Base erosion and profit shifting, more commonly known as BEPS, is a series of action plans first initiated by the Organisation for Economic Co-operation and Development (OECD) in July 2013. The BEPS initiative developed as a result of concerns raised by a number of governments that international tax law has not developed at the same rate as international business structures, with the result that the latter are increasingly used in such a way as to exploit areas in which the former have not kept pace.

Although the term BEPS is used generically, the term actually refers to a series of specific aims set out in the BEPS Action Plan. Each of the 15 Actions is being addressed separately by the OECD. Many were the subject of a final report in October 2015, but others are at an earlier stage. In view of this, each action needs to be considered in isolation when reviewing BEPS, notwithstanding the fact that they are part of the same initiative.

i Action 1 – addressing the tax challenges of the digital economy

It has long been recognised that the OECD Model Tax treaty has not kept pace with technology. The concern in this area is that the rise of the ‘digital economy’ presents difficulties for existing tax systems, including the fact that a company can have a significant digital presence in the economy of another country without being liable to tax in that other country under current tax rules. In March 2014, the OECD issued an initial discussion draft that was followed by various other discussion meetings and communications. The initial discussion document and elicited some criticism for proposing certain areas in which digital businesses should be treated differently to others. The consultation process resulted in a consensus that neutrality should apply and that businesses should be treated in the same way, regardless of the activity in which they engage. Accordingly, the final report, published by the OECD in September 2014, concluded that the challenges of the digital economy were better addressed through the other BEPS Actions, notably the one relating to permanent establishment. Given this conclusion, no further action is anticipated in the specific area of the digital economy.

ii Action 2 – neutralise the effects of hybrid mismatch arrangements

The OECD is concerned that tax advantages can be obtained through ‘hybrid mismatches’, meaning cross-border arrangements that attract asymmetrical tax results in two or more countries as a result of differences in the tax treatment of financial instruments, asset transfers or entities. The tax advantages can include a double tax deduction in two countries for the same economic expense, or a tax deduction in one country without any corresponding inclusion of taxable income in another country. Accordingly, the recommendations on hybrid mismatch arrangements are intended to ensure taxpayers implement less complicated and more transparent cross-border investment structures where deductions and corresponding receipts are treated in a similar manner.

In September 2014 the OECD published its proposals on hybrids, including recommendations for changing participating countries’ laws and tax treaties to provide that:

  • a dividend exemptions do not apply to payments received on hybrid instruments where the payment is deductible for the payer;
  • b payments on hybrid instruments or through hybrid entities will not be deductible if the recipient is not taxable on the payment. Where the jurisdiction of the payer has not enacted legislation to achieve the above effect, the recipient must include the payment as ordinary income; and
  • c partnerships are not permitted to access treaty benefits where neither treaty jurisdiction treats the income as income of one of its residents.

The September changes preserved the position that mere timing differences should not be caught by the proposals (although in the very long term deferral may still be within the scope of the new rules).

In October 2015, the OECD issued a final report on hybrid mismatch arrangements which recommended that domestic rules also be altered where necessary to neutralise the results arising from hybrid mismatch arrangements. The October 2015 report also contained considerably more guidance on both the implementation of the rules and transitional arrangements. These cover the complex situations that may arise in the appropriate counteraction measures. This depends on the arrangement and its effect, so that in essence the payer jurisdiction denies deduction for payment or the payee jurisdiction includes payment as income. The October 2015 release also contained specific recommendations to ensure that hybrid instruments and entities are not used to obtain the benefits of treaties inappropriately. These included the following areas:

  • a dual-resident entities – the existing Model Treaty rule that is the dual-resident tie-breaker (Article 4(3)) will now state that residence in such cases should be determined not just by place of effective management, but should take into account effective management, place of incorporation or constitution and ‘other relevant factors’, creating subjectivity and greater uncertainty for business;
  • b transparent entities – a widening of the existing Model Treaty rule about persons covered (Article 1) will seek to ensure that income of a transparent entity attracts the benefits of tax treaties in appropriate cases but also that these benefits are not granted where neither contracting state treats, under its domestic law, the income of that entity as the income of one of its residents, encouraging a tax and refund process; and
  • c interaction between the domestic hybrid (and other) recommendations and the provisions of tax treaties – the OECD has considered and given its opinion on a number of specific issues but there are likely to be practical issues which will need to be addressed when they arise.

The OECD does contribute to greater certainty in suggesting that countries may consider a rule that an entity that is considered to be a resident of another state under a tax treaty, under the expanded rule, will be deemed not to be a resident under domestic law.

The UK government is already consulting on new anti-hybrid rules following the Chancellor’s Autumn Statement in December 2014. France enacted new anti-hybrid rules in 2013. Other jurisdictions have yet to follow suit.

iii Action 3 – strengthen controlled foreign companies (CFC) rules

The OECD is concerned that CFC and similar anti-deferral rules have not kept pace with modern international business structures. In 2015 consultation was undertaken in this area and a final report was issued in October 2015. No consensus was agreed in the final report, with the recommendations being set out in the form of the following six areas to consider – definition of a CFC, CFC exemptions and threshold requirements, definition of income, computation of income, attribution of income, prevention and elimination of double taxation. The final report more clearly identifies that there are different policy drivers for CFC regimes. It also recognises that there is no ‘one size fits all’ solution even then, so only provides a more coordinated approach to countries looking to introduce CFC rules in the future. Those with existing regimes are unlikely to introduce changes as a result solely of this report.

iv Action 4 – limit base erosion by interest deduction and other financial payments

The concern in this instance is that interest and other financial payments may give rise to deductions that are (in the OECD’s view) excessive, particularly in the case of related-party debt. Consultation in 2015 yielded a final report in October 2015.

The final report reminds readers of the three key scenarios viewed as BEPS risks in the area of the deductibility of interest and other financial payments. These were:

  • a groups placing higher levels of third-party debt in high tax countries;
  • b groups using intragroup loans to generate interest deductions in excess of third-party interest expense; and
  • c groups using debt to fund the generation of tax-exempt income.

Given the flexibility afforded by the recommendations it is likely that there will remain a variety of different approaches to target interest deductibility, and that several territories (e.g., Australia and Germany) may feel little or no need to amend their current rules in this area. The OECD notes that a country should not deliberately adopt a higher fixed ratio owing to a policy to attract international investment due to lenient interest deductibility rules.

The fixed ratio that a territory chooses to adopt should be determined taking into account several factors, the report suggests, including; the level of additional rules that might allow groups to benefit from a deduction in excess of this fixed ratio (e.g., group-wide ratio rules), the level of interest rates in the relevant territory (e.g., high interest rate economies might choose a higher fixed ratio) and the number of targeted rules also in place in that territory.

The report attempts to justify the proposed fixed ratio range on the basis that 87 per cent of listed companies it studied would in principle be able to deduct all of their net third-party interest expense. But these may not be representative of the wider population of businesses, and there is an implicit assumption that groups are equally leveraged in every single territory. The reality is that most groups will have to reassess their capital structures globally in order to still be able to obtain a deduction for third-party interest expense.

It is anticipated that territories introducing new rules in this area should give groups sufficient time to restructure their arrangements before the rules come into effect. This could, for example, include a grandfathering provision for third-party debt for a certain period of time.

v Action 5 – counter harmful tax practices more effectively, taking into account transparency and substance

The OECD is examining a number of ‘preferential’ tax regimes and practices. In particular, there are concerns about the practices of some tax authorities in giving taxpayer-specific rulings and clearances where (in the OECD’s view) there is a lack of transparency. There are also concerns about certain ‘patent box’ and similar regimes that offer a tax incentive to encourage companies to locate the development, manufacture or exploitation of intellectual property in a country – the OECD is concerned about whether these regimes are distortive and whether they are necessarily associated with substantial economic activity.

The OECD has published an initial report on this subject. The focus of the report was on aligning taxation with the ‘substance’ of transactions, defined by reference to determining where people are located, and where the performance of ‘significant people functions’ (a recurring BEPS theme) takes place. However, inevitably, identifying the location of substantial activity is a subjective decision, making objective criteria difficult. The report also voiced concerns about regimes that apply to mobile activities and that unfairly erode the tax bases of other countries, potentially distorting the location of capital and services. The report also included proposals for improving transparency through compulsory spontaneous exchange on taxpayer-specific rulings related to preferential regimes.

Following the report, there was a shift in focus towards the ‘patent box’ regimes, with first the UK and Germany and then all OECD and G20 countries endeavouring to take this action forward by agreement as to what constituted harmful in this context. The proposal – based around a ‘nexus approach’, which allows a taxpayer to receive benefits on intellectual property income in line with the expenditures linked to generating the income, has now been endorsed by all OECD and G20 countries. Automatic exchange of rulings has been confirmed in relation to various named areas of particular risk, with clarification of the exchange being with the countries of the immediate parent and the ultimate parent plus residence countries of affected related parties. This compulsory exchange must take place within three months for rulings issued after 1 April 2016 (rulings from 1 January 2010 still extant at 1 January 2014 need to be exchanged by 31 December 2016).

The review of the non-‘patent box’ regimes in the list of 43 preferential regimes originally identified appears not to have made much progress. In October 2015 it was announced that this review will continue in 2016 along with the development of a strategy for wider implementation which draws in more non-OECD countries plus a clearer statement of the new criteria for what is ‘harmful’ (and an ongoing monitoring mechanism).

vi Action 6 – prevent treaty abuse

The OECD has proposed changes to international tax treaties and domestic tax rules to prevent the granting of treaty benefits in circumstances that are (in the OECD’s view) abusive. The main aim of this action is to prevent the granting of treaty benefits in inappropriate circumstances including, in particular, cases of ‘treaty shopping’ where a resident of a particular jurisdiction seeks to enjoy the benefits of a double taxation agreement entered into by a different jurisdiction in order to reduce taxes from a source jurisdiction.

This has proved to be one of the most contentious areas in the BEPS project, with some disagreement among jurisdictions in the discussion process. The action seeks to prevent treaty benefits being obtained from interposing a holding company or other intermediate entity between an investor jurisdiction and an investee jurisdiction, common in acquisition structures. Identifying whether such interposition is for valid non-tax reasons and how treaty benefits could thus be retained when appropriate was the main point of contention.

In early September 2014 the OECD released a draft report setting out its current thoughts on formulating a response to treaty abuse. This document provided an update on the OECD’s views since the release of their original discussion document, published in March 2014. Following this report, a follow-up discussion draft was published in November 2014, with a revised version being issued in May 2015. These were followed by a final report in October 2015.

A key point of discussion has been two different approaches to amending tax treaties to prevent treaty abuse along with some other, more minor, changes to the standard treaty text.

The first is the inclusion of a limitation on benefits (LOB) provision, similar but not identical to that already included in some bilateral treaties entered into by the United States and certain other jurisdictions. The LOB would essentially deny treaty benefits unless the person claiming them satisfies one of a number of objective tests – including being listed on a recognised stock exchange or carrying on an active trade or business in the country in which it is resident, the holding or management of investments being specifically excluded.

The second proposal is a principal purposes test (PPT), which would be a more general (and potentially subjective) anti-abuse test. The PPT would essentially deny treaty benefits where it is reasonable to conclude that the obtaining of treaty benefits is one of the principal purposes of a transaction or arrangement (unless it can be established that granting treaty benefits in those circumstances would accord with the purposes of the treaty).

The final report has recommended flexibility in implementation to allow adaptation to each country’s specific circumstances and negotiated bilateral tax treaties. The report allows for a range and combination of options – for a LOB plus anti-conduit rule, PPT or both. In additional areas, there are proposed amendments to specific rules on dividend transfers, shares taking their value from immoveable property, dual residence and certain permanent establishment issues. In addition, there is a proposed change to the Model Tax Convention (the preamble and commentary on interaction with domestic anti-abuse rules) stating that both countries, when entering into a treaty, intend to avoid creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty shopping arrangements.

An important outstanding area remains in respect of Action 6. Examination of the treaty entitlement of investment funds will be revisited in the first part of 2016. Thus, in a potentially vital area, this action is unresolved.

vii Action 7 – prevent the artificial avoidance of permanent establishment (PE) status

The OECD is concerned that taxpayers are using artificial structures to avoid having a taxable PE in countries in which they generate substantial income. In November 2014 initial proposals were issued which underwent significant change in 2015 before the issuance of a final report in October 2015.

The key areas of proposed change were as follows:

  • a a widening of the dependent agent test;
  • b a narrowing of the independent agent exemption;
  • c a tightening of the specific activity exemptions from PE status for facilities used for storage, display or delivery of goods, etc. (including an anti-fragmentation test to prevent activities being split across separate legal entities); and
  • d certain measures to prevent abuse of the 12-month building site PE rule.

The main area of controversy in respect of Action 7 relates to dependent agents. Currently, there can be instances in which, despite ‘significant people functions’ in a jurisdiction, an entity can ensure that personnel can never conclude contracts there, thus falling outside the existing definition of PE. The finalised PE proposals provide that persons having ‘the principal role leading to the conclusion of contracts that are routinely concluded without material modification [by the principal]’ will create a PE. The relevant proposed guidance on what these tests amount to is somewhat unclear, although the OECD has indicated the guidance will be reviewed in 2016.

The new proposals on PE are extremely unclear in relation to dependent agents and it is hoped that further guidance will clarify this.

viii Actions 8, 9 and 10 – ensure that transfer pricing outcomes are in line with value creation

These actions were originally separated into different areas, namely intangibles (Action 8), risk and capital (Action 9), and other transferable risks (Action 10). However, since all related to transfer pricing and the proposed modifications to the OECD transfer pricing guidelines, they were ultimately amalgamated with a final report covering all three issued in October 2015.

The OECD is concerned that multinational enterprises (MNEs) have been able to transfer intangibles and other mobile assets into low-tax environments on a basis they this does not capture the full value of those assets in the jurisdictions in which they originate. The revised guidance published by the OECD in October 2015 attempts to ensure that transfer pricing outcomes align with value creation of MNE groups in different ways according to the circumstances.

In relation to delineation of transactions, the focus is on contractual terms and actual legal ownership in light of the substance of the ‘commercial or financial relations’ between related parties in order to form a basis to compare how unrelated parties would behave under similar circumstances. The OECD also affirms the exceptionality of recharacterisation and the importance of accurately delineating transactions through a detailed functional analysis. The guidelines further question the inherent trustworthiness of the terms of contracts entered into between related parties as a stand-alone basis for risk allocation and, instead, identifies the conduct of the associated enterprises as the ultimate deciding factor in accurately delineating a transaction and aligning transfer pricing outcomes.

In relation to intangibles the guidance provides clarification on the determination of arm’s-length conditions for transactions that involve the use or transfer of intangibles and the parts dealing with ‘ownership of intangibles and transactions involving the development, enhancement, maintenance, protection and exploitation of intangibles’, in particular specifying that the return ultimately retained by or attributed to the legal owner depends upon the functions it performs, the assets it uses, and the risks it assumes and upon the contributions made by other MNE group members through their functions performed, assets used and risks assumed. An analytical framework is also introduced consisting of six steps to ensure that all members of the MNE group are appropriately compensated for the functions they perform, the assets they contribute and the risks they assume. Furthermore, a distinction is drawn between ‘marketing intangibles’ and ‘trade intangibles’, explicitly stating that it is important to distinguish intangibles from market conditions or local market circumstances that are not capable of being owned or controlled with specific guidance on the application of the arm’s-length principle in the context of how to address location savings and other local market features, assembled workforce and MNE group synergies.

In considering cost contribution arrangements (CCAs) the OECD has affirmed an underlying theme that parties performing activities under arrangements with similar economic characteristics should receive similar expected returns regardless of the existence of a CCA. The guidelines also specify that a participant must have the capability and authority to control the risks associated with the ‘risk-bearing opportunity’ and one only providing funding should receive a limited return, raising concerns regarding consistency with the arm’s-length principle. This is one of the more controversial areas of the proposals.

These provisions will amend the OECD transfer pricing guidelines, referred to by many jurisdictions and even referred to in the legislation of some (e.g., the UK). Accordingly, unless a jurisdiction specifically contradicts certain elements of the above, they are likely to find their way into law without any action from the country involved.

ix Action 11 – establish methodologies to collect and analyse data on BEPS and the actions to address it

The OECD is still developing proposals for collecting data from taxpayers on the scale and economic impact of BEPS and tools for tax authorities that will enable them to evaluate the effectiveness of the measures taken to counter BEPS. In October 2015 the OECD published some estimates of potential corporate losses arising from BEPS, but acknowledged that the full scope of this remains unknown (see below regarding controversy).

x Action 12 – require taxpayers to disclose their aggressive tax planning arrangements

The OECD has developed proposals to require taxpayers to disclose aggressive tax planning arrangements to tax authorities on a timely basis. Initially, early in 2015, this action proposed some wide reaching reforms. However, the OECD’s recommendations have since been modified and countries are still free to choose whether or not to introduce mandatory disclosure regimes.

The final report on this action, issued in October 2015, contains specific recommendations for rules targeting international tax schemes. They refer to situations in which a country has particular concerns in relation to cross-border BEPS outcomes. The final report also limits the recommendation to disclosures only where a taxpayer in that country enters into a transaction with material domestic tax consequences for it:

  • a if it was aware or ought to have been aware of the cross-border BEPS outcome; or
  • b if, after making reasonable enquiries, it becomes aware that it is an intra-group transaction that forms part of an arrangement that includes a cross-border BEPS outcome that would have been domestically reportable.

Greater reliance is, as a result, placed on specific recommendations for the development and implementation of more effective information exchange and cooperation between tax administrations. The Joint International Tax Shelter Information Centre network of tax administrations will be used as a platform for such sharing.

xi Action 13 – re-examine transfer pricing documentation

The OECD is concerned that tax authorities do not have sufficient information about the affairs of international businesses to enable them to assess whether profits, income and value have been allocated between affiliates on an arm’s-length basis. The OECD, therefore, in September 2014, proposed revised standards for transfer pricing documentation and a template for a new ‘country-by-country’ reporting regime.

The proposals on transfer pricing documentation would require multinational enterprises to provide high-level global information about their business operations and transfer pricing policies in a ‘master file’ that would be available to tax authorities in all relevant countries and more detailed information in a ‘local file’ that would be provided to each relevant country, which would identify related-party transactions relevant to that country, the amounts involved and the company’s analysis of the transfer pricing implications.

The proposed ‘country-by-country’ reporting regime would require multinational enterprises to report annually on the amount of their income, profit, tax paid, total employees, capital, retained earnings and tangible assets in each jurisdiction in which they do business and to identify their entities and business activities in those jurisdictions.

The OECD has also noted that some countries (for example, Brazil, China, India and other emerging economies) would like to add further information regarding interest, royalty and related party service fees. Those points will not be included in the template in this report, but the compromise is that the OECD has agreed that it will review the implementation of this new reporting and, before 2020 at the latest, decide whether there should be reporting of additional or different data.

In October 2015, the OECD issued its final report on this action. It states that the country-by-country reporting requirements will go live from 1 January 2016. The relevant obligations will require a three-tiered approach to documentation, comprising:

  • a the high-level country-by-country report which is to be made available via treaty exchange to taxing authorities in each country in which a MNE operates (a brand new report);
  • b a master file giving an overall perspective on the business; and
  • c a local file which contains specific transfer pricing information for each relevant country of operation.

The OECD has an agreed template for the country by country report and has introduced a new master file requirement and new standards for the local file. The rules will only apply to multinationals with a turnover above €750 million, but the provisions have already been criticised as being unduly onerous and impacting the confidentiality of commercially sensitive information.

xii Action 14 – make dispute resolution mechanisms more effective

The BEPS project is likely to result in some fundamental and novel changes to international tax rules, which could introduce new uncertainties for taxpayers. The OECD has acknowledged that action needs to be taken to ensure certainty and predictability for businesses where possible, and has therefore committed to specific processes for resolving disputes. These were consolidated in a final report issued in October 2015. Countries will be obliged to follow minimum standards to ensure that treaty obligations relating to the mutual agreement procedure (MAP) are fully implemented in good faith and that MAP cases are resolved in good time; that the implementation of administrative processes that promote the prevention and timely resolution of treaty-related disputes; and that taxpayers can access MAP when eligible. There are also certain best practices designed to secure these standards.

xiii Action 15 – develop a multilateral instrument to implement the BEPS actions

The implementation of the measures that emerge from the BEPS project is likely to be a formidable challenge. It would potentially require changes to thousands of bilateral tax treaties. The OECD’s ambition is to develop a single, multilateral instrument that would be signed by all the countries involved and that would effectively amend or override thousands of treaties at once. The development of the multilateral instrument for overriding bilateral tax treaties for BEPS changes is being taken forward by an ad hoc group which has previously said it would aim to have the instrument ready for signature by the end of 2016.


The entire BEPS project is not without controversy, with some arguing that it entirely erodes the autonomy of jurisdictions to address tax issues between themselves. However, it is key to note that BEPS is only as significant as its implementation. If countries choose not to adopt certain recommendations then they will have no impact in those countries. Significantly, areas such as hybrid mismatches, treaty agreement and transfer pricing arrangements are matters for and between jurisdictions and the OECD cannot unilaterally alter these. Accordingly, it remains to be seen whether opposition to certain proposals will result in them having little ultimate impact.


1 At the time of writing, Jenny Wheater was a partner at Duane Morris. She is currently counsel at Linklaters. The information in this chapter was accurate as of January 2016.