Are Australian BEPS Countermeasures Effective?

Multinational enterprises (MNEs) are known to artificially shift their profits from high-tax jurisdictions to low-tax jurisdictions (including tax havens) to reduce their corporate income taxes, resulting in the erosion of tax bases in high-tax jurisdictions. This practice is thus referred to by the Organisation for Economic Co-operation and Development (OECD) as base erosion and profit shifting (BEPS).

The OECD/G20 BEPS Project

The OECD, at the request of the G20, launched the BEPS Project in 2013, and released a series of final reports in 2015. The final reports cover 15 action items to address BEPS related to different tax avoidance arrangements, harmful tax practices and information asymmetry between taxpayers and authorities.

Since the launch of the BEPS Project, the Australian Parliament has been making changes to Australian tax laws to implement the Project’s recommendations. Australia has also introduced its unilateral measures, such as the Multinational Anti-Avoidance Law (MAAL) and the diverted profits tax.

While previous studies have evaluated the effectiveness of BEPS Project from legal and regulatory perspectives, it has yet to be assessed empirically. The impacts of BEPS activities and the real effect of the countermeasures remain to be quantified.

Our recent journal article, published in the Australian Tax Forum, measures (1) the extent of cross-border profit shifting activities by foreign-owned Australian companies (FOACs) that are Australian subsidiaries of foreign MNEs; and (2) the change in the extent of cross-border profit shifting pre and post the BEPS project to empirically assess the effectiveness of the BEPS countermeasures as implemented in Australia.

Research design

We adopt and adapt the widely cited Hines and Rice (1994) approach to investigate the relation between profit before tax reported by FOACs in Australia and the tax rate differentials between Australia and other countries where the related foreign MNE groups operate as an indicator of BEPS. We measure how the deviation of reported accounting profits by a FOAC from its ‘true’ profits is affected by the tax rate differentials. The ‘true’ profit is estimated via the FOAC’s labour and capital inputs, which indicate real business activities. Given that the Australian corporate income tax rate of 30% is high compared with those of many other countries, and that foreign owners of FOACs cannot enjoy the full benefits of dividend imputation, FOACs have incentives to shift profit to group members located in low- or no-tax jurisdictions.

We capture the tax rate differentials by: (1) the international tax rate differential between a FOAC and its parent, either its immediate parent or its ultimate parent; and (2) the average tax rate differential between a FOAC and other group members in different host countries within the same MNE group. We further convert the absolute values of corporate tax rates in various countries into relative rankings and calculate the ranking of the Australian corporate tax rate relative to the tax rates of all other countries in which a foreign MNE group operates in percentile.

We investigate whether and how the estimated relation changes after the gradual implementation of BEPS countermeasures in Australia. The study period is the 14 years to 2020. The dividing line for the post-BEPS period is 2013 because it was from this year Australia started to implement the recommendations of the BEPS Project and introduced unilateral BEPS countermeasures. In this way, we assess empirically the effectiveness of the Australian BEPS countermeasures.

Empirical findings

We find a significant level of profit shifting by FOACs from Australia to lower tax countries throughout the 14-year study period from 2007 to 2020. Specifically, we find that the higher the Australian corporate rate relative to the tax rates of the FOACs’ immediate and ultimate parent companies and the higher the ranking of the Australian tax rate relative to those of other countries where foreign multinationals operate, the lower is the profit reported by FOACs in Australia.

For example, we find that when the international tax rate differentials between Australia and countries where FOACs’ immediate parent entities operate increase by one percentage point, profit before tax reported by FOACs in their income statements decreases by nearly 1.58% when labour input is measured by the number of employees, and by 1.04% when labour input is measured by employee compensation.

When the international tax rate differential between FOACs and their ultimate parent entities increases by one percentage point, profit before tax reported by FOACs in the income statements decreases by 2.14% when labour input is measured by the number of employees, and by around 1.54% when labour input is measured by employee compensation.

Cross-border profit shifting from Australia to lower tax countries has not shown any general sign of progressive reduction after the implementation of Australian BEPS countermeasures from 2013. There is some evidence indicating that profit shifting might have reduced in 2019 in an additional test. However, the reduction did not sustain in 2020.

Discussion and conclusion

The lack of effectiveness might be explained by the limitations of Australia’s transfer pricing rules and thin capitalisation rules. Other countermeasures, such as the MAAL and the diverted profits tax, might not have resulted in a significant increase in profit before tax in FOACs’ income statements. Although the Australian Taxation Office (ATO) claimed that the operation of the MAAL had already seen a substantial amount of taxable sales being returned to Australia, an increase in sales revenue does not necessarily mean that reported profit would increase correspondingly. FOACs could also have booked more expenses (cost of sales and other expenses) in Australia at same time.

However, we cannot categorically conclude that the BEPS countermeasures adopted by Australia are not effective. The ATO may take years to conduct tax audits, raise amended assessments and go through the lengthy tax dispute resolution process before the effect of these BEPS countermeasures on outward profit shifting can be reflected in the financial reports of FOACs. In short, there are law enforcement or administrative time lags. Therefore, even if a BEPS countermeasure came into effect during the study period, its effectiveness might not be reflected by the accounting numbers in the income statements of FOACs. For instance, according to the ATO, by December 2019, many tax audits and disputes involving BEPS countermeasures were still in progress or unresolved. Hence, the ATO’s Tax Avoidance Taskforce has been extended to 2025 through the Federal Budget 2022–23, where a further AUD 325 million was provided for the operation of the taskforce.

With the results in mind, we call for future research to extend the study period, especially the period after the implementation of BEPS countermeasures and perform similar analysis using improved datasets and research designs.

 

Journal article

Tran, A. and W. Xu, 2023, “A study of profit shifting using the Hines and Rice approach”, Australian Tax Forum, Volume 38, Number 1, pp. 1-49.