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Global Tax Policy Challenges After COVID-19: Transfer Pricing and Withholding Tax Aspects

Posted on Sep. 21, 2020

This article is part of the series, “Post-COVID-19: How Governments Should Respond to Fiscal Challenges to Spur Economic Recovery,” coordinated by the International Tax and Investment Center (ITIC) to offer tax policy guidance to developing countries during the post-pandemic recovery phase.

Hafiz Choudhury is a principal with The M Group Inc. and a senior adviser with the International Tax and Investment Center (ITIC). He is based in Washington. Peter Hann is a senior consultant with The M Group and is based in the United Kingdom.

In this installment, the authors consider how governments can increase tax compliance during the COVID-19 crisis through more efficient enforcement of existing legislation in areas such as transfer pricing and the effective use of withholding mechanisms without discouraging businesses from restructuring or protecting supply chains.

Copyright 2020 Hafiz Choudhury, Peter Hann, and ITIC. All rights reserved.

Introduction

Economic Challenges After the COVID-19 Crisis

Restrictions arising from the COVID-19 crisis have led to serious declines in economic activity. Governments worldwide have had to find additional resources for their healthcare efforts. In many countries, financial support has also been provided where possible for individuals and businesses hit by the consequences of social distancing, lockdowns, and closures.

The fiscal effect has thus been twofold. On the one hand there has been an increase in government spending and borrowing; on the other, the crisis has resulted in reductions in tax collection as incomes and profits fall and tax relief is provided to aid recovery efforts.1 Looking beyond the current situation as at the start of June, governments will next be called upon to further increase spending to promote a revival of their economies.

Emerging economies will be facing the economic consequences of the COVID-19 crisis with very little fiscal capacity to introduce appropriate stimulus measures, as they have already been borrowing to offset the effects of the health crisis. Emerging markets generally rely on foreign capital inflows, but some outflows of foreign capital have occurred during the health crisis. They face higher borrowing costs, a squeeze on liquidity, and weaker economic growth.2

Governments worldwide will thus be under pressure to collect more tax to put public finances in order. In the case of developing countries with scarce resources, this involves the use of the existing legal and administrative resources to target areas where additional tax can most easily be assessed and collected. Developing countries will be particularly pressured to make revisions to the tax rules and regulations to improve collections from international transactions, such as those to facilitate transfer pricing audits and improve withholding taxes assessment and collection. These governments have to balance the need raise taxes to restore public finances and the need to take tax measures, including lowering tax rates to stimulate their economies, attracting new investment, and creating employment opportunities for their people.

Multinational Supply Chains

The crisis has also exposed some of the difficulties of globalized, fragmented supply chains. Following the lessons learned from the crisis, many multinational enterprises are concerned about the security of their supply chains. This will lead to more analysis of the potential risks to supplies in their home countries and more research into the security of the independent suppliers selling to related-party suppliers and their vulnerability in similar future crises.

Some groups may take the decision to move certain functions from one country to another to improve security. Some of these functions may be transferred from one developing country to another, while others may transfer functions to an industrialized country where the suppliers are considered to be more secure. Some groups may even decide to bring some functions back to the home country; this process may be accelerated by measures in developed countries that for political or economic policy reasons wish to “reshore” manufacturing industries or secure access to strategically important goods. As a result of these considerations, the number of business restructurings within multinational groups may increase after the initial health crisis is over.

Growth-Friendly Tax Policy

Many countries will have taken on further debt in their efforts to mitigate the effects on their citizens of the measures taken to combat the coronavirus. After the immediate crisis is over, they will need to raise more revenue, but at the same time they will need to take stimulus measures to revive their economies following the severe effects that lockdowns and other emergency measures will have had on their economies. Governments must bear in mind the need for a balanced approach to work out how to increase tax revenue without damaging or jeopardizing economic recovery. The ITIC’s “Principles for Developing Country Hydrocarbon Investment Policies” provide guidelines to consider in this context.

For developing countries, it would be wise to make use of existing tax legislation and administrative provisions to look for areas where their laws and guidelines are not being put to optimum use to collect the right amount of tax. A key consideration in this process must be to have a transparent process that recognizes that there are good and valid reasons for shifting of functions, assets, and risks by an MNE. Where practicable, this should entail input from the industries affected. Some of these shifts may simply arise for the supply chain considerations mentioned above. There is often pressure on tax administrations in developing countries to consider whether certain MNE activities might be deemed to be abusive transfer pricing — that is, to enable profit shifting to take place. Tax administrations in developing countries should bear in mind the need to maintain growth-friendly tax policies in their efforts to ensure that the correct amount of tax is being collected.

Post-Pandemic Transfer Pricing Administration

Capacity in the Tax Administration

The first step should be to assess current levels of knowledge and experience of transfer pricing within the tax administration, and to look at how these resources are currently used. In the medium-term, administrations may wish to bring together their transfer pricing expertise into a separate specialized unit within the organization. This unit can build up its specialist knowledge through training courses and capacity building programs, either in-house or with the assistance of outside expertise from regional and international bodies. Input from industry bodies might also be provided to gain an understanding of this perspective, since any practice or reporting revisions must be workable — and not serve as a deterrent to economic activity. A review could also be done of other types of transfer pricing resources within the administration, such as the access to information and the availability of information technology systems that can support tax compliance, save time, and back up audit strategies and tax collection.

Making Use of Existing Forms and Returns

The OECD’s base erosion and profit shifting action 13 report notes that documentation is required to make sure that taxpayers pay sufficient attention to ensure that their transfer pricing is in line with the arm’s-length principle, provide information to enable the tax administration to perform a transfer pricing risk assessment and select taxpayers for audit, and provide information necessary to perform an audit of transfer pricing issues.

The tax administration must make sure that it makes full use of the information already collected through the CbC reports and other documentation. This can be done by making the information available to staff with the appropriate specialism and qualifications and by ensuring the information is used in preparing risk assessments, audits, and tax assessment. Information from different returns or different sources should be collated efficiently so information is not lost.

Examining Transfer Pricing Documentation

Before looking for information further afield, the tax administration should make sure that it is using the information supplied to it by the local taxpayer in its tax return, transfer pricing information return (if any), and transfer pricing documentation. If taxpayers submit an annual transfer pricing information return, this can be used to gain an overview of group activities and the role of the local taxpayer in the enterprise group. This will give some idea of the amount of related-party transactions and their size, and this information can be used in transfer pricing risk assessment and audit planning.

Another way to collect information might be the use of targeted transfer pricing questionnaires. These could be used to gather information from certain groups of taxpayers or industrial sectors or to gain further information on certain areas of transfer pricing that are not currently sufficiently covered in the annual tax return or transfer pricing information return.3 These questionnaires could also be used as part of the risk assessment for selecting taxpayers for audit by pinpointing areas of weakness in the transfer pricing position; or they could be used to collect further information during an audit, in addition to the normal ad hoc requests for further information that may be made by the tax auditor.

The risk assessment can be used in selecting taxpayers for audit and more closely inspecting their transfer pricing documentation to identify high-risk transactions or areas where the documentation is weak. The audit can then be targeted toward the highest risk issues or transactions, with a recognition that certain sectors bear inherently less transfer pricing risk; for example, where prices are public or there are existing means of independent cost oversight — that is, via joint venture partners. Where such additional information is available (posted prices or audits conducted by partners in a JV structure) that should also be taken into account.

The tax administration should request all information necessary to complete a risk assessment, including information that is held by foreign related parties where the local entity can reasonably be expected to obtain the information. In the case of information that is not available to the local taxpayer, the tax administration can use provisions in exchange of information agreements to obtain this from other tax authorities. The tax administration should always take into account the need to balance the need for the information with the compliance costs for the taxpayer.

Finding Comparable Companies and Transactions

Employment of accepted transfer pricing methods — the comparable uncontrolled price (CUP) method, the resale price method, the cost-plus method, and the transactional net margin method — requires the use of comparable transactions or margins. In practice it may be difficult for developing country tax administrations to obtain information on comparable transactions or margins that is sufficient to apply the arm’s-length principle in a particular situation. However, in the context of the hydrocarbons sector, the availability of published index prices as CUPs and their worldwide acceptance provide robust determinations of arm’s-length value.

There may be fewer businesses operating in a developing economy in a particular sector, and the information available on a particular business may not be complete or available at all. The available databases tend to concentrate on data from developed countries and those data are potentially less likely to be suitable in analyzing transactions in developing economies. The toolkit on the use of comparables issued by the Platform on Collaboration for Tax concludes that strategies to help developing country tax administrations deal with issues relating to comparable transactions could include: (1) the use of safe harbors; (2) making better use of the available data while protecting taxpayer confidentiality; and (3) devising a framework that allows the application of the most suitable transfer pricing method.4

For analysis of transactions taking place within an MNE, for example, within the digital sector, a profit-split method may be the appropriate method. In that case, data on comparable transactions would not be needed. In other situations where data are not available or the resources are not sufficient to apply another transfer pricing method, a developing country could consider an antiavoidance measure — for example, a restriction on the tax deduction for net interest expenses (again bearing in mind the potential deterrent to prospective capital investment).

International Exchange of Information

Owing to the scarcity of resources available, many developing country tax administrations often find themselves at a disadvantage when dealing with MNEs. Developing countries must take advantage of all opportunities to obtain information on multinational groups operating in their territory. In some cases, information may be obtained through using the provisions for exchange of information in relevant agreements including double tax treaties.

In the past few years, countries have been introducing a requirement for country-by-country reporting as recommended in the OECD report on BEPS action 13. The CbC reports are exchanged between tax administrations and provide an opportunity to gain an overview of the activities of MNEs across the countries in which they operate. Developing country tax administrations can therefore use these reports to identify the strategy of the groups operating in their country and help clarify the functions of the entities located in their jurisdiction in the context of wider group operations.

Business Restructurings

Post-Crisis Restructurings

MNE reorganizations following the
COVID-19 crisis could include moving manufacturing subsidiaries from one developing country to another, removing functions or risks from a local entity, setting up a regional holding company or intellectual property holding company, or moving some functions back to the home country. The reorganization may involve transfers relating to the ownership and management of intellectual property rights or marketing intangibles.

Correct Delineation of Transactions

Transfer pricing rules may be difficult to apply owing to the high degree of integration among the entities that are part of MNEs and the complexity of intragroup transactions involving intangibles or services. MNEs may also use complex financing arrangements that present a challenge to the capacity of developing country tax administrations. It is necessary to perform a functional analysis and accurately delineate the transactions taking place. The tax administration needs to understand the structure before and after the restructuring and look closely at how income flows have changed and what functions and risks have been transferred. This process needs to take into account the supply chain considerations mentioned above and be understood from a purely technical perspective.

Location-Specific Advantages

Location-specific advantages (LSAs) are cost savings resulting from operating in a particular location. They may be the result of government grants, incentives, or other industrial policies in the host location. The availability of well-educated low-cost labor in the host location and the presence of relevant raw materials and a network of suppliers in the local area or proximity to customers and markets may also be considered to be LSAs. There are often savings that would normally, though not always, arise in developing economies rather than in developed countries.

When a multinational group relocates a part of its business to a low-cost economy, the group can achieve net cost savings as a result of lower expenditure on raw materials, labor, rent, transportation, and infrastructure after allowing for additional costs, such as training expenses for new staff, that may arise from the relocation.5 An important factor in post-COVID-19 business restructurings will be consideration of LSAs that may have been a factor in the analysis in the past.

Accurate delineation of the transaction is a priority. An industry analysis and a quantitative analysis are necessary as part of the transfer pricing analysis. The analysis would look at the factors in the local market that tend to reduce costs or increase sales for the multinational group, arising from unique features of the local economy. Any increases in costs should also be taken into account. The LSAs can be identified, and the most appropriate transfer pricing method should then be applied to establish the amount of the LSAs that should be allocated to the local entity.

Intangibles

Identifying Intangibles

Intangible assets are increasingly important as a driver of profits within MNEs. Identification and valuation of intangibles is therefore an important part of the transfer pricing analysis by the tax administration. It is important for developing country tax administrations to identify particular intangibles, establish the ownership of the intangibles and look at how they are valued, assess the contribution of the intangibles to value creation within the MNE group, and decide which group members contributed to the value of the intangible.6 The appropriate transfer pricing method should then be established to allocate the profit between the related parties.

Valuing Intangibles

There is concern in many tax administrations about profits being shifted by means of the transfer of an intangible at an undervaluation. The valuation of the intangible should be examined carefully in line with global standards as outlined in the U.N. Practical Manual on Transfer Pricing and in the OECD guidelines. An important consideration for developing countries is that the concept of an intangible is wider than just patents, copyrights, and trademarks, and could include wide categories such as available human capital, network effects, best practices, or noncontractual relations with the suppliers or with the customers. Although these types of intangible asset are not necessarily defined in law, they may have a value that should be compensated for at arm’s length. The comparability analysis could therefore take these intangibles into account as part of the economic characteristics. The relative value of intangibles after the crisis should also be taken into account in any transaction involving transfers of intangibles.

Marketing Intangibles — Local Input

Marketing intangibles such as trademarks, trade names, or customer lists can be created by marketing activities and boost the sales of a product or a service. The local distributor of an MNE may benefit from central marketing activities within the group and may make a payment to a foreign related party in relation to use of the brand. Such activities are not relevant to commodity-based enterprises.

Tax authorities look at any payments made by the local entity to the parent company for the use of the brand and consider the relevance of that global brand in the local context. In a post-crisis environment, the relative value of marketing intangibles in relation to the overall performance of the local economy should be taken into consideration.

The local marketing activities may be similar to those of independent comparable companies, but in some cases the local enterprise may be carrying out wider marketing activities than those of independent distributors, developing its own marketing campaigns, expanding its offering further than the group’s central guidelines, and spending more on its marketing activities than comparable independent distributors.7 The tax authority could in this case consider the possibility that a local marketing intangible is being developed. The excess marketing activities may have been compensated for with a greater return than that for marketing activities of independent comparable firms. However, in a post-crisis environment, the market realities may have changed significantly, and this reality needs to be taken into account.

Financial Transactions

General

On February 11 the OECD released a report entitled “Transfer Pricing Guidance on Financial Transactions: Inclusive Framework on BEPS: Actions 4, 8-10.” The guidance follows the BEPS approach of accurate delineation of the actual transaction to arrive at the amount of debt to be priced. The report looks at the economic characteristics that are relevant in the analysis of the terms and conditions of financial transactions, including the industry in which the multinational group is operating. The guidance recognizes that in order to counter base erosion effect of debt financing, some countries have made the tax policy choice to introduce in their domestic tax laws measures aimed at either reducing the advantage of debt financing or increasing the advantages of equity financing. Such measures could include general antiavoidance rules, specific antiavoidance rules (SAARs), or application of arm’s-length pricing. The OECD guidance recognizes that in a cross-border scenario, the transfer pricing provision in treaties is relevant but domestic law has priority, except in cases of discrimination.

The U.N. Practical Manual on Transfer Pricing is also developing guidance on the transfer pricing treatment of financial transactions. U.N. guidance will look at OECD analyses, but will express itself independently with a focus on developing country issues and priorities. It emphasizes that an intercompany financial transaction should be considered from the perspective of both parties to the transaction. The transfer pricing analysis should look at the transaction actually undertaken by the associated enterprises as they have structured it, and the tax administration should base its analysis on the actual conduct of the parties.

In the post-crisis period, especially in an era of historically low interest rates and increased financial risks, it can be assumed that many corporate treasurers will seek to restructure financing arrangements in line with the revised level of risk the MNE wishes to assume. As a general principle, the transfer pricing analysis must take into account the point in the economic, business, or product cycle where the transaction is taking place. MNE groups operating in different sectors may need different amounts or types of financing as the capital intensity levels differ between industries. Tax administrations in developing countries would need to understand the broader trends in the economy in looking at the transfer pricing aspects of financing and refinancing transactions — with a view to encouraging investment and economic growth.

Guidance and Post-Crisis Implications

Key areas of guidance include treasury functions, intragroup loans, guarantees, and implicit support (for example, the guidance on treasury functions states that the taxpayer must first delineate the actual transactions and determine exactly which treasury functions are carried on by the entity). The treasury function will usually be a support service to the main value-creating operation. In some cases, the activities may be services, depending on the facts and circumstances, and pricing will follow the OECD guidance on intragroup services. Regarding the identification and allocation of economically significant risks, the approach of the treasury function to risk will depend on the multinational group’s policy, which may set out certain objectives, such as targeted investment returns, reduction of cash flow volatility, or specified balance sheet ratios. The U.N. guidance being developed is broadly similar.

In considering the transfer pricing consequences of a financial guarantee, the taxpayer must understand the nature and extent of the obligations guaranteed and the consequences for the parties to the transaction, accurately delineating the actual transaction. In considering implicit support/effect of group membership, if there is no explicit guarantee, any expectation that other group members will provide support to an associated enterprise in relation to borrowings will arise from the borrowing entity’s membership status within a group of companies. In considering intragroup loans, the commercial and financial relations between the associated borrower and lender, and the economically relevant characteristics of the transaction, should be taken into account.

This is an evolving area, where both developed and developing countries are devising approaches at the national level. As mentioned above, the post-crisis period is likely to present new transfer pricing challenges, whether through restructuring of supply chains, realignment of financing structures to take advantage of the new environment, or both. Tax administrations in developing countries should consider the guidance in the U.N. Transfer Pricing Manual and from the OECD, as well as input from key industry representatives, in developing a consistent approach based on these principles, rather than adopt ad hoc approaches to specific transactions.

Transfer Pricing Audits

Risk-Based Audit Selection

Efficient tax audits can increase tax revenue for the period under audit, and by encouraging increased tax compliance, can increase tax revenue in the future. Many developing countries have challenges due to limited resources; if they hope to raise more tax revenue by increasing the efficiency of audits they will need to do so with the resources they already have. Greater efficiency can be achieved through risk-based auditing, which ensures that the highest risk sectors, taxpayers, transactions, and tax amounts are selected for audit. This is the optimum strategy for raising the most tax revenue with existing resources.

The method by which risk assessment is carried out depends on the nature of the business activity, as well as availability of information. If the documentation requirements are detailed, this can help risk assessment of taxpayers for audit selection. For purposes of risk assessment, various categories of transactions could be identified, such as profit shifting resulting from business restructuring, from incorrect/incomplete functional analysis, or from use of inappropriate transfer pricing methods. Having reviewed and identified risks, the tax administration should quantify those risks and where necessary, should perform an in-depth review of documentation with a functional analysis to more accurately quantify the risk. The decision to go ahead with an audit should be taken after a review of the potential tax at risk, taking into consideration the resource commitment the audit would entail.

Audit Planning

A plan should be drawn up to identify the transfer pricing issues that are to be examined during the audit with a planned timetable for action. The audit planning should look at the available documentation and determine what further information needs to be collected from the taxpayer, backed up by interviews with company staff. An audit will be more efficient if it focuses on high-risk transactions or issues that have been identified beforehand. A well-planned and coordinated audit process can lead ultimately to a more effective use of resources in tax revenue generation.

Taxation of the Digital Economy

Post-Crisis Scenario

There is currently an international discussion in relation to taxation of the digital economy. The OECD is leading a dialogue on a new profit allocation rule that would apply for taxpayers with highly digital business models and certain other consumer-facing businesses.8 (The commodities-based and extractive sectors would be exempt from this regime.)

There would be a new taxing right to give jurisdictions a share of deemed residual profit allocated to market jurisdictions using a formula. This residual profit would be the remainder after allocation of the deemed routine profit to the countries where the relevant activities are carried out. Implementation of this proposal could be of advantage to lower-income countries, as they could collect some tax revenue from digital companies whose users are located within their jurisdiction. The proposals are still under consideration by the OECD’s inclusive framework.

The U.N. tax committee is also considering the provision of guidance on tax treaty issues, domestic law issues, and VAT issues in relation to the tax challenges of the digital economy.9 There are, however, concerns that new rules for the attribution of taxing rights would not be in the interest of developing countries. Many smaller developing countries that rely on export earnings could be affected by a shift to taxing rights based on demand or destination elements. Lower-income developing countries could benefit if the nexus allowing the host country to tax a company’s profits arising in its territory takes into account several factors affecting the value of digital goods or services from which profits are generated.

If tax treaties are amended to allocate new taxing rights, countries would also need to implement domestic law provisions to tax the profits. The U.N. tax committee could therefore also be involved in developing and designing domestic tax measures that would address the challenges of the digital economy. The U.N. guidance could take the OECD consultations into account and look at measures that would benefit low-income developing countries, as well as suggest alternative approaches that are adapted to the concerns of developing countries.

Generally, these rules will not be introduced in the near future and are unlikely to form part of the post-crisis response, even though there might be some temptation to expend energy on this source of revenue as a panacea to the current COVID-19-related revenue challenges. The OECD rules may be agreed in late 2020, but given other preoccupations in the post-crisis period, this does not seem likely. Even if some form of global consensus is achieved, this will need further time to reach agreement on implementation approaches. U.N. guidance is likely to be even further away. For the moment, it may be best for developing countries to concentrate on more immediate tax issues (for example, taxation of the informal economy) rather than devote extra resources to solutions around taxation of the digital economy. For the near term, the priority must be domestic resource mobilization for revenue growth — aligned with sustainable economic recovery.

GLOBE Proposal

Another part of the OECD approach to the tax challenges of the digital economy is the global anti-base erosion (GLOBE) proposal. This aims to develop a coordinated set of rules to ensure that international businesses pay a minimum level of tax. This proposal is still under discussion and may be implemented at a later date. Although it may be useful in the future, this proposal cannot be taken into account in tax policy in the short term.

An analysis presented by the OECD on February 13 of the economic effect of the introduction of pillars 1 and 2 of the proposals on taxation of the digital economy indicates a positive revenue effect that would be broadly similar for high-, middle-, and low-income countries.10 This is, however, a very high-level preliminary view and needs further analysis. In the present scenario, there is a risk that focus on this will be a distraction in solving the very real revenue challenges from the crisis.

Withholding Tax

Cross-Border Intellectual Property Transactions

Establishing the correct rate for royalties paid for the use of intellectual property held by a foreign related party may be a complex process, especially if suitable comparable transactions are not available. Cross-border payments for the use of IP are thus sometimes considered a method by which profits may be shifted from an entity in a developing country into a related IP company situated in a low-tax jurisdiction.

Developing country tax administrations with scarce resources often protect their position by imposing a withholding tax on payments for use of IP. The rate of withholding tax is computed by applying an adequate rate to the gross payment. A withholding tax is relatively simple and inexpensive to operate and can be enforced by the imposition of suitable penalties in the case of failure to withhold the appropriate amount. To ensure fairness, the withholding tax can be offset against the corporate income tax liability in relation to the income. The normal transfer pricing rules can also be applied to the payments. Care must be taken to ensure the withholding tax is designed to affect only the intended activities so as not to create a deterrence to prospective capital investment.

Technical Service and Management Fees

Technical service fees are often charged by a foreign company for work such as consultancy or design services. The definition of technical fees that are subject to withholding tax will differ from one country to another. Technical service fees can generally be distinguished from royalties paid for intangibles or know-how because the work is carried out by the service provider, rather than just providing the know-how and letting the customer carry out the work. The distinction is rather blurred in some cases because the customer and the service provider may work together on the technical services, so judgment may be required in distinguishing the two categories of payment for withholding tax purposes. A withholding tax on royalties for technical service fees can be collected and enforced by the tax administration with relatively low compliance time and costs.

A management fee is a charge imposed for the management or administrative services of a foreign parent company or head office. Such fees have often been seen by tax administrations as a vehicle used by MNEs to shift profits out of a jurisdiction. Establishing the correct fee under the transfer pricing rules is a difficult process, and for this reason developing countries may choose simpler methods that are easier to administer. A simple approach is to impose a withholding tax on management fees and possibly make the tax deduction for the fee dependent on the correct deduction and remittance of the withholding tax. A suitable rate for the withholding tax must be found, with adequate enforcement and application of penalties for compliance failures.

Branch Profits Remittance Tax

A withholding tax is sometimes imposed on the remittance of profits by branches of foreign companies. This is charged in addition to the corporate income tax charged on the profits of a permanent establishment. The tax is generally regarded as the equivalent of the dividend withholding tax imposed on remittances by a subsidiary to its foreign parent company.

If the branch profits remittance tax is relatively high, the taxpayer may attempt to remit profits in other forms such as technical service fees or management fees, possibly by overstating the amount of benefit received from related parties in those areas. Attention must therefore be paid to the arm’s-length nature of these categories of cross-border payment.

Challenges of Investment Hubs

There is considerable debate around the role of low-tax jurisdictions and their use to shift profits between jurisdictions. To save administrative costs, some countries impose a withholding tax on payments to low-tax jurisdictions as defined in their tax rules. Withholding tax may be an option where investigation of the transfer pricing position would be costly for the tax administration in terms of time and resources. Another method of discouraging profit shifting is to deny a tax deduction for payments to low-tax jurisdictions. These domestic law solutions, combined with other remedies (for example, a thin capitalization rule) might be a simpler approach to addressing any perceived risks from potential abuse, rather than further investment of limited resources in complex global approaches such as the BEPS action plan. As noted previously, the assistance of expertise from regional and international bodies, as well as input from industry groups, might be beneficial in designing a tax revenue strategy that does not deter economic activity.

Tax Treaties and Withholding Taxes

A double tax treaty may reduce the withholding tax on certain types of income such as dividends, interest, and royalties with provision for relief for double taxation. While in the longer term, developing countries will need to consider carefully before conceding taxing powers over passive income, in the present post-crisis period, withholding tax measures with adequate treaty protection provide a workable solution for the revenue needs of developing countries. The effort in the post-crisis period should thus be on making withholding taxes provisions and relief under treaties more efficient and to reduce compliance costs in this regard. There is always a balance and trade-off between the need to attract foreign investment and the need to increase domestic tax revenue. Developing countries may be helped by the guidance issued by the U.N. on tax treaty negotiation.11

Conclusion

Tax administrations in both developed and developing countries face pressures to collect more tax with their existing resources on the basis of current law. This means that more effective use must be made of the information available to them so the current laws can be better applied in the assessment and collection of taxes due. Tax return forms and transfer pricing documentation must be scrutinized carefully to find the areas of high risk of tax revenue leakage; tax audits can then be concentrated on those areas. The emphasis must be on avoiding unnecessary compliance costs and finding a balance between revenue needs and the need for more investment to grow the tax base. In this context, it will also be necessary to examine the range of tax incentives granted and consider if they are still fit for purpose, bearing in mind that such incentives stimulate economies by decreasing barriers to prospective investment.

Withholding taxes are a relatively efficient way of collecting tax, and if these are already included in the local law, they should be enforced effectively. Tax administrations should always ensure that taxpayers are categorizing payments correctly for withholding tax purposes, especially where there are significant differences in withholding tax rates for different categories of income.

Using current law and regulations, tax revenue can be enhanced if appropriate and balanced procedures and approaches are employed. More efficient use of the existing transfer pricing rules can be combined with more training and specialization of tax staff.

Developing countries can collaborate with regional or international organizations, including relevant industry bodies, to promote capacity-building and exchange of practical guidance. By making full use of existing resources, transfer pricing rules, and withholding taxes, tax administrations in developing countries can move swiftly to increase recovery of taxes due to support government finances in a fair and practical manner that does not deter economic growth.

FOOTNOTES

1 For a comprehensive and regularly updated table of C19 related measures, see RegFollower, “COVID-19: Tax Relief Measures Around the World” (July 21, 2020).

2 See Oxford Economics, “Coronavirus — Fiscal Challenges for Emerging Markets,” Tax Notes Int'l, Sept. 7, 2020, p. 1359.

3 See Platform for Collaboration on Tax, “Practical Toolkit to Support the Successful Implementation by Developing Countries of Effective Transfer Pricing Documentation Requirements,” consultation draft (Sept. 27, 2019).

4 See Platform for Collaboration on Tax, “Addressing Difficulties in Accessing Comparables Data for Transfer Pricing Analyses” (Sept. 1, 2017).

5 See U.N. Practical Manual on Transfer Pricing for Developing Countries (2017), section B.2.3.2.51.

6 Id. at section B.5.2.

7 Id. at section B.5.2.13.

8 See OECD, “Statement by the OECD/G20 Inclusive Framework on BEPS on the Two-Pillar Approach to Address the Tax Challenges Arising From the Digitalisation of the Economy” (approved Jan. 29-30, 2020).

9 See the report of the 19th session of the U.N. Committee of Experts on International Cooperation in Tax Matters (Oct. 15-18, 2019).

10 See OECD, “Update on Economic Analysis and Impact Assessment,” webcast (Feb. 13, 2020).

11 See U.N., “Manual for the Negotiation of Bilateral Tax Treaties Between Developed and Developing Countries” (2019).

END FOOTNOTES

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