OECD tax initiative raises Estonian tax regime into spotlight
Hannes Lentsius, PwC
The tax environment in Europe is changing. The credit crunch and slowly recovering economy has put pressure on the European regulators and the tax authorities to search for means to increase the tax revenue. Furthermore, there has been several aggressive tax planning schemes published in the press. The global companies have implemented them in shifting the profits from high tax burden countries to low tax territories resulting with significant tax saving. This has led to a public debate on the tolerance of harmful tax competition, fair allocation of the tax burden between the members of the society as well as the social responsibility of the enterprises. On the other side, the globalisation has brought up a number of areas of business activities such as digital economy or intellectual property that require modern tax regulations.
On February 2013 OECD published its first draft tax report designed to address the means against aggressive international tax planning named Base Erosion and Profit Shifting (BEPS)[1]. Unlike several previous tax policy initiatives number of OECD member states have committed to support BEPS and act accordingly.
BEPS is divided into 15 action points that cover wide area of taxation. The following provides an overview of six most significant areas:
- Digital economy: the rapid expansion of online business and the absence of physical attendance of the seller in the country where the customer resides is probably one of the greatest challenges OECD faces in the BEPS context. The new tax rules need to split the tax revenue equally between the countries of seller and the customer as well as ascertain tax neutrality between the traditional and digital trading.
- Hybrid instruments: the differences in the tax and legal treatment of certain financial instruments have enabled to avoid taxation of certain types of income or generate double deduction in one of the countries concerned. For example, a taxpayer may be allowed to deduct interest on inter-company loan but the country of the lender recognises the income as tax exempt dividend instead of charging tax on the interest income. This enables to save tax on gaining interest deduction in one country but the respective income is never taxed in the other country.
- Tax treaty abuse: artificial and non-business driven set-up of companies in countries that have beneficial bilateral tax treaties may lead to non-taxation of certain source of income or creation of inappropriate tax incentives. For example, multinational group may reduce the withholding tax on royalties by routing the payments via companies located in territories with beneficial tax treaties. This is treated as tax treaty abuse if these companies are established purely or dominantly for the benefit of gaining tax saving and are lacking commercial substance.
- Harmful preferential regimes: certain countries have introduced unfair tax incentives for the purposes of attracting foreign investments. Besides attracting the investments these incentives generally reduce directly the tax revenues of other states. For example, some countries enable to make double deduction on royalty income as a result the effective tax rate could be multiple times smaller compared to the country’s nominal tax rate. It is also true that some countries enable the taxpayers to conclude secret agreements with the tax authorities on the applicable tax regime and tax rates.
- Transfer pricing: in line with the transfer pricing regulation the price charged in inter-company dealings should meet the arm’s length standard. However, the transfer pricing analysis is becoming increasingly complicated in the light of globalised and highly integrated economy. This may open up opportunities for the multinational companies to transfer the profits from high tax burden country to low tax territory and reduce the overall tax expense. OECD is committed to provide additional guidance and harmonise the administrative practices throughout its member states.
- Disclosure: Following the initiative of US and Great Britain the working group of OECD is drafting common standards applicable to the taxpayers for disclosing their unclear tax position and aggressive tax planning.
In addition, BEPS is also addressing taxation of permanent establishments, exchange of information between the tax authorities of various countries, financial instruments and resolution of cross-border disputes.
It is true that the final deliverable of BEPS initiative and its effect on the international taxation will depend upon the political compromises and the commitment of the member states to implement the respective changes into their domestic tax legislation. However, BEPS represents a clear signal that the regulators of the developed countries are focusing closely on challenging aggressive tax planning and the countries with respective reputation are forced to tighten their regulations.
In light of the BEPS initiative Estonian income tax regime should be regaining its attractiveness. The compliance of the Estonian tax regime with the European Union law has been successfully tested in several cases by the European Court. Estonian tax system should also not constitute harmful preferential tax regime in the context of BEPS.
Ability to decide the level and the timing of the tax charge by simply making a decision to re-invest retained earnings or distribute them by the Estonian company should be an attractive opportunity. Estonian simple tax legislation with few exceptions should be equally important by reducing the cost of tax compliance and easing doing business in Estonia. The time spent for tax compliance puts Estonia to a remarkably high position among other OECD member states. The qualities of the tax regime should enable Estonia to outstand on the international tax arena and provide notable advantage in competing for the foreign investments.
[1] http://www.oecd.org/ctp/beps.htm
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