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Evaluating BEPS
6 November 2017, by Haiyan Xu and Reuven S.Avi-Yonah

Following the financial crisis and ensuing austerity, politicians discovered the problem of tax avoidance. On the corporate tax avoidance front, the OECD and G20 launched the Base Erosion and Profit Shifting (BEPS) project in 2013, and this has in October, 2015 culminated with the release of a series of action steps that the OECD and G20 countries have undertaken to adopt. OECD Secretary-General Angel Gurria has stated that: Base erosion and profit shifting affects all countries, not only economically, but also as a matter of trust. BEPS is depriving countries of precious resources to jump-start growth, tackle the effects of the global economic crisis and create more and better opportunities for all. But beyond this, BEPS has been also eroding the trust of citizens in the fairness of tax systems worldwide. The measures we are presenting today represent the most fundamental changes to international tax rules in almost a century: they will put an end to double non-taxation, facilitate a better alignment of taxation with economic activity and value creation, and when fully implemented, these measures will render BEPS-inspired tax planning structures ineffective. Is Mr. Gurria justified in his optimism? We do not think so. These efforts are commendable and to some extent have an impact. But in our opinion they are inadequate. The basic problem is that they take as a given the fundamental consensus underlying the international tax regime, also known as the “benefits principle.” Under the benefits principle, active (business) income should be taxed primarily at source while passive (investment) income should be taxed primarily at residence. This compromise between the claims of residence and source countries was reached by the four economists in 1923 and still serves as the foundation of the international tax regime. It is embedded in over 3,000 bilateral tax treaties and in the domestic laws of the US and most other countries. Not surprisingly, it is also reflected in BEPS, which is an attempt to improve source-based taxation of active income. In our opinion, the benefits principle should be reconsidered, because the reliance on source-based taxation for active income and residence-based taxation for passive income requires cooperation by too many jurisdictions. The problems of BEPS stem from its reliance on the benefits principle.

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