IS SUNLIGHT THE BEST DISINFECTANT? REASSESSING BEPS ACTION 5'S TAX RULING TRANSPARENCY.

• Author: Hasson, Patrick
• Position: Base erosion and profit sharing

INTRODUCTION 1546 I. TAX RULINGS, TAX COMPETITION, AND THE OECD BEPS PROJECT 1554 A. An Overview of Tax Rulings and Their Potentially "Harmful" Uses 1554 1. Tax Rulings: Their Purpose and Uses 1554 2. Tax Rulings and Tax Competition: An Analysis of the Apple/Ireland State Aid Case 1558 B. The OECD's Earlier Work on Harmful Tax Practices 1563 1. The 1998 Report 1564 C. The OECD BEPS Project and Tax Ruling Transparency 1565 1. The OECD BEPS Project's Actions 1566 2. Action 5's Transparency Framework 1567 II. THE SHORTCOMINGS OF ACTION 5 AND THE COMPLEMENTARITY OF TRANSPARENCY AND DISGORGEMENT 1571 A. Expected Behavioral Responses Following Action [section]'s Transparency Framewoek 1572 1. In the Absence of Transparency 1572 2. Incorporating Action 5's Tax Ruling Transparency 1578 B. The Complementarity of Transparency and Disgorgement 1584 1. Complementarity and the Magnitude of the Tax Concession 1584 2. Complementarity and the Content of the Tax Ruling 1589 III. IMPLEMENTING A BEPS-FOCUSED DISGORGEMENT MECHANISM 1593 A. An Analysis of E. U. State Aid Law 1593 1. Substantive State Aid Law and Its Application to Tax Rulings 1594 2. The Procedural Aspects of State Aid Law Enforcement 1596 B. The Structure of a BEPS-Focused Disgorgement Mechanism 1598 1. The Inadequacy of State Aid Law to Combat BEPS Issues 1598 2. The Specifics 1601 C. Reasons for the Adherence to the BEPS-Focused Disgorgement Mechanism 1604 CONCLUSION 1605 INTRODUCTION

For decades, the taxation of cross-border income generating activities has elicited significant attention from governments and policy experts. (1) Academics (2) and policymakers (3) have long been concerned about multinational enterprises (MNEs) exploiting differences in countries' tax laws to pay as little tax on income as possible. Corporate inversions (4) and other transactions with names such as the "Double Irish With a Dutch Sandwich" (5) have only illuminated the ease by which MNEs can shift income and either defer or completely eliminate tax liability. Countries trying to prevent this tax-motivated income shifting often seem to be playing a fruitless game of "whack-a-mole" as new tax avoidance strategies replace the old. (6)

While in many instances countries may feel slighted by taxpayers' efforts to avoid taxation, in other instances countries intentionally facilitate opportunities for MNEs to reduce their tax liabilities. (7) Because decreasing an MNE's tax liability is equivalent to providing a direct cash subsidy, countries have intentionally adopted favorable tax regimes to induce firms to shift income to those countries. Countries that successfully facilitate income shifting raise a sliver of tax revenue on this income they could not otherwise obtain absent such shifting. Much of this tax competition, however, involves only artificial income shifting rather than an increase in economic activity.

And countries sometimes induce this income shifting by select taxpayers using a seemingly mundane aspect of tax administration: tax rulings. Tax rulings (8) are a tax administration's stance on the proper application of tax laws to a particular transaction. To obtain a ruling, the taxpayer typically submits a ruling request to the tax administration explaining the general structure of the transaction at issue and how it thinks the relevant tax laws apply. The tax administration, such as the Internal Revenue Service (IRS), then responds with a ruling. Rulings may be adverse to taxpayers (9) or beneficial to them. (10) And rulings can go beyond merely clarifying the proper application of tax laws to a particular transaction by serving as a means to also effectively impose a taxpayer-favored tax liability, often significantly departing from the substance of the applicable tax laws.

LuxLeaks and the Apple/Ireland state aid controversy have only further highlighted countries' use of tax rulings to induce income shifting. LuxLeaks involved a 2014 report by the International Consortium of Investigative Journalists detailing Luxembourg's habitual practice of issuing incredibly taxpayer-favored rulings intended to remain confidential. (11) The report details the complex financial structures involving Luxembourg subsidiaries that, by virtue of the tax rulings granted, reduced MNEs' effective tax rates below one percent. (12) Similarly, the Apple/Ireland state aid case showed that Apple avoided roughly [euro]13 billion in taxes by attributing the majority of its international sales to Irish subsidiaries then, by virtue of an Irish tax ruling, allocating most of the profits to different Apple subsidiaries that were not subject to any tax. (13)

In response to widespread artificial income shifting, such as that involved in LuxLeaks and the Apple/Ireland case, the Organization for Economic Cooperation and Development (OECD) launched its Base Erosion and Profit Shifting (BEPS) Project. BEPS refers generally to tax avoidance strategies whereby taxpayers shift income to tax favored locations without an associated shift of economic activity, which the OECD estimates deplete countries' tax revenues by $100-240 billion annually. (14) The OECD/G20 BEPS Project, (15) through its myriad policy tools called "Actions," attempts to combat this type of tax avoidance by harmonizing tax principles across countries and creating minimum standards to which participating countries must adhere. (16) While the OECD BEPS Project focuses on ending many tax avoidance strategies, Action 5 specifically addresses the issue of tax rulings by requiring all participating countries to exchange, or share, those rulings with countries whose tax bases may be affected by the tax rulings issued. (17)

The OECD (18) and other commentators have argued that the OECD BEPS Project's tax ruling transparency can adequately prevent countries from using rulings to grant unwarranted tax concessions. (19) But others have questioned the ability of transparency to have any effect given that there are no repercussions for countries that deviate from Action 5's tax ruling transparency minimum standards. (20) These latter commentators' conclusions are correct. (21) The OECD BEPS Project's tax ruling transparency alone will not change firm or country behavior because exposing tax avoidance does not reduce its net benefits to either countries or firms. And participating countries do not seem to heed the OECD's 2018 recommendation to impose sanctions on firms that improperly utilize "preferential regimes." (22) In fact, the 2018 recommendation is so fundamentally flawed that it does not warrant any serious consideration with respect to Action 5's behavioral implications. (23) Accordingly, Action 5's tax ruling transparency will not produce the results envisioned by the OECD; namely, countries' use of tax rulings to induce income shifting.

However, tax ruling transparency may deter some tax-motivated income shifting in the context of European Union's state aid law. (24) State aid law generally bars the use of state resources to provide a competitive advantage to firms operating in E.U. Member States, (25) and requires Member States to recover such resources that violate this standard, referred to as unlawful aid. State aid not only contemplates direct government outlays, but also the reduction of firm tax liabilities through tax rulings. (26) As such, any tax concession that a Member State issues through a tax ruling is potentially subject to disgorgement through the enforcement of state aid law. (27)

The OECD BEPS Project's tax ruling transparency increases the likelihood that the Member State who issued the ruling must recover, and consequently the recipient MNE must surrender, the tax concession afforded. Increased transparency enables the European Commission--the body responsible for enforcing state aid law--to more productively identify unlawful state aid. This directly reduces the expected value of the tax concession to the recipient MNE. Consequently, rulings become less effective at inducing tax-motivated income shifting, which can change country and MNE behavior of issuing and accepting, respectively, tax concessions afforded by tax rulings. The possibility that an MNE may have to surrender the tax concession in the European Union is the sole reason to expect any behavioral changes following the implementation of Action 5's tax ruling transparency. Action 5's behavioral impact can only stem E.U. countries' use of tax rulings to induce income shifting, however, because there is no comparable disgorgement or penalty mechanism for countries outside the European Union.

But even in the E.U. state aid context, tax ruling transparency will only prove moderately effective. State aid law, from a theoretical perspective, is not well equipped to handle BEPS issues, and some state aid decisions concerning tax rulings, such as the recent decision involving Apple, (28) highlight some of its limitations. Merely extending state aid law to non-E.U. countries, while perhaps theoretically tempting because of its existing disgorgement mechanism, will not stem the use of tax rulings to facilitate tax avoidance. The state aid cases that involve tax rulings and require disgorgement of the afforded tax concession rest on flawed applications of state aid law, as they implicitly disregard the fact that the tax ruling is the sole reason the income shifting necessarily at issue occurred. (29) As such, a BEPS-focused disgorgement mechanism, (30) procedurally analogous to state aid law enforcement but with a substantive foundation consisting of the OECD BEPS Project Actions, other OECD guidelines, and the issuing country's tax laws is the best means for the OECD and countries participating in the OECD BEPS Project adversely affected by tax ruling-induced income shifting to significantly combat the use of tax rulings as a tax avoidance tool.

Although some commentators acknowledge that countries are not incentivized to adhere to the OECD BEPS Project...