Is the Interest Limitation Rule under BEPS Action 4 on the Right Track? ― In Defense of Reprioritizing the Group Ratio Method over the Fixed Ratio Method ―
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The exercise of a jurisdiction’s taxing power, which is part of its sovereignty, has territorial limits. MNEs are doing their economic activities on the world like a single stage through a network of entities stationed in each jurisdiction. This asymmetry lets each country continue to play hide-and-seek with the MNEs which seek to escape their tax burden by shifting profits from high tax jurisdictions to low tax jurisdictions. Each country’s separate response to MNEs’ sophisticated technique of profit shifting produces erosion of high tax jurisdiction’s tax base. Reflection on this failure serves as the birth of BEPS Project urging a coordinated action among nations. BEPS Action 4 targets at addressing base erosion of profit shifting using debt financing. The means to resolve this type of base erosion is limiting deduction of interest expense incurred from the debt. Two main front runners for performing the duty are the Group Ratio Method (GRM) and the Fixed Ratio Method (FRM). Three main points of how much the method breaks BEPS, which is simpler from overall tax system’s viewpoint and which is more compatible with BEPS Project’ goal signal that the GRM is better than the FRM. Nevertheless, BEPS Action 4 Report suggests that the FRM go ahead of the GRM. This aspect witnesses MNEs’ stiff opposition to the GRM.
Abstract
The exercise of a jurisdiction’s taxing power, which is part of its sovereignty, has territorial limits. MNEs are doing their economic activities on the world like a single stage through a network of entities stationed in each jurisdiction. This asymmetry lets each country continue to play hide-and-seek with the MNEs which seek to escape their tax burden by shifting profits from high tax jurisdictions to low tax jurisdictions. Each country’s separate response to MNEs’ sophisticated technique of profit shifting produces erosion of high tax jurisdiction’s tax base. Reflection on this failure serves as the birth of BEPS Project urging a coordinated action among nations. BEPS Action 4 targets at addressing base erosion of profit shifting using debt financing. The means to resolve this type of base erosion is limiting deduction of interest expense incurred from the debt. Two main front runners for performing the duty are the Group Ratio Method (GRM) and the Fixed Ratio Method (FRM). Three main points of how much the method breaks BEPS, which is simpler from overall tax system’s viewpoint and which is more compatible with BEPS Project’ goal signal that the GRM is better than the FRM. Nevertheless, BEPS Action 4 Report suggests that the FRM go ahead of the GRM. This aspect witnesses MNEs’ stiff opposition to the GRM.
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