Derived Therefrom in an International and Cross-border Context: Issues and Options for Reform (Germany: Springer, 2013).

Bird RM, ‘Why Tax Corporations?’ (Working Paper No 96-2, Technical Committee on Business Taxation, December 1996).

Brada J and Buus T, ‘Detection of Possible Tax-Evasive Transfer Pricing in Multinational Enterprises’ (2009) 4(2) European Financial and Accounting Journal 65.

Buus T and Brada J, ‘VAT and Tax Credits: A Way to Eliminate Tax-Evasive Use of Transfer Prices?’ (2010) 5(1) European Financial and Accounting Journal 28.

Castillo E, Conejo AJ, Pedregal P, García R and Alguacil N, Building and Solving Mathematical Programming Models in Engineering and Science (New York, United States: John Wiley and Sons Ltd, 2001).

Ciarlet PG, Miara B and Thomas J, Introduction to numerical linear algebra and optimisation (Great Britain: Cambridge University Press, 1989).

De Mooij R, Keen M and Perry V, ‘Taking a bite out of Apple? Fixing international corporate taxation’ on VoxEU.org CEPR’s Policy Portal (14 September 2014); available at: http://www.voxeu.org/article/fixing-international-corporate-taxation.

De Simone L and Stomberg B, ‘Do investors differentially value tax avoidance of income mobile firms?’ (Working Paper, University of Texas at Austin, June 2012).

Devereux MP and Sørensen PB, ‘The corporate income tax: international trends and options for fundamental reform’ (Economic Paper No 264, European Economy, December 2006).

Devereux MP, ‘Trade-offs in the Design of Taxes on Corporate Profit’ (Paper presented at the Oxford Sydney Conference, Ross Parsons Centre: The University of Sydney, 30-31 March 2012).

Froot KA and Hines JR, ‘Interest allocation rules, financing patterns, and the operations of U.S. multinational’ (Working Paper No 4924, NBER Working Paper Series, November 1994).

Grubert H and Altshuler R, ‘Corporate Taxes in the World Economy: Reforming the Taxation of Cross-Border Income’, in: Diamond J and Zodrow G (eds.) Fundamental Tax Reform: Issues, Choices, and Implications (Cambridge, MA: MIT Press, 2008).

Grubert H and Altshuler R, ‘Fixing the System: An Analysis of Alternative Proposals for the Reform of International Tax’ (2013) 66(3) National Tax Journal 671.

Hanlon D, ‘Thin Capitalisation Legislation and the Australia/United States Double Tax Convention: Can They Work Together?’ (2000) 3(1) Journal of Australian Taxation 4.

Haufler A and Runkel M, ‘Firms’ financial choices and thin capitalization rules under corporate tax competition’ (2012) 56(6) European Economic Review 1087.

Hong Q and Smart M, ‘In praise of tax havens: International tax planning and foreign direct investment’ (2010) 54(1) European Economic Review 82

Huizing H, Laeven L and Nicodème G, ‘Capital Structure and International Debt Shifting’ (Economic Paper No 263, European Economy, December 2006).

ICC Commission on Taxation and the ICC Committee on Customs and Trade Regulations, ‘Transfer pricing and customs value’ Policy Statement, Document No. 180/103-6-521, February 2012.

Inotai A, ‘Macroeconomic Impacts of the 2008–09 Crisis in Europe’, in: DeBardeleben J and Viju C, Economic Crisis in Europe: What it Means for the EU and Russia (Houndmills, Basingstoke, Hampshire; New York: Palgrave Macmillan, 2013).

Iyer PS, Operations Research (India: Tata McGraw-Hill Education, 2008).

Jacobs OH and Spengel C, ‘The Effective Average Tax Burden in the European Union and the USA: A Computer-based Calculation and Comparison with the Model of the European Tax Analyzer’ (ZEW Discussion Paper No 99-54, Centre for European Economic Research (ZEW) and University of Mannheim, September 1999).

Kayis-Kumar A, ‘Taxing cross-border intercompany transactions: Are financing activities fungible?’ (2015) 30(3) Australian Tax Forum 627.

Kayis‑Kumar A, “Thin capitalisation rules: a second‑best solution to the cross‑border debt bias?” (2015) 30(2) Australian Tax Forum 299.

Mardan M, ‘Why Countries Differ in Thin Capitalization Rules: The Role of Financial Development’ (CESifo Working Paper Series No 5295, CESifo Group Munich, 2015)

Markle KS and Shakelford DA, ‘Cross-Country Comparisons of the Effects of Leverage, Intangible Assets, and Tax Havens on Corporate Income Taxes’ (2012) 65 Tax Law Review 415.

McDonnell A, Russell H, Sablok G, Burgess J, Stanton P, Bartram T, Boyle B, Manning K (2011) ‘A Profile of Human Resource Management in Multinational Enterprises Operating in Australia’, University of South Australia, University of Newcastle, Victoria University, La Trobe University and Curtin University; available at: http://www.unisa.edu.au/Global/business/centres /chrm/docs/projects/intrepid/Australia11_MNE_Report_Final.pdf.

Miniaci R, Panteghini P, Parisi ML, ‘Debt Shifting in Europe’ (Working Paper WP11/21, Oxford University Centre for Business Taxation, 15 November 2011).

Mintz J, ‘The Corporation Tax: A Survey’ (1995) 16(4) Fiscal Studies 23.

Mintz JM and Weichenrieder AJ, The Indirect Side of Direct Investment: Multinational Company Finance and Taxation (Cambridge, Massachusetts: MIT Press, 2010).

OECD, ‘BEPS Action 4: Interest deductions and other financial payments’ (Final Report, 5 October 2015).

OECD, Dealing Effectively with the Challenges of Transfer Pricing (Paris: OECD Publishing, 1 March 2012).

Phillips DT, Ravindran A and Solberg JJ, Operations Research: Principles and Practice (USA: John Wiley & Sons, Inc., 1976).

Picciotto S, ‘The U.K.’s Diverted Profits Tax: An Admission of Defeat or a Pre-Emptive Strike?’ [19 January 2015] Tax Notes International 239.

Raimondos-Moller P and Scharf K, ‘Transfer pricing rules and competing governments’ (2002) 54(2) Oxford Economic Papers 230.

Seto TP, ‘Four Principles of Optimal Tax System Design’ (Legal Studies Paper No 2008-36, Loyola Law School, March 2013).

Shapiro AC and Balbirer SD, Modern Corporate Finance: An Interdisciplinary Approach to Value Creation (Upper Saddle River, New Jersey: Prentice Hall, 1999), Topic F4 ‘The Multinational Financial System’; available at: http://www.prenhall.com/divisions/bp/app/finflash/html/onlinehtml/topicf/topicf4.html.

Sommer C, Separate Accounting Or Unitary Apportionment? The Fairy Tale of Arm's Length Pricing and General Equilibrium Analysis of Multinational Enterprise Behavior Under the Formulary Taxation Alternative (Lohmar: Köln, Reihe Steuer, Wirtschaft und Recht, 2011).

Sørensen PB, ‘Issues in the Theory of International Tax Coordination’ (Bank of Finland Discussion Papers No 4/90, 20 February 1990).

Taha HA, Operations Research: An Introduction (USA: Pearson Prentice Hall, 8th ed, 2007).

Vasarhelyi MA and Moon D, ‘Optimizing tax allocation among countries in the multinational entity: a tale of many contingencies’ (Presentation delivered at the TTN Taxation Seminar New York 2011, Morgan Lewis Bockius LLP: New York, NY, 16 May 2011).