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Making Sense of Profit Shifting: Manal Corwin

13 min readBy: Erik Cederwall

Manal Corwin is the National Leader of the International TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. practice of KPMG LLP and Principal in Charge of Washington National Tax—International Tax Policy. She is the former Deputy Assistant Secretary for International Tax Affairs in the Office of Tax Policy at the U.S. Department of the Treasury.

Ms. Corwin is a world-renowned international tax practitioner and tax policy expert. Her unique insight into the dynamics of international tax and the taxation of multinational enterprises is actively shaping the debate on how to design better structures for transnational cooperation in taxation among governments.

Previously, Ms. Corwin served as the Deputy and then Acting International Tax Counsel in the Office of Tax Policy at the U.S. Department of the Treasury and practiced as an attorney specializing in international taxation at the law firm of Covington & Burling in Washington, D.C. Ms. Corwin also served as a judicial clerk for then Chief Judge Levin Campbell on the U.S. Court of Appeals for the First Circuit.

Ms. Corwin is a member of the Massachusetts and the District of Columbia bar associations.

Ms. Corwin received her J.D. from the Boston University School of Law, where she was Editor-in-Chief of the Law Review, and earned her undergraduate degree from Harvard University.

In this interview with the Tax Foundation, Ms. Corwin examines how the profit shiftingProfit shifting is when multinational companies reduce their tax burden by moving the location of their profits from high-tax countries to low-tax jurisdictions and tax havens. phenomenon is changing the global tax landscape and what that means for the business community and for governments. In addition, Ms. Corwin highlights the benefits and possible implications of increased cooperation from a worldwide and U.S. perspective. This interview is part of our 2015 Tax Foundation Forum series and has been edited for clarity and length.

Tax Foundation: How is the profit shifting phenomenon changing international taxation?

Manal Corwin: Any company that operates across borders by definition will end up shifting profits. International tax rules exist because it is understood that cross-border operations necessarily require some shifting/allocation of profit across borders. These rules establish globally agreed conventions and standards for the appropriate allocation of profits when a company is doing business across borders. The BEPS project is not concerned with eliminating all profit shifting, but rather profit shifting that results in base erosion. Specifically, the BEPS initiative is concerned with whether current rules allow for inappropriate profit shifting—profit shifting that in some way erodes the tax bases of countries in ways that were not intended.

TF: That concern stemming from inappropriate profit shifting, how has that changed the actions of players in the international tax arena?

Corwin: In short—politicians at the highest level in G20 countries committed to address the issues and included it on the G20 agenda, the OECD initiated the BEPS initiative in an attempt to address concerns while preserving policy coherence and coordination for international tax rules, and multinationals went on the defensive and tried to manage the reputational risk from the charged public environment.

Over the last few years, there has been an increased public and mainstream awareness of the taxation of multinational corporations. This phenomenon was particularly pronounced in Europe where austerity measures enacted in the wake of the financial crisis increased the attention on the tax practices of multinationals and questions about whether they are paying their fair share of tax. The public focus increased pressure on politicians, particularly in Europe, to take action to address concerns.

As this pressure built, there was an increasing risk that countries might take unilateral actions to address public concerns that would be inconsistent with longstanding internationally agreed standards and lead to increased double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. of business and competent authority disputes between countries.

To mitigate these risks while addressing policy concerns, the OECD launched the BEPS initiative. The initiative was intended to address concerns, particularly about stateless income (income that may not be taxed anywhere), through coordinated and principled recommendations for modifications to current rules to align them with modern ways of doing business.

The challenges for business include complex and unclear rules that don’t necessarily fit modern ways of doing business; competition among governments for revenue, resulting in differences in interpretation of international standards and potential double taxation; increased costs associated with controversies and unresolved competent authority disagreements without effective dispute resolution mechanisms, and increased compliance costs.

What are the unique factors or drivers that are underlying the profit shifting phenomenon?

There are a number of drivers underlying the current environment. First, increased globalization and changing business models present businesses with multiple viable options for where they do business. The modern reality with globalization is that most businesses are going to be operating in more than one jurisdiction. Efficient supply chains often require centralization of functions in different jurisdictions. Thus, a multinational enterprise might be manufacturing in one jurisdiction, selling in another, and perhaps providing services from a third. Such operating structures are established to achieve maximum economic and business efficiencies.

Second, globalization of business has also led to increased competition among jurisdictions to attract business activity and to claim jurisdiction to tax cross-border revenues.

Finally, in certain cases, current international tax rules and standards are out of date relative to modern ways of doing business. This contributes to policy concerns about BEPS, results in uncertainty for businesses and governments trying to apply these rules, and increases compliance costs and controversies among jurisdictions.

I would like to discuss the concept of determining where value added occurs on a geographic basis. What specific challenges are there in determining where—in what jurisdiction—income from multinationals should be booked?

It's a very good question. That is one of the challenges for international tax rules and standards in general. You start out with the notion that every jurisdiction has a sovereign right to tax business as they wish. They have the domestic power to write the rules they want. Countries, however, also have an interest in attracting business activity and investment. That interest has led countries to be willing to collaborate with other jurisdictions to agree to international standards that coordinate taxing rights in a manner that avoids double taxation and thus removes barriers to cross-border investment.

Coordinated international tax rules that avoid double taxation require a common view as to when there is sufficient activity in one country by a company resident in another country for the first country to impose tax. In addition, they require a common view as to how much of the company’s overall profit is attributable to that activity. The current scale and scope of globalization of business activity as well as the ability to conduct business across borders without the need for significant physical presence has impacted the global consensus on the nature and location of value creation and thus the effectiveness of current rules to determine when a country has jurisdiction to tax business activity.

Let's approach this topic from a different angle. Why and for whom is it important to address profit shifting?

Addressing jurisdictional concerns about BEPS in a coordinated manner is in the interest of business and governments. For business, certainty and clarity regarding how they will be taxed is critical. This requires a consensus among revenue authorities, in theory and practice, regarding the taxation of cross-border business activity. Absent such a consensus, businesses will be subject to double taxation, face increased controversy, and be subject to unnecessary compliance costs. Certainty and clarity is also in the interest of governments. Governments have an interest in protecting their tax bases, while attracting business activity and investment. Achieving both of those objectives requires coordination with other governments on international tax principles that appropriately allocate taxing rights. Absent clear and coordinated rules, governments will face increased enforcement costs, will have to expend resources to resolve disputes with other governments regarding taxation, and will be compromised in their ability to attract investment.

Right now, we have different players in the international tax arena with respect to governments. There are high-tax jurisdictions, low-tax jurisdictions, and then in some sense we have developed countries and developing countries. From that perspective, since base erosion for one county often is base broadeningBase broadening is the expansion of the amount of economic activity subject to tax, usually by eliminating exemptions, exclusions, deductions, credits, and other preferences. Narrow tax bases are non-neutral, favoring one product or industry over another, and can undermine revenue stability. for another, for which type of country or government does profit shifting matter the most?

I think every country at some level has a stake in this conversation. Any country who taxes corporate activity and relies on corporate tax revenues has a stake in protecting its tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. . Each of these countries is balancing two considerations. They want to protect their tax base, but they also want to attract investments. What they want to be able to do is make sure that they can collect tax, but they also want business to feel that investing in their jurisdiction is attractive, not overly costly, and cumbersome. Achieving the right balance between these two objectives can be challenging and sometimes lead to mixed messages and inconsistent policies. We have seen this tension play out over the last couple of years in the UK, for example. Over the last couple of years, the UK has actively promoted itself as being open for business and offered incentives like the patent boxA patent box—also referred to as intellectual property (IP) regime—taxes business income earned from IP at a rate below the statutory corporate income tax rate, aiming to encourage local research and development. Many patent boxes around the world have undergone substantial reforms due to profit shifting concerns. regime to attract business activity, while at the same time leading the charge in questioning whether corporations are paying their fair share of tax and ultimately enacting the diverted profits tax, which is widely perceived as getting ahead of and inconsistent with the coordination that the BEPS initiative was intended to foster.

Low-tax jurisdictions also have a stake in the conversation. They too seek to attract business activity. To the extent they are perceived as facilitating BEPS or categorized as tax havens, however, they will not be attractive choices for multinational entities who are increasingly concerned about public perception and reputational risks.

Finally, developing countries also have an interest in attracting investment and protecting their tax base, but also face the additional challenge of limited resources. In that regard, clear rules that are coordinated and easy to enforce are critical for developing countries.

How can multilateral cooperation, and specifically the BEPS project, help address profit shifting?

As I noted earlier, coordinated action that results in clear, principled rules and standards that promote certainty and predictability, protect tax bases, and prevent double taxation is the key to addressing this issue. Given the charged political environment and the pressure to pursue unilateral actions, however, this is proving difficult.

So far, what are positive aspects and possible areas of improvement in the BEPS project’s process?

The impetus of the BEPS initiative was the recognition that coordinated action to address government concerns about double non­taxation or the current state of the international tax rules was far better than politically driven unilateral actions, which could result in double taxation and increased controversy. That continues to be a positive aspect of the effort, notwithstanding the fact that maintaining coordination is proving challenging. In addition, the promise of improved MAP [Mutual Agreement Procedure] processes and greater buy-in to the use of binding arbitration to resolve disputes, if successful, will be a very positive achievement and an important legacy of this effort.

Is there anything that you think can be improved in the process?

I think the biggest challenge for the process is the very tight time frame established at the outset to address too many complex areas of law that have been around for many years. While the time frame was dictated by political pressures to act fast, it has presented challenges. In addition, the complexity as well as the political factors have made it such that consensus and coordination have not fully been preserved. Several countries have jumped ahead of the process and adopted new rules that reflect unilateral interests rather multilateral coordination. These rules, at least at this point, appear to be departures from existing international standards. I think these developments compromise the original goal of the initiative and present challenges for the process and its outcome.

What could the BEPS project mean for U.S. lawmakers, U.S. firms, and U.S. tax revenues?

For U.S. lawmakers, the adoption of certain anti-BEPS measures by other countries, especially unilaterally and ahead of the enactment of U.S. tax reform, could mean that revenues that might otherwise have been U.S. tax revenues will be claimed by other jurisdictions. U.S. lawmakers need to consider protecting the U.S. tax base as well as the interests of U.S. multinationals.

For U.S. multinationals, the impact is pretty significant. There has been a politically driven, disproportionate focus on U.S. multinationals that has distracted policy makers from focusing on coordinated action based on principled standards. As a result, politically driven unilateral actions could have a disproportionate impact on U.S. multinationals and will compromise the objectives and outcomes of the initiative as well as the effectiveness of longstanding international rules and standards.

How could the U.S. gain from further involvement in multilateral cooperation in international taxation?

U.S. involvement in the process is necessary to protect U.S. interests and to reinforce the value and importance of coordination on international standards for taxation of multinational enterprises’ income.

Basically, the bottom line is that international tax rules exist in order to coordinate how income that's crossing borders is going to be taxed and allocated between jurisdictions and to address concerns about double taxation. So absent coordination and absent buy-in, by all the relevant jurisdictions to those rules, you end up defeating the purpose in many ways of having international standards and rules in the first place.

I think the U.S. is an important voice at the global table.

What major developments do you expect in the next 1-2 years in international taxation?

I think there will be several major developments in international taxation in the next couple of years. The first is greater transparency. Multinationals, pursuant to Action 13 of the BEPS project, will be required to report information on all of their operations on a country-by-country basis and share that information with the governments of every jurisdiction in which they operate. Second, while the specifics of how the transfer pricing standards will be amended is not yet final, it seems fairly certain that these rules will require additional substance to justify the allocation of profit to risk and capital. Third, I think there will be increasing pressure on source country taxation with more subjective standards emerging from the OECD consensus as well as unilateral actions. Fourth, I think that multinationals are likely to face increased compliance costs and greater controversy over the next two years as a result of the scope of changes that will be taking place and the clash of politically motivated unilateral actions to address BEPS. Finally, as I noted earlier, I think there will be certain positive improvements in MAP to the extent a critical mass of countries adopt arbitration and the planned global forum on MAP improves compliance with and accountability for best practices in resolving controversies.

These comments represent the views of the interviewee only, and do not necessarily represent the views or professional advice of KPMG LLP.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.