Regulatory Framework for Tax Incentives in Developing
Countries After BEPS Action 5
Irma Johanna Mosquera Valderrama*
The aim of this article is to assess the regulatory framework of Base Erosion Profit Shifting Project (BEPS) Action 5 in order to evaluate tax incentives in the form of preferential tax regimes that provide benefits to geographically mobile business income in developing countries. To conduct this assessment, this article first addresses the use of preferential tax regimes considering BEPS Action 5. Thereafter, and taking into account the concerns expressed by international organizations, regional tax organizations and scholars, the author contends that the evaluation of tax incentives in light of BEPS Action 5 results in additional burden for developing countries. Countries will need to assess their tax incentives considering the factors provided by the 1998 OECD report and BEPS Action 5. Since there are no terms of reference for the application of these factors, the country will have to assess its own tax incentives, which brings increased uncertainty and compliance burden for developing countries. In order to provide some guidance in this evaluation, the author provides a list of the factors used by the 1998 OECD report and BEPS Action 5 and their application to tax incentives. Subsequently, this article will assess the legitimacy of the application of BEPS Action 5 to developing countries and will demonstrate that its assessment framework is ambiguous and prevents developing countries from enacting legitimate tax incentives. Finally, this article will conclude and provide some recommendations for further research.
Keywords: BEPS, tax incentives, harmful tax, fair tax competition, developing countries
1 I
NTRODUCTIONTax incentives in developing countries aim to attract for-eign direct investment (FDI) in order to increase economic growth by creating more employment, to transfer technol-ogy and to improve economic conditions in a specific sector/region. Examples of these tax incentives include, for instance, free trade zones, tax holidays, and carry back/ forward of losses, among others. The scope of application can be geographical (based on location) or specific for a sector/industry (e.g. hotel industry, agribusiness, etc.).
Since 2013, the discussion on what type of tax incentives (if any) are required to attract foreign direct investment has
increased primarily due to the introduction of the Base Erosion Profit Shifting Project (BEPS) that aims to tackle aggressive tax planning by multinationals. The BEPS Project contains ten best practices and 4 Minimum Standards.1 From these 4 Minimum Standards, BEPS Action 5 addresses tax incentives that are regarded as preferential tax regimes in order to assess whether these regimes can be regarded as harmful tax practices. The content of BEPS Action 5 is based, to a great extent, on the 1998 OECD Report on Harmful Tax Competition2 (1998 OECD Report) that was published by the OECD Forum on Harmful Tax Practices (FHTP).3
Notes
* Associate Professor of Tax Law, Faculty of Law and Lead Researcher GLOBTAXGOV ERC Project, Institute of Tax Law and Economics, University of Leiden, the
Netherlands. The writing and research carried out for this article is the result of the ERC research in the framework of the GLOBTAXGOV Project (2018-2023). The GLOBTAXGOV Project investigates international tax law making including the adoption of OECD and EU standards by 12 countries. The GLOBTAXGOV Project has received funding from the European Research Council (ERC) under the European Union’s Seven Framework Programme (FP/2007-2013) (ERC Grant agreement n. 758671). A first draft of this article was discussed at the IDEFF (Instituto de direito económico financeiro e fiscal) Conference that took place 4 October 2019 at the University of Lisbon, Portugal. Thank you to the participants for their valuable input. The author is also grateful to the anonymous peer reviewers of this article.
Email: i.j.mosquera.valderrama@law.leidenuniv.nl.
1 The BEPS 4 minimum standards that should be implemented are the countering of harmful tax practices and exchange of rulings (Action 5), preventing of treaty abuse
(Action 6), re-examining transfer pricing documentation including country-by-country reporting (Action 13), and enhancing resolution of disputes (Action 14). In addition, a Multilateral Convention to swiftly implement some of the BEPS measures in double tax conventions have been signed by more than ninety jurisdictions. This convention that has been in force since 1 July 2018 has been ratified by more than thirty jurisdictions.
2 OECD, Harmful Tax Competition: An Emerging Global Issue (OECD Publishing 1998), http://dx.doi.org/10.1787/9789264162945-en (accessed 9 Dec. 2019).
3 The Forum on Harmful Tax Practices (FHTP) is the body that has the mandate to monitor and review tax practices of jurisdictions around the world, focusing on the
Despite the limited reference4to the terminology‘tax incentives’ in the content of BEPS Action 5, countries’ tax incentives in the form of preferential tax regimes for geographically mobile business income are also being reviewed in the framework of BEPS Action 5. As a result, the FHTP has examined tax incentives and will continue to do so in the form of preferential tax regimes in the jurisdictions (136 at the time of this writing in December 2019) that are committed to the implementa-tion of the BEPS 4 Minimum Standards.5
More recently, in January 2019, the OECD published a policy note, ‘Tax Challenges of the Digitalisation of the Economy’.6This note was approved by the BEPS Inclusive Framework and contains two proposals: Pillar 1 dealing with taxation of highly digitalized business and Pillar 2 introducing a global anti-base erosion proposal (GloBE) including an income inclusion rule and an undertaxed payments rule.7
Following this policy note, a Public Consultation Document was published in February 2019. In this docu-ment and when referring to GloBE, the OECD acknowl-edges that developing countries often with smaller markets are dependent on natural resource taxation, tax incentives, and free trade zones to attract foreign direct investment. Nevertheless, the OECD states that the GLoBE ‘seeks to advance a multilateral framework to achieve a balanced outcome which makes business location decisions less sen-sitive to tax considerations, limit compliance and adminis-tration costs and avoid double taxation’.8
Considering these developments, the introduction of Pillar 2 that provides a minimum tax rate in the income inclusion rule will need to be analysed taking into account the need of developing countries to introduce tax
incentives to attract foreign direct investment. As stated in the Programme of Work9 and the November 2019 Public Consultation,10‘depending on its ultimate design, the GloBE proposal could effectively shield developing countries from the pressure to offer inefficient incentives and in doing so help them in better mobilising domestic resources by ensuring that they will be able to effectively tax returns on investment made in their countries’.11
Since the GLoBE proposal is still being discussed (at the time of this writing),12it is too early to assess it and the consequences for developing countries. However, the findings of this article can be beneficial for analys-ing the introduction of this minimum tax since devel-oping countries that need investment will need to redesign their tax systems so that they can comply with this minimum tax and continue being attractive to investors.
In a blogpost, this author contended:
The global anti-base erosion proposal and mainly the income inclusion rule will have a significant influ-ence in the tax policy of developing countries to attract foreign direct investment. The proposal of the income inclusion rule raises several questions in global tax governance, since by introducing this rule developing countries will have to reconsider their tax incentives. The question is, what will developing countries get in return? Would this proposal help to achieve the 2030 Sustainable Development Agenda? Would this proposal help developing coun-tries to attract foreign direct investment? And if not, what can be done? One could perhaps look at the threshold, and the type of sector for which this
Notes
Framework on BEPS: Action 5, OECD/G20 Base Erosion and Profit Shifting Project (OECD Publishing 2017), https://doi.org/10.1787/9789264283954-en (accessed 9 Dec. 2019).
4 In a word search of BEPS Action 5, the word‘incentives’ is only referred to when addressing tax incentives for Research and Development. OECD, Countering Harmful Tax
Practices More Effectively, Taking into Account Transparency and Substance, Action 5–2015 Final Report, OECD/G20 Base Erosion and Profit Shifting Project (OECD Publishing 2015), https://doi.org/10.1787/9789264241190-en (accessed 9 Dec. 2019) .
5 This evaluation takes places by means of a peer review process that was conducted by the OECD Forum on Harmful Tax Practices. The most recent review was published on
23 July 2019. OECD, OECD Releases Latest Results on Preferential Regimes and New Results on No or Only Nominal Tax Jurisdictions (23 July 2019), https://www.oecd.org/tax/ beps/oecd-releases-latest-results-on-preferential-regimes-and-new-results-on-no-or-only-nominal-tax-jurisdictions.htm (accessed 9 Dec. 2019).
6 OECD, Addressing the Tax Challenges of the Digitalisation of the Economy– Policy Note: As Approved by the Inclusive Framework on BEPS on 23 Jan. 2019, OECD/G20 Base Erosion
and Profit Shifting Project (OECD Publishing 2019), https://www.oecd.org/tax/beps/policy-note-beps-inclusive-framework-addressing-tax-challenges-digitalisation.pdf (accessed 9 Dec. 2019).
7 ‘The “income inclusion rule” allows countries to tax the foreign income of its own firms if the effective tax burden abroad falls short of a certain minimum threshold. The “undertaxed payments
rule” gives countries the right to tax outgoing payments from foreign firms’ domestic affiliates to their related parties abroad as long as the associated profit is taxed below a certain level’. J. Englisch & J. Becker, International Effective Minimum Taxation– the GLOBE Proposal, 11(4) World Tax J. 1 (2019).
8 OECD, Addressing the Tax Challenges of the Digitalisation of the Economy, Public Consultation Document 13 Feb.– 6 Mar., OECD/G20 Base Erosion and Profit Shifting Project
(OECD Publishing 2019), http://www.oecd.org/tax/beps/public-consultation-document-addressing-the-tax-challenges-of-the-digitalisation-of-the-economy.pdf (accessed 9 Dec. 2019).
9
OECD, Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy, OECD/G20 Inclusive Framework on BEPS (OECD Publishing 2019), https://www.oecd.org/tax/beps/programme-of-work-to-develop-a-consensus-solution-to-the-tax-challenges-arising-from-the-digitalisation-of-the-econ omy.pdf (accessed 9 Dec. 2019).
10 OECD, Global Anti-Base Erosion Proposal (‘GloBE’) – Pillar Two, Public Consultation Document, 8 Nov. 2019–2 Dec. 2019 (OECD Publishing 2019), https://www.oecd.org/tax/
beps/public-consultation-document-global-anti-base-erosion-proposal-pillar-two.pdf.pdf (accessed 9 Dec. 2019).
11 According to the OECD, there is evidence that tax incentives are frequently provided in developing countries in circumstances when governments are confronted with
pressures from businesses to grant them. OECD supra n. 10, at 29.
12 See OECD, Public Comments on Public Consultation Document and Public Consultation Meeting (9 Dec. 2019),
minimum tax rate will be applicable, so that it does not affect sensible sectors in the country (agriculture/ manufacturing) or does not affect underdeveloped areas that need a tax incentive to guarantee foreign investor willingness to participate in their economic development.13
What all of this means is that countries, including devel-oping countries, must reassess their tax incentives and primarily their preferential tax regimes. If the country is a member of the BEPS Inclusive Framework, the assess-ment will be conducted in the peer review by the OECD Forum on Harmful Tax Practices and the proposed (if adopted) GLoBE (Pillar 2) proposal.
Against this background, the main research question that is addressed in this article is whether BEPS Action 5 is the right regulatory framework to evaluate tax incentives in the form of preferential tax regimes for developing countries.
Even though the analysis of BEPS Action 5 can occur for developed and developing countries, this article focuses on developing countries since they are particularly keen on using tax incentives to attract foreign direct investment. This author has argued elsewhere that:
while tax incentives in developed countries mainly aim to promote export, research and development activities and improve the overall position of the domestic firms on global market, the primary role of tax incentives in developing countries is often the opposite. Tax incen-tive regimes in developing countries aim to attract foreign direct investment, often into specific regions in the country or specific market sectors.14
In order to answer the research question, this article is structured as follows. Section 2 will address tax incen-tives as preferential tax regimes considering the 1998 OECD Report and BEPS Action 5. Section 3 will address the importance of tax incentives for developing countries as acknowledged by literature, international organiza-tions (International Monetary Fund, the United Nations, World Bank and the OECD) and regional net-work of tax administrations (Inter-American Centre of
Tax Administrations (CIAT), and African Tax
Administration Forum (ATAF). Section 4 will assess the legitimacy of the application of BEPS Action 5 to developing countries and will demonstrate that its assessment framework is ambiguous and prevents devel-oping countries from enacting legitimate tax incentives.
Section 5 concludes and provides some recommendations for further research.
2 T
AX INCENTIVES AS PREFERENTIAL TAX REGIMES IN BEPS ACTION5
This section addresses tax incentives as preferential tax regimes considering the 1998 OECD Report on Harmful Tax Competition and BEPS Action 5. Section 2.1 pro-vides the main elements of tax incentives in the form of preferential tax regimes that afford benefits for geographi-cally mobile business income. Section 2.2 addresses the main elements for evaluating tax incentives from the 1998 OECD Report and BEPS Action 5. Section 2.3 applies the factors of the 1998 OECD report and BEPS Action 5 to tax incentives in developing countries.
2.1 Preferential Tax Regimes
In general, countries grant preferential tax treatment in the form of tax incentives in order to attract investment to certain sectors of the economy or certain geographical areas or to make the country attractive as a business hub for other countries within the region. The form of these incentives differs among countries, but some examples are, for instance, headquarter regimes, special economic zones, regimes to foster sharing of technological developments, and regimes for specific sectors of the economy (e.g. finan-cing and leasing; banking and insurance; distribution cen-tres and service cencen-tres; and shipping, holding company and fund management regimes).
A study by the United Nations and the CIAT addres-sing the design and assessment of tax incentives in developing countries has stated that the use of specific targeting regimes including sectorial targeting regimes has:
many advantages, such as restricting the benefits of the incentives to those types of investment that policymakers consider to be most desirable and mak-ing it possible to target those sectors that are most likely to be influenced by tax considerations. Among the sectors of the economy and types of activities commonly preferred are manufacturing activities and pioneer industries, as well as export promotion, locational incentives and investments that result in significant transfers of technology.15
Notes
13 I. J. Mosquera Valderrama, Global Tax Governance in the G20 and the OECD: What Can Be Done?, Blogpost (12 Mar. 2019), https://globtaxgov.weblog.leidenuniv.nl/2019/03/
12/global-tax-governance-in-the-g20-and-the-oecd-what-can-be-done/ (accessed 9 Dec. 2019).
14 I. J. Mosquera Valderrama & M. Balharova, Tax Incentives in Developing Countries. A Case Study: Singapore and Philippines in Taxation, International Cooperation and the 2030
Sustainable Development Agenda, in United Nations University Series on Regionalism (I. J. Mosquera Valderrama, D. Lesage & W. Lips eds, Springer Publications, still forthcoming 2020).
15 United Nations & CIAT, Design and Assessment of Tax Incentives in Developing Countries: Selected Issues and a Country Experience iii (United Nations 2018), https://www.ciat.org/
The following section 2.2 intends to provide an over-view of the application of BEPS Action 5 to tax incentives in the form of preferential tax regimes.16
2.2 1998 OECD Report and BEPS Action 5
The OECD BEPS Action 5 is, to a great extent, based on the OECD 1998 Report on Harmful Tax Competition. The OECD 1998 report addressed the preferential tax regimes that can be regarded as harmful tax regimes. Both the 1998 report and Action 5 specifically addressed that the work is:
on preferential regimes that provide benefits to geogra-phically mobile business income (such as income from the provision of intangibles, and financial services), which present a risk of BEPS activity. The review does not include regimes that relate to non-geographi-cally mobile activities such as manufacturing, given that these present an inherently lower risk of BEPS activity. These activities have been out of scope from the FHTP work since the 1998 Report.17
In BEPS Action 5, the OECD, when referring to the 1998 report, states that‘in order for a regime to be considered preferential, it must offer some form of tax preference in comparison with the general principles of taxation in the relevant country’.18 Therefore, a tax incentive can be
regarded as harmful if it provides for a reduction in the tax rate or a decrease in the tax base for investors, for instance, in the case of Intellectual Property (IP) regimes, free trade zones, etc. However, in order to determine the benefit (in the rate or base), reference will need to be made to the tax system of the specific country and not to other countries.19 Otherwise stated, the analysis on whether a tax regime is preferential should be on a case by case basis (per incentive and per country).
In addition, BEPS Action 5 requires substantial activity that is also based on the 1998 report. According to BEPS Action 5, this:
factor looks at whether a regime“encourages purely tax-driven operations or arrangements” and states that “many harmful preferential tax regimes are designed in a way that
allows taxpayers to derive benefits from the regime while engaging in operations that are purely tax-driven and involve no substantial activities”.20
This is, for instance, the case when there is no link (legal/ economic) to the country.
In summary, the OECD BEPS Action 5 tackles preferential tax regimes that can be exploited for artificial profit shifting and, therefore,‘have the potential unfairly erode the tax bases of other countries, potentially distorting the location of capi-tal and services’.21
In order to determine whether a preferen-tial tax regime can be regarded as a harmful tax regime, the 1998 OECD report and BEPS Action 5 provide a checklist of factors to be assessed by the FHTP (See section 2.3. below).
2.3 Factors to evaluate tax incentives
as (harmful) preferential tax regimes
In order to assess whether a preferential regime is regarded as harmful, twelve (four key and eight other) factors have been addressed in the OECD 1998 report. These factors were revisited in 2018 by the BEPS Inclusive Framework reducing it to ten (five key and five other factors). The main modifications were the classification of the substantial activ-ities requirements as a key factor and the repeal of two other factors due to the lack of usefulness for assessing whether a preferential regime can be regarded as a harmful tax regime (use of tax treaties and promotion of a regime as a tax minimization vehicle).The reason for the first factor was the use of BEPS Action 6 to counteract abuse of tax treaties that has made this factor no longer relevant and, for the second factor, the difficulty to apply it in practice.22
Despite the changes to the checklist by the BEPS Inclusive Framework, developing countries are concerned about the ambiguity of these factors that also creates a burden for the tax administration of these countries that have limited tech-nical knowledge and/or limited capacity to understand the changes that are required by the FHTP in the tax system.
Furthermore, these changes will require tax reforms that can take time primarily due to the political environment of the country. Since there are no terms of reference for the application of these factors, the country will have to carry out its own analysis seeking cooperation from the OECD;
Notes
16 For a comparison of the 1998 report and the EU Code of Conduct, see E. Osterweil, OECD Report on Harmful Tax Competition and European Union Code of Conduct Compared, 39
(6) Eur. Tax’n (1999).
17
OECD, Harmful Tax Practices– 2018 Progress Report on Preferential Regimes: Inclusive Framework on BEPS: Action 5, OECD/G20 Base Erosion and Profit Shifting Project 13 (OECD Publishing 2019), https://doi.org/10.1787/9789264311480-en (accessed 9 Dec. 2019).
18 OECD, supra n. 3. OECD, supra n. 4, at 19.
19 ‘For example, where the rate of corporate tax applied to all income in a particular country is 10%, the taxation of income from mobile activities at 10% is not preferential, even though it may be
lower than the rate applied in other countries’. OECD, supra n. 4, at 20.
20 OECD, supra n. 4, at 23. 21 Ibid., at 11.
other international organizations (e.g. IMF and World Bank); or other countries’ tax administrations and/or academic experts which also can create different perspective on the way that these actors evaluate the applicability of these factors to their tax incentives. These views are provided in section 3 below.
The criteria for assessing preferential tax regimes on income from geographically mobile financial and other service activities are briefly addressed in the table below. This table also aims to provide some guidelines regarding the applicability of these factors to tax incentives with a specific focus on developing countries.
3 T
HE STUDY OF TAX INCENTIVES INDEVELOPING COUNTRIES IN THE LITERATURE
,
INTERNATIONALORGANIZATIONS AND REGIONAL NETWORK OF TAX ADMINISTRATIONS
This section addresses the concerns in the literature and of international organizations and the regional network of tax administrations regarding the importance of tax incen-tives for developing countries considering the BEPS Project.
FOUR KEY FACTORS 1998 REPORT
FIVE KEY FACTORS 2018 PROGRESS REPORT
APPLICABILITY TO TAX INCENTIVES IN DEVELOPING COUNTRIES
(1) The regime imposes no or low effective tax rates on income. (2) The regime is ring-fenced from the domestic economy.23
(3) The regime lacks transparency, e.g. favourable application of laws and regulations, negotiable tax provisions, and a failure to make widely available administrative practices.
(4) There is no effective exchange of information (EOI) in relation to tax-payers benefiting from the operation of a preferential tax regime.
(1) The regime imposes no or low effective tax rates
(2) The regime is ring-fenced from the domestic economy.
(3) The regime lacks transparency. (4) There is no effective exchange of information with respect to the regime. (5) The regime fails to require sub-stantial activities.
(1) Applicable if low or zero tax rate. Comparison with rates within the country.
(2) Applicable if tax incentive granted only for certain areas or certain types of investors.
(3) Applicable if tax incentive is dis-cretionary, no clear evaluation on why the tax incentive is granted, or no information publicly available on the incentives.24
(4) Applicable since Information referring to the tax incentives needs to be exchanged among countries. This is the case regarding rulings or any other instrument. Attention should be given to difficulties in respect of transfer pricing documen-tation containing trade and business secrets.
(5) Applicable if the reasons to invest in the country are (a) the tax incentive (e.g. use of incentive for a specific sector without any physical presence in the country–only an independent agent not regarded as a permanent establishment) and/or (b) the lack of substantial activities (e.g. mailbox companies)
Notes
23 A‘Ring-fencing may take a number of forms, including: (i) a regime may explicitly or implicitly exclude resident taxpayers from taking advantage of its benefits, (ii) enterprises which benefit
from the regime may be explicitly or implicitly prohibited from operating in the domestic market’. OECD, supra n. 17. J. M. Weiner & H. J. Ault, The OECD’s Report on Harmful Tax Competition, 51(3) Nat’l Tax J. 604 (1998).
24 As stated by Ault, a‘regime is non-transparent when taxpayers may receive special administrative treatment that allows a particular activity to operate with a low effective tax rate or when
3.1
Literature
The topic of tax incentives was discussed extensively by academic scholars even before the introduction of the BEPS Project.30 In addition, since its introduction,
several articles (from academia, government and practi-tioners) have expressed their concerns in the use of BEPS actions on tax incentives (mainly Action 3 (Controlled Foreign Corporations) and Action 5) and also on the EIGHT OTHER FACTORS 1998
REPORT
FIVE OTHER FACTORS 2018 PROGRESS REPORT
APPLICABILITY TO TAX INCENTIVES IN DEVELOPING COUNTRIES
(1) An artificial definition of the tax base:‘applicable to rules that allow costs to be deducted even though the corresponding income is not taxable, rules allowing deductions for deemed expenses that are not actually incurred, and rules that permit overly generous reserve charges or that otherwise restrict the tax base for particular operations’.
(2) Failure to adhere to international transfer pricing principles (i.e. arm’s length)25
(3) Foreign source income exempt from residence country tax (i.e. terri-torial system). Encourages the loca-tion of activities for tax rather than business purposes.
(4) Negotiable tax rate or tax base.26 (5) Existence of secrecy provisions whether because of bank secrecy, anonymous debt instruments or bearer shares
(6) Access to a wide network of tax treaties.
(7) The regime is promoted as a tax minimization vehicle.
(8) The regime encourages operations or arrangements that are purely tax-driven and involve no substantial activities.
(1) An artificial definition of the tax base.
(2) Failure to adhere to international transfer pricing principles.
(3) Foreign source income exempt from residence country tax.
(4) Negotiable tax rate or tax base. (5) Existence of secrecy provisions. (6) Repealed
(7) Repealed
(8) Introduced as a key factor see above.
(1) Applicable, but the analysis for developing countries should consider whether there are legitimate purposes for these rules such as offsetting the impacts of inflation or reducing the double taxation of certain types of income.27
(2) Applicable, but one question that should be addressed is how to apply this factor to countries who have not adhered to the arm’s length principle (e.g. Brazil) or who deviate from the OECD transfer pricing guidelines (e. g. use of sixth method).28
(3) Applicable if exemption of foreign source income from residence country tax can be regarded as incentive, but its consequences will need to be further evaluated. Difficult to assess by developing countries with limited capacity (personnel, technical resources).
(4) Not clear if this requirement would also apply to tax rulings or stabilization clauses/contracts.29 (5) No really useful mainly due to the Global Standard on EOI and the amendment/repeal of bank secrecy provisions.
Notes
25 OECD, supra n. 2, at 31.
26 According to the 1998 OECD report, this flexibility allows the taxpayer and tax authority of the country sponsoring the regime to either negotiate a‘soak-up’ tax when the
home country allows a foreign tax credit or allows the taxpayer to avoid being subject to the home country’s CFC regime when application of the CFC regime depends upon the host country tax rate. OECD, supra n. 2, at 31.
27 This was also mentioned in OECD, supra n. 2.
28 The Sixth Method was introduced by Argentina, and it is one method of valuation in addition to the OECD five valuations methods. The Sixth Method‘is applicable to
commodities and is distinct because it draws a comparison with a market quote, instead of allowing the comparison to be made with trans-actions and prices agreed between unrelated parties’. V. Grondona, Transfer Pricing: Concepts and Practices of the‘Sixth Method’, 2 Tax Cooperation Pol’y Brief 1 (May 2018), https://www.southcentre.int/wp-content/uploads/2018/05/ TCPB2_Transfer-Pricing-Concepts-and-Practices-of-the-%E2%80%98Sixth-Method%E2%80%99-in-Transfer-Pricing_EN.pdf (accessed 9 Dec. 2019).
29 See s. 3.1. below. See also I. J. Mosquera Valderrama, The Rights of Multinationals in the Global Transparency Framework: McCarthyism?, 18(1) Derivatives & Fin. Instruments
(2016), s. 3.3.2.3.
30 For tax design and drafting, see D. Holland & R. J. Vann, Chapter 23 Tax Law Design and Drafting, in Income Tax Incentives for Investment, vol. 2 (V. Thuronyi ed., IMF 1998).
differences between the EU and OECD approaches, among others.31
One scholar, Zolt, has also analysed the use of tax incentives by developing countries in a post-BEPS world. 32 In a 2015 report, Zolt summarized the con-siderations of countries to introduce tax incentives including the type of tax incentives in developing coun-tries, the non-tax factors influencing investment deci-sions, and the ways to abuse tax incentive regimes.33 In this report,34 reference was also made to the 2013 OECD’s Task Force on Tax and Development Draft Principles to enhance the Transparency and Governance of Tax Incentives for Investment in developing Countries.35 Even though the use of tax incentives for specific sectors and free trade zones for specific regions have also been targeted in the review by the FHTP, no reference was made by Zolt to BEPS Action 5 and the link between preferential tax regimes and tax incentives.36
In this author’s opinion, the review by the FHTP in BEPS Action 5 of the preferential tax regimes has also redesigned the way that tax incentives are dealt with by countries, including developing countries. Since developing countries lack the technical capacity and resources, the easiest way for a country to comply with the FHTP is to repeal the tax incentive rather than amend or change it in a way that the country can still be attractive for foreign investment and continue to benefit from technology, research and development from developed countries.
This can be improved if the FHTP is more transparent on the application of these criteria so that it helps to exchange best practices within the region and also among regions. For instance, in the 2017 progress report regarding the regional headquarters regimes, Singapore and Thailand Regional Operating Headquarter Regimes were regarded as harmful whereas Turkey Regional Headquarters was out of the scope of the FHTP. There is no further information on what features Turkey had in
this regime that made it possible to still have the regime without being targeted by the FHTP.37
In respect of preferential tax regimes, in 2018, Keen (International Monetary Fund (IMF) official writing in a personal capacity) stressed that the preferential tax regimes in BEPS Action 5 is more an issue of tax competition than tax avoidance. For Keen:
the lesson is that preferential tax regimes themselves are not a distinct source of damage in strategic inter-actions of international tax setting (though they may create distinct difficulties in terms, for instance, of enabling tax avoidance, or in weakening the credibility of resistance to lobbying for special treatments). They are in that respect just one instance of the general pressures towards inefficiently low tax rates on mobiles activities, and the best form of coordinated response is likely to be not an insistence on uniformity, but,… a movement towards some form of minimum taxation.38
The question is then whether tax incentives in the form of preferential tax regimes really harmful. This question will be addressed in section 3.2.2 below.
Further to the discussion of preferential tax regimes and tax competition, in the BEPS Project, it is important when addressing tax incentives in developing countries to consider the different challenges in countries that are depending on foreign direct investment or countries that are depending on their extractive industry (i.e. oil, gas, mining).
Developing countries that are depending on foreign direct investment may benefit‘from exchange of best practices and of technical assistance for drafting and implementing tax rules including careful selection of tax incentives’.39
If one example can illustrate this, for instance, it is the use of tax incentives for the hotel sector in Colombia introduced by Law 788 of 2002. With this law, the profits obtained in the hotel sector could be exempted (0%) for thirty years. In 2016, Law 1819 changed the incentive to introduce a reduced tax rate (9% – normal rate 33%) for a term of
Notes
31 See for a country analysis: A. R. Masuku The Legal Framework of the Botswana Special Zone: The SPEDU Region and Action 5 of the OECD/G20 Base Erosion and Profit Shifting
Initiative, 78(10) Bull’n Int’l Tax’n 19 (2018). M. M. Abdellatif Khalil & B. Tran Nam, The Tax Policy Debate Regarding Tax Incentives in Developing Countries: The Case of Targeted Tax Incentives in Egypt, 70(7) Bull’n for Int’l Tax’n (2016). For a general analysis: M. Keen, Competition, Coordination and Avoidance in International Taxation, 72(4/5) Bull’n for Int’l Tax’n 220–225 (2018). See also A. Bal, Tax Incentives: Ill-Advised Tax Policy or Growth Catalysts, 54(2/3) Eur. Tax’n 63–70 (2014). See also H. M. Bjerkesteun & H. G. Wille, Tax Holidays in a BEPS Perspective, 43(1) Intertax 106–120 (2016).
32 See E. Zolt, Tax Incentives: Protecting the Tax Base, Paper for Workshop on Tax Incentives and Base Protection, Paper for Workshop 23–24 Apr. 2015 (UN 2015). See also E. Zolt,
Tax Treaties and Developing Countries, University of California, Los Angeles (UCLA)– School of Law, Law-Econ Research Paper No. 18–10.
33 Zolt, supra n. 32, at 7 & 20. 34
Ibid., at 24.
35
OECD, Draft Principles to Enhance the Transparency and Governance of Tax Incentives for Investment in Developing Countries (OECD Publishing 2013) www.oecd.org/ctp/tax-global/ transparency-and-governance-principles.pdf (accessed 9 Dec. 2019). For the content of these draft principles. See s. 3.2.1 below.
36 However, Zolt referred to BEPS as having the potential to provide additional tools to tax authorities to improve tax collection and to tax foreign investors in developing
countries, for instance, through the CFC rules (BEPS Action 3) or to limit base erosion via interest deductions (BEPS Action 4). Zolt, supra n. 32, at 31, 32.
37 OECD, supra n. 3.
38 Keen, supra n. 31, at 220–225.
39 I. J. Mosquera Valderrama, The OECD-BEPS Measures to Deal with Aggressive Tax Planning in South America and Sub-Saharan Africa: The Challenges Ahead, 43(10) Intertax 615–
twenty years.40 Even though the government wanted to apply the reduced tax rate of 9% to all past and new investments in the hotel sector, the Constitutional Court decided, when reviewing the compatibility of Law 1819 against the constitution, that the changes could only occur for the future (C235/19). For the court, the taxpayer has enjoyed the benefit, and it is not possible to change the conditions of the tax benefit since it will contradict the principles of good faith and non-retroactivity. Therefore, the tax rate of 9% is only applicable for investments begin-ning in 2019 for a period of twenty years.
In this case, the drafting of the tax incentive could benefit from including a regular systematic evaluation once the tax incentive has been granted. This evaluation should take place at least every two years and should focus on whether the tax incentive has achieved the specific goals in terms of effective-ness and efficiency. By introducing this systematic evaluation as one of the conditions for the tax incentive, the taxpayer is aware that the conditions in the tax incentive may change, and any modifications to it will not affect the good faith and legitimate expectations of the investor (taxpayer).
Developing countries depending on the extractive indus-try may benefit from more transparency in the use of stability clauses/contracts in taxation. Their use may result in tax base erosion and in the limitation of the govern-ment’s power to levy taxes. These countries agree on stabi-lization clauses/contracts with investors (companies) in order to protect the investor from changes in the tax legislation. These clauses effectively guarantee that legisla-tive changes will not be applicable to the taxpayer for the period of the contract/clause (i.e. five, ten or twenty years). Such stability clauses have previously applied to the extrac-tive industry (e.g. Ghana, Zambia and South Africa).41 Therefore, these countries require more transparency and accountability ‘on the part of investors and governments regarding the potential benefits of such clauses’.42
3.2 International Organizations
3.2.1 The Role of Tax Incentives and the BEPS
Project
International organizations have also addressed the role of tax incentives considering the BEPS Project. For instance,
in 2014, the OECD published a two-part report to the G20 Development Working Group on the impact of BEPS in Low Income Countries (the Report). The first part dealt with the experiences of developing countries and international organizations on the main sources of BEPS in developing countries and how these relate to the BEPS Project.43 The second part addressed the ways to assist developing countries to meet the challenges of the most relevant BEPS issues for these countries.44
The first part of the report stated that developing coun-tries often experience acute pressure to attract investment by offering tax incentives, which may erode the country’s tax base with little demonstrable benefit. In this report, the use of tax incentives was not considered as an issue directly linked to BEPS but an issue of importance for developing countries beyond the realm of the BEPS Project.
The second part of the report addressed the use of wasteful tax incentives (i.e. incentives that erode the tax base with little demonstrable impact on investment). In addition, the report proposed the use of the 2013 OECD’s Task Force on Tax and Development Draft principles to enhance the transparency and governance of tax incentives for investments in developing countries as a diagnostic framework to analyse the problem of tax incentives in developing countries.45
In the drafting of tax incentives, the OECD provided ten draft principles including the introduction of a com-prehensive policy and objectives for granting tax incen-tives, the transparency and periodically review of the tax incentives, the ratification of the tax incentive through the tax law maker, the public release of the tax expen-ditures including the calculation of the amount foregone and a list of the largest beneficiaries of the tax incentives, the use of tax laws to grant the tax incentive, the collec-tion of data to systematically monitor the overall effect and effectiveness of individual tax incentives, and to enhance regional cooperation to avoid harmful tax competition.46
In the 2015 Toolkit on Tax Incentives for Low-Income Countries, the OECD, the IMF, the World Bank, and the UN stated:
Tax incentives generally rank low in investment cli-mate surveys in low-income countries, and there are many examples in which they are reported to be redundant– that
Notes
40 See, for an overview of the incentives in Colombia for the hotel sector, Procolombia, Investment Incentives in Colombia,
https://www.investincolombia.com.co/investment-incentives/other-incentives.html and for the Constitutional Court decision CO: C-235/19, http://www.corteconstitucional.gov.co/relatoria/2019/C-235-19.htm (accessed 9 Dec. 2019).
41
Mosquera Valderrama, supra n. 39, at 622 & 623.
42 Ibid., at 623.
43 OECD, Part 1 of a Report to G20 Development Working Group on the Impact of BEPS in Low Income Countries (OECD Publishing, July 2014),
http://www.oecd.org/tax/part-1-of-report-to-g20-dwg-on-the-impact-of-beps-in-low-income-countries.pdf (accessed 9 Dec. 2019).
44 OECD, Part 2 of a Report to G20 Development Working Group on the Impact of BEPS in Low Income Countries (OECD Publishing, Aug. 2014),
https://www.oecd.org/ctp/tax-global/part-2-of-report-to-g20-dwg-on-the-impact-of-beps-in-low-income-countries.pdf (accessed 9 Dec. 2019).
is, investment would have been undertaken even without them. And their fiscal cost can be high, reducing oppor-tunities for much-needed public spending on infrastruc-ture, public services or social support, or requiring higher taxes on other activities.47
Therefore, this toolkit addressed the use of‘wasteful’ tax incentives for low-income countries and the need to change these incentives to improve their effectiveness and efficiency. However, these issues are not referring to BEPS Action 5 but to incentives in general and the way to prevent base erosion by enhancing the transparency and governance of tax incentives for investment in developing countries. The follow-ing section 3.2.2. will address the views from international organizations regarding harmful tax practices with preferen-tial tax regimes (tax incentives) in developing countries
3.2.2 Tax Incentives, Harmful Tax Practices and Tax
Competition
In March 2019, the IMF published a article, Corporate Taxation in the Global Economy, also addressing the BEPS and current challenges of international taxation. In this report, the IMF stated that ‘current initiatives, focused on “harmful tax practices” (offering preferential tax treatment to firms without economic substance), leave some open ques-tions’. The recognition that preferential regimes are not necessarily damaging is consistent with developments in thinking over the last decade. Substance requirements, how-ever, bring their own difficulties: potential tax savings may be so large that companies are willing to allocate whatever resources are needed to pass a substance test, however unpro-ductive they truly are in that use; and tax competition becomes focused on attracting real activities. This reflects inherent limitations in addressing tax competition only in the form of specific regimes; it is increasingly recognized that low/zero taxation have adverse spill over effects’.48
Therefore, the IMF acknowledges that there are still open questions on whether the preferential tax regimes constitute harmful tax practices.
In the IMF/World Bank April 2019 Spring Meetings Official Session: Taxing to Develop International Taxation Challenges for Africa, one representative of the IMF (Keen) also addressed the above IMF article in his presentation49 and inquired whether preferential regimes are necessarily harmful. For this representative, ‘further, distortions remain (through for instance the relocation of parent companies) and underlying weaknesses of the sys-tem are patched rather than fixed’.50
This subsequently demonstrates that tax incentives and the exploitation of preferential tax regimes should be carefully addressed by governments and international organizations.
3.3 Regional Network of Tax Administrations
In 2018, the United Nations and the CIAT published a report for the design and assessment of tax incentives in developing countries with a case study of the Dominican Republic.51This report was constructed, to some extent, from the work pro-vided by Zolt in the 2015 report52(see 3.1. above). In addi-tion, a specific checklist for drafting tax incentive legislation and a cost-benefit analysis framework for assessing tax incen-tives were introduced. This report did not address the applica-tion of the BEPS Acapplica-tion 5 checklist to tax incentives (described in section 2.3. above).
Representatives of the ATAF have also made reference to ‘the need to put appropriate transparency and governance procedure for the granting of tax incentives’.53 Regarding the abuse of tax incentives, the OECD-ATAF has also published a document that addresses the use of exchange of information to detect the potential abuse of tax incentives targeted at foreign direct investment.54More recently in a meeting organized in April 2019 by the IMF and the World bank, the ATAF representative referred to the challenges of
Notes
47 See IMF, OECD, UN, World Bank, Options for Low Income Countries: Effective and Efficient Use of Tax Incentives for Investment, Report to the G-20 Development Working Group (Oct.
2015), https://www.imf.org/external/np/g20/pdf/101515.pdf (accessed 9 Dec. 2019). See also OECD, Principles to Enhance the Transparency and Governance of Tax Incentives for Investment in Developing Countries, http://www.oecd.org/ctp/tax-global/transparency-and-governance-principles.pdf (accessed 9 Dec. 2019).
48 IMF, Corporate Taxation in the Global Economy, Policy Paper No. 19/007 12 (Mar. 2019), para. 14, https://www.imf.org/en/Publications/Policy-Papers/Issues/2019/03/08/
Corporate-Taxation-in-the-Global-Economy-46650 (accessed 9 Dec. 2019).
49 M. Keen, Presentation Session 1: Corporate Taxation in the Global Economy, with a Focus on the Issues for Developing Countries, https://www.imf.org/en/News/Seminars/Conferences/
2019/03/08/taxing-to-develop-international-taxation-challenges-for-africa (accessed 9 Dec. 2019).
50 Remarks by Michael Keen in Brettonwoods Project, Taxing to Develop: International Taxation Challenges for Africa, IMF/World Bank Spring Meetings Official Session Taxing
to Develop: International Taxation Challenges for Africa (Apr. 2019), https://www.brettonwoodsproject.org/2019/04/taxing-to-develop-international-taxation-challenges-for-africa/ (accessed 9 Dec. 2019).
51 United Nations & CIAT, supra n. 15. 52
Zolt, supra n. 32.
53 N. Monkam, Presentation the African Tax Administration Forum (ATAF), 3d International Association of Prosecutors, African-Indian Ocean Regional Conference 15 (3 Mar.
2014) 15, https://www.iap-association.org/getattachment/Conferences/Regional-Conferences/Conference-Documentation-Zambia/3AIORC_Zambia_P1_Nara_Monkam_ Presentation.pdf.aspx (accessed 9 Dec. 2019).
54 ‘Many developing countries have tax incentives to attract foreign direct investment or promote exports. Tax revenues may be lost as some investors may improperly claim incentives or shift income
BEPS in Africa including the weak domestic legislation, the limited capacity of the tax administration, and the excessive tax incentives, among others.55
In summary, the literature, international organiza-tions and regional network of tax administraorganiza-tions have addressed the challenges that countries, including developing countries, face regarding tax incentives for investment. These challenges are the need to enhance transparency and governance in the granting (before and after) of the tax incentive and to introduce a cost-benefit analysis to evaluate the tax incentives. However, it is not clear whether these challenges are being addressed by discussing preferential tax regimes within BEPS Action 5. Instead, this author contends that, by complying with BEPS Action 5, developing countries are diverting their attention to address the most important challenges regarding tax incentives as highlighted in this section.
4 T
HE LEGITIMACY AND FEASIBILITY OFOECD BEPS
ACTION5
AND ITSAPPLICATION TO TAX INCENTIVES IN DEVELOPING COUNTRIES
This section assesses the legitimacy and feasibility of OECD BEPS Action 5 and its application to tax incentives vis-á-vis developing countries. This section also intends to demonstrate that the criteria to comply with BEPS Action 5 is ambiguous for countries, including developing countries, and, therefore, BEPS Action 5 may deviate the attention of developing countries from enacting legitimate tax incentives for investment.
4.1 Legitimacy Issues of BEPS Action 5
vis-à-vis Developing Countries
The peer review of the minimum standard of BEPS Action 5 is undertaken by the FHTP. The FHTP was created by the OECD in 1998 to monitor the implementation of the mea-sures and guidelines addressed in the 1998 OECD Report on Harmful Tax Competition, however, with the BEPS 4 Minimum Standards, the FHTP has revamped its work mainly by reviewing the harmful preferential tax regimes and the exchange of rulings of BEPS Action 5. According to the terms of reference and methodology of BEPS Action 5, the delegates of the FHTP represent members of the BEPS Inclusive Framework.56However, since this FHTP and the 1998 report have been initiated by the OECD,57the question of the legitimacy58of this FHTP in respect of non-OECD countries can be questioned especially if, in most of the peer review reports of BEPS Action 5, the FHTP was the only one that provided feedback on the compliance of the country with BEPS Action 5.59
Another problem in the legitimacy of the FHTP is that the peer review of Action 5 has been performed not only for countries participating in the BEPS Inclusive Framework but also for those beyond the realm of the BEPS Inclusive Framework. One example is the Philippines which has not committed to the BEPS Inclusive Framework60but, in the 2017 report, was reviewed by the FHTP regarding the regio-nal operating headquarters of which elimination was recom-mended by the FTHP.61It is not clear from the peer review report why the Philippines was reviewed, however, this review opens the door to review other countries who have not com-mitted to implementing the BEPS Inclusive Framework. The following section 4.2 will assess the use of the criteria to evaluate preferential tax regimes in developing countries.
Notes
55 Presentation by M. Baine in Brettonwoods Project, Taxing to Develop: International Taxation Challenges for Africa, IMF/World Bank Spring Meetings Official Session Taxing to
Develop: International Taxation Challenges for Africa (Apr. 2019), https://www.brettonwoodsproject.org/2019/04/taxing-to-develop-international-taxation-challenges-for-africa/ (accessed 9 Dec. 2019).
56 OECD, BEPS Action 5 on Harmful Tax Practices: Transparency Framework, Peer Review Documents 18–19 (OECD Publishing, Feb. 2017),
http://www.oecd.org/tax/beps/beps-action-5-harmful-tax-practices-peer-review-transparency-framework.pdf (accessed 9 Dec. 2019).
57 The 1998 OECD Report was drafted by the‘Special Sessions on Tax Competition’ created by the OECD Committee of Fiscal Affairs. This report was adopted by the
Committee at its session on 20 Jan. 1998. OECD, supra n. 2. See also Weiner & Ault, supra n. 23 where the authors state that‘although non-Member countries did not participate in the actual drafting of the Report, the OECD held three separate regional seminars during the course of the project that were designed to include non-member countries in the dialogue’.
58 In the past, this author used the concept of legitimacy to address the participation and representation of non-OECD, non-G20 (including developing countries) in the BEPS
agenda setting. See I. J Mosquera Valderrama, Legitimacy and the Making of International Tax Law: The Challenges of Multilateralism, 7(3) World Tax J. (2015).
59
For instance, regarding the Peer Review Report on Exchange of Information of Tax Rulings (another standard included in BEPS Action 5), the FHTP was the only one provided feedback as a peer in twenty-four of forty-four countries in the 2016 peer review report and sixty-five of ninety-two countries in the 2017 peer review report.
60 Concisely, the reasoning for not participating in the BEPS Inclusive Framework was explained by Jacinto Henares, the Internal Revenue Commissioner of the Philippines
(until 30 June 2016), at the time of the discussion of the BEPS Project, as a participant,‘the Philippines did not have any right to vote, and was merely asked to participate to provide the viewpoint of a developing country and to allow the OECD to be able to say that their actions are inclusive. The Philippines agreed to participate when it was able to get a confirmation that whatever were decided in the said Forum would not be binding on the Philippines as it is not allowed to vote. After the release of the 2015 BEPS package in Oct. 2015, the OECD invited the Philippines to join the Inclusive Framework in Kyoto, Japan in July 2016, but the Philippines did not join’. I. J. Mosquera Valderrama, Output Legitimacy Deficits and the Inclusive Framework of the OECD/G20 Base Erosion and Profit Shifting Initiative, 72(3) Bull’n for Int’l Tax’n (2018) See also J. Henares, A Commentary on the BEPS Project and Its Influence on Developing Countries, in Asian Voices: BEPS and Beyond (S. Sim & M-J. Soo eds, IBFD 2017).
4.2 Assessment of Preferential Tax Regimes in
Developing Countries
4.2.1. Use of the 1998 OECD Harmful Tax Report
in the Peer Review
Since the introduction of the BEPS Project, more than 287 tax regimes have been reviewed by the FHTP. Countries have amended their regimes following the FHTP recommendations.62 For this review, the 1998 OECD Harmful Tax Practices Report has been used as a frame-work for determining whether a preferential tax regime is harmful. This report was revised in 2018 by the BEPS Inclusive Framework. However, as explained in section 2.3. above, most of the criteria of the 1998 report are still used by the FHTP since only two factors (use of tax treaties and promotion of a regime as a tax minimization vehicle) of the 1998 report have been repealed.
The application of this framework to evaluate tax incentives in the form of preferential tax regimes as harm-ful has been analysed in section 2.3. above. This analysis demonstrated that it is not clear for countries, including developing countries, how these requirements need to be met. This ambiguity is also the result of the lack of terms of reference to further explain these criteria and their application to the countries’ preferential regimes. These terms of reference exist for the transparency framework (exchange of rulings) in BEPS Action 5.63 Hence, devel-oping countries that are now under review question the applicability of the criteria of the 1998 report to their preferential regimes but also the lack clarity on the con-tent of these criteria.64
At the time of the 1998 report, the OECD’s original plan‘was to require developing countries to abolish their harmful preferential tax regimes or, at least, to“remove” their“harmful features”’.65However, due to the technical and political difficulties, the OECD focused first on tax havens by requiring transparency and exchange of infor-mation from these countries. 66 The OECD results until 2006 showed the limited progress in achieving these objectives.67With the introduction in 2009 of the global standard on transparency by the OECD with the political
support of the G20 and the creation of the Global Transparency Forum (with 158 members, i.e. OECD countries and non-OECD countries including developing countries and tax havens), transparency and exchange of information became the global standard.68
Considering these developments, in the author’s view, two of the criteria (whether the regime lacks transparency or the lack of effective exchange of information) of BEPS Action 5 are no longer useful for evaluating harmful tax regimes. These two criteria could have been beneficial elements at that time (1998), however, the introduction of the Global Standard on Exchange of Information that resulted in countries amending or repealing bank secrecy have changed the countries’ approach to transparency.
Another concern of developing countries is that the introduction of BEPS Action 5 will create more tax com-petition among countries69and that developing countries will not be able to compete with developed countries since the tax incentive is one of the elements that can bring foreign investment into a country.
For instance, in respect of tax incentives, the 1998 report stated: Tax competition and the interaction of tax systems can have effects that some countries may view as negative or harmful but others may not. For example, one country may view investment incentives as a policy instrument to stimulate new investment, while another may view investment incentives as divert-ing real investment from one country to another. In the context of this last effect, countries with specific struc-tural disadvantages, such as poor geographical location, lack of natural resources, etc., frequently consider that special tax incentives or tax regimes are necessary to offset non-tax disadvantages, including any additional cost from locating in such areas. Similarly, within coun-tries, peripheral regions often experience difficulties in promoting their development and may, at certain stages in this development, benefit from more attractive tax regimes or tax incentives for certain activities. This outcome, in itself, recognises that many factors affect the overall competitive position of a country. Although the international community may have concerns about potential spill over effects, these decisions may be
Notes
62 See OECD, OECD Releases Latest Results on Preferential Regimes and New Results on No or Only Nominal Tax Jurisdictions, OECD Base Erosion and Profit Shifting (OECD
Publications 2019), https://www.oecd.org/tax/beps/oecd-releases-latest-results-on-preferential-regimes-and-new-results-on-no-or-only-nominal-tax-jurisdictions.htm (accessed 9 Dec. 2019).
63 OECD, supra n. 56, at 18–19.
64 W. Lips & I. J. Mosquera Valderrama, Global Sustainable Tax Governance in the OECD-G20 Transparency and BEPS Initiatives, in Tax Sustainability in an EU and International
Context (C. Brokelind & S. Van Thiel eds, IBFD, GREIT, forthcoming 2020).
65 M. Littlewood, Tax Competition: Harmful to Whom?, 26 Mich. J. Int’l 411, 469 (2004), https://repository.law.umich.edu/mjil/vol26/iss1/15 (accessed 9 Dec. 2019). 66 According to Ault‘at that time the lack of effective exchange of information addressed the situation where countries were unwilling or unable to exchange information due to administrative
policies, limited access to banking information or other practices that allow an investor to shield the financial account from potential examination by tax authorities interested in preventing fiscal evasion and avoidance’. Weiner & Ault, supra n. 23.
67 OECD, Tax Co-operation Towards a Level Playing Field. Assessment by the Global Forum on Taxation (OECD Publishing 2006), https://dx.doi.org/10.1787/9789264024083-en
(accessed 9 Dec. 2019).
justifiable from the point of view of the country in question.70
These considerations mentioned in the 1998 report but not in BEPS Action 5 should be also taken into account when evaluating the application of BEPS Action 5 to preferential regimes in developing countries.
Weiner and Ault, when analysing the 1998 report, referred to the use of low tax rates in tax incentives that: countries may provide investment incentives to stimu-late additional investment. This investment may occur internally, or through attracting foreign investment. Whether these incentives are harmful depends on their design, and the determination must be based on an ana-lysis of all the facts and circumstances. Merely offering a relatively low tax rate is not sufficient to be labelled harmful tax competition. 71
This means that the analysis of preferential tax regimes as being harmful needs to be analysed on a country-by-country basis taking into account the specific tax, legal, and geographical features of the country.
f the preferential tax regime can erode the tax base of other countries, the OECD should also answer the following ques-tions: Do developing countries’ preferential regimes cause harmful effects and reduce global welfare? If not, then should the analysis of the harmfulness of the preferential regime be different for developed and developing countries?72
Littlewood further argues:
Given that the countries making the complaint are mostly rich (as is evidenced by the fact that they used the OECD as their vehicle), and given also that the countries using preferential regimes are mostly poor, the theory that the shifting of investment resulting from preferential regimes (or from causes including preferential regimes) is likely to add to global welfare seems entirely plausible. Given that the shifting is induced by tax incentives, it may be that the tax revenues lost by the country losing the investment do not reappear in the hands of the government of the country gaining the investment. It does not follow, however, that the country operat-ing the regime cannot gain. The reason is that the shifted investment, although producing less tax rev-enue than in its original country, might nonetheless produce private benefits for its new host country-in forms such as wages, training, and technology trans-fer. Benefits of these kinds seem in fact to be com-mon. They also, in some circumstances, generate
government revenues for example, tax on income from employment.73
In order to provide more clarity on the harmful effects of a preferential tax regime, in the author’s view, the BEPS Inclusive Framework and the FHTP should also address the three additional questions that the 1998 report intro-duced to assess the harmfulness of the preferential tax regime. These questions are addressed in section 4.2.2. below.
4.2.2 Assessing the Harmfulness of the Preferential
Tax Regime
In addition to the factors mentioned in section 2.3. above, the 1998 OECD Report also addressed three questions to assess the economic effects of a preferential tax regime in terms of its potential harmfulness. For this purpose, even if the regime appears to be harmful, it‘may be considered not to be actually harmful if it does not appear to have created harmful economic effects’.74
These questions are:
(1) Does the tax regime shift activity from one country to the country providing the preferential tax regime rather than generate significant new activity? (2) Is the presence and level of activities in the host
country commensurate with the amount of invest-ment or income?
(3) Is the preferential regime the primary motivation for the location of an activity?
For preferential tax regimes in developing countries, these three questions are relevant primarily if they want to continue to offer tax incentives to attract foreign investment.
Some of the questions that should be raised are whether all tax incentives by developed and developing countries should be treated equally under the framework of BEPS Action 5 and, if not, how can these three questions help to further evaluate the impact of the tax incentives in developing countries vis-à-vis developed countries?
For instance, regarding the first question, does the tax regime shift activity from one country to the country providing the preferential tax regime rather than generate significant new activity? It is important that developing countries as a source of investment are assessed fairly in respect of the tax and business environments of the home
Notes
70 OECD, supra n. 2, at 15 & 16. 71 Weiner & Ault, supra n. 23.
72 The reason, as rightly argued by Littlewood,‘is that the OECD has offered no reason to suppose that any loss to developed countries will be greater than the gain to
developing countries operating preferential regimes’. Littlewood, supra n. 65.
country (which can be a developing or developed country). In this case, the analysis of the shifting of activity from one country to another should be done by comparing the tax incentives among developing countries within the region and not between developed and developing countries.
Littlewood has addressed the shifting of activities from developed to developing countries and the discomfort of developed countries. In this case:
If developing countries succeed in attracting foreign investment, this could entail negative consequences for the country of residence of the foreign investor. For example, a firm might close down a factory in a high-tax rich country and establish a new one in a low-tax poor country. From the rich country’s point of view, the consequences might include both (a) a decrease in economic activity generally (manifesting itself in job losses, in particular) and (b) a fall in government revenue. It is not surprising, then, that the rich countries have watched with some discom-fort the efdiscom-forts of the developing countries to attract foreign investment by means of tax incentives.75 If the preferential tax regime shifts the activity from France to Vietnam, it could be possible to argue that the shifting is allowed insofar as there is an analysis on how this shifting will affect the region and what require-ments in the drafting of tax incentives will be introduced to investors in Vietnam to ensure that the tax incentive create benefit for the country (e.g. job creation, transfer of technology, etc).
As highlighted in the OECD draft principles, ‘the issue of tax incentives cannot be tackled in isolation. Governments can work together on a regional basis to increase cooperation in the area of tax to avoid a race to the bottom when they provide competing tax incentives’.76
In this author’s view, this calls for a regional approach to tax competition.
The second question of whether the presence and level of activities in the host country commensurate with the amount of investment or income should be assessed differently in developed and developing coun-tries. In this case, the presence and level of activities of an investor in the host country is important and should be analysed on a case by case basis. The comparison of the tax incentive with the home (developed) country should not occur since the developing country will have less to offer than the developed country. It should be kept in mind that developing countries do not have many opportunities to attract investment mainly due to
the lack of infrastructure, political stability, or geographical location and, therefore, the introduction of a special zone or an export regime can be the way to attract foreign direct investment.
The third question of whether the preferential regime is the primary motivation for the location of an activity is the one that can bring more difficulties for developing countries since, in most cases, the preferential tax regime is the primary motivation for the location of an activity. Foreign investors consider taxation as one of the elements for deciding to invest in one country or another. Other factors considered as legal requirements are network of tax treaties and investment treaties, one stop shops to deal with all concerns from investors, physical infrastructure, and less corruption, among others.77
5 C
ONCLUSIONS AND RECOMMENDATIONSThis article aims to answer the question of whether BEPS Action 5 is the right regulatory framework to evaluate tax incentives in the form of preferential tax regimes for devel-oping countries. Following the analysis of the preferential tax regimes considering BEPS Action 5, this author con-cludes that BEPS Action 5 and the list of factors for evalu-ating preferential tax regimes that is based in the 1998 OECD report are not the right framework for evaluating tax incentives in developing countries.
Since the 1998 report, twenty years have passed, and some of the elements mentioned in this report (e.g. whether the regime lacks transparency or that there is no effective exchange of information) are no longer valid taking into account the developments in exchange of information. Therefore, in the author’s view, the content of the factors to assess preferential tax regimes should be revisited to take into account these developments. Furthermore, attention should be given to the assessment of the economic effects of preferential regimes taking into account the differences between developed and developing countries.
Following the concerns of legitimacy addressed by developing countries, scholars, international organizations and regional tax organizations, the author concludes that there should be more clarity and transparency on the criteria and the way that the FTHP conducts the review of preferential regimes but also on what constitutes harm-ful preferential regimes so that countries can exchange best practices and learn from each other.
The analysis in this article demonstrates that the review by the FHTP of the preferential regimes and the tax
Notes
75 Littlewood, supra n. 65. 76 OECD, supra n. 35, at 4.
77 This is also shown in the analysis made by the World Bank, Doing Business Guides (2020) http://www.doingbusiness.org/ and US Department of State, 2019 Investment
incentives diverts the attention away from more important issues identified by scholars, international organizations and regional tax organizations for the design of tax incen-tives in developing countries. Some issues that should be addressed by developing countries are, for instance, pro-viding tax incentives for a specific limited time and limited budget (gap until certain amount of revenue) without any discretionary decision by political parties or governments; and incentives that are being evaluated and reviewed systematically.
BEPS Action 5 and the current discussion of the Pillar 2 (GLoBE) proposal should not divert the atten-tion from developing countries for also creating an evaluative framework for tax incentives that enhances
transparency and governance. In this author’s view, a new framework to evaluate the usefulness of tax incen-tives should be elaborated. This framework should also take into account the 2013 OECD draft principles for tax incentives described in section 3.2. This framework has been developed elsewhere by the author78 and includes the following: Systematic review of tax incen-tives; clear target and eligibility criteria for granting the incentive; design of a fiscal budget for the tax incentive; limit the institutions/people granting the incentive, introduction of tax incentives in one single tax law, use of one-stop-shop agencies, and including the development of a code of conduct with sanctions in case of corruption, among others.
Notes
78 This framework will be addressed in I. J. Mosquera Valderrama, Tax Incentives: From an Investment, Tax and Sustainable Development Perspective, in Handbook of International
