Soft Tax Law & Multilateralism: Modifying treaties with anti-BEPS measures

As observers of global tax policy know, international tax issues are dealt with in bilateral treaties that more or less adhere to a 'model' tax treaty developed and periodically updated by the OECD (provisions in a rival UN Model are occasionally invoked, and the US has its own model with its own distinctions and idiosyncrasies). There are those who have long lamented the problem of having thousands of bilateral agreements that can't be easily or quickly updated when the OECD revises the model (thus curbing the impact of OECD soft law).

As part of the base erosion and profit shifting (BEPS) initiative, the OECD is currently developing a
"Multilateral instrument on tax treaty measures to tackle BEPS" which would be used to 'modify' all existing tax treaties in force among signatory countries. The OECD says this mechanism (which it calls an 'innovative approach') 'would preserve the bilateral nature of tax treaties' even as it modified all existing bilateral treaties 'in a synchronized way'. The OECD says there are "limited precedents" for modifying bilateral treaties with a multilateral instrument.

But are there really any precedents at all? I couldn't think of any off-hand. A quick check with a few international law colleagues yielded few comparators. Tim Meyer suggested the EU harmonizing efforts on Bilateral Investment Treaties (BITs) as a candidate, albeit noting that this does not contemplate directly overriding existing BITs but requires EU members to change their bilateral arrangements to conform with EU investment policy.

Tim also made the interesting observation that"treaties that reference customary international law standards, such as BITs’ reference to the minimum standard of treatment" could be overridden in a somewhat similar fashion. He explained that "[i]f custom changed, such as through the promulgation of soft law documents or multilateral treaties, it would change the BITs that incorporate the customary standard. That isn’t exactly the same thing [as the new OECD multilateral instrument], but similar."

The OECD's work in developing "global consensus" has in the past led some to describe OECD standards as "soft law" and others to suggest that the OECD may be understood to articulate customary international tax law; moreover the OECD has itself now taken to describing its model as soft law (including in its 2014 report on the multilateral instrument). I have urged caution in defining OECD proclamations as soft law or customary law given the OECD's exclusive membership of mainly rich countries, which excludes all of the BRICs and most of the rest of the world, as I think the nomenclature lends an imprimatur of legitimacy to OECD proclamations that may not be deserved. But it seems clear that the BEPS action items, and the new global forum to "monitor compliance" with them, are intended to overcome the exclusivity problem while endowing OECD norms with ever-greater law-like effect (without offending the unicorn that is "tax sovereignty").

It seems likely to me that a multilateral agreement that modifies existing tax treaties is actually intended to ultimately replace those treaties, making small and incremental modifications until the underlying bilateral treaties become superfluous or extinct. Accordingly I view the OECD's multilateral 'modification' function to be an exercise in creeping harmonization as well as "ossification" (or maybe transformation) of soft law into hard law.

Adding together the other elements of BEPS, including the new global forum to compel national compliance with 'minimum standards' as they develop, I recently suggested that the OECD's tax folks are giving birth to a new global tax order complete with rules, audits, and reform processes. This is perhaps not the order envisioned by those who have in the past called for global tax coordination in a supranational body for the sake of pursuing global tax justice. If the OECD-based regime is not fully supranational yet, it is close, and it looks increasingly inevitable once it sets a multilateral agreement in place.

There are many fascinating threads of soft law and public international law are at work in these developments. I recently came across an article by Jung-Hong Kim on the topic, entitled A New Age of Multilateralism in International Taxation?, abstract:

 With the OECD/G20 BEPS project, the current international tax landscape is facing challenges and changes unprecedented for the past several decades. This paper looks at the development of bilateralism and multilateralism in the current international tax regime, takes stock of the BEPS works and analyzes the proposed Multilateral Instrument. Then, the paper discusses the emerging multilateral tax order in international taxation. 

Historically, bilateralism has been the constant trend of tax treaties, and later multilateral tax treaties have emerged in some regional areas. There being some deficiencies with bilateral treaties such as dilapidation, delay in entry into force and vulnerability to treaty shopping, the experience of multilateral tax treaties can help build a foundation for future development of a multilateral tax treaty to complement the bilateral tax treaty network. 

With a caveat that BEPS output is fluid at this stage, drawing on the various examples of existing non-tax multilateral treaties, the Multilateral Instrument will be a desirable and feasible tool to reflect the necessary changes resulting from BEPS project. For Korea whose tax treaties need a systematic upgrade after a noticeable growth in quantity, the negotiation on the Multilateral Instrument of the BEPS project will be a great opportunity to revisit the existing bilateral tax treaties and to make appropriate amendments with bilateral treaty partners in multilateral format. 

Beyond BEPS, supposing that the work on the Multilateral Instrument results in a multilateral convention, the inevitable question is the emergence of a multilateral tax order. In terms of feasibility of such a multilateral tax order, there are both positive and negative sides. The positive side is that the relative success of Global Forum on Tax Transparency can be a guidance on the post-BEPS multilateral tax order. On the other hand, the phenomenon of diminishing multilateral trade regime and bilateral investment treaty regime seem to be a negative evidence. Another point to consider is the appropriate forum to manage the multilateral tax order. For this, there are two competing organizations, i.e., the OECD CFA and UN tax committee, each of which having some limit to be developed into an intergovernmental forum. 

After all, the essential question will be how those major players such as the U.S., EU, China, India etc. could build a consensus by compromising on the institutional and substantive aspects of the multilateral tax order. For now, for the emerging multilateral tax order to proceed on a sound basis, the work of the BEPS project should bear substantive and meaningful fruits. 

This is a useful contribution to the discussion and I would like to see more analysis on the OECD's developments, especially from the perspective of nonOECD countries that are being drawn in as BEPS Associates. I would be interested to hear from readers with thoughts on the public international law foundations and precedents, particularly any comparator regimes that I should be thinking about.

Dataset and research on tax treaties by Martin Hearson and ActionAid

Martin Hearson recently developed an an impressive dataset of tax treaties involving 519 agreements signed from 1970 to 2014 by low and lower-middle income countries in Asia and Sub-Saharan Africa. He prepared this dataset for ActionAid, an NGO that has taken on global tax policy as a development issue. Martin also posted a working paper detailing the methodology used to analyse and score each treaty. Here is the summary:

This paper introduces a new dataset that codes the content of 519 tax treaties signed by low- and lower-middle-income countries in Africa and Asia. Often called Double Taxation Agreements, bilateral tax treaties divide up the right to tax cross-border economic activity between their two signatories. When one of the signatories is a developing country that is predominantly a recipient of foreign investment, the effect of the tax treaty is to impose constraints on its ability to tax inward investors, ostensibly to encourage more investment. 

The merits of tax treaties for developing countries have been challenged in critical legal literature for decades, and studies of whether or not they attract new investment into developing countries give contradictory and inconclusive results. These studies have rarely disaggregated the elements of tax treaties to determine which may be most pertinent to any investment-promoting effect. Meanwhile, as developing countries continue to negotiate, renegotiate, review and terminate tax treaties, comparative data on negotiating histories and outcomes is not easily obtained. 

The new dataset fills both these gaps. Using it, this paper demonstrates how tax treaties are changing over time. The restrictions they impose on the rate of withholding tax developing countries can levy on cross-border payments have intensified since 1970. In contrast, the permanent establishment threshold, which specifies when a foreign company’s profits become taxable in a developing country, has been falling, giving developing countries more opportunity to tax foreign investors. The picture with respect to capital gains tax and other provisions is mixed. As a group, OECD countries appear to be moving towards treaties with developing countries that impose more restrictions on the latter’s taxing rights, while non- OECD countries appear to be allowing developing countries to retain more taxing rights than in the past. These overall trends, however, mask some surprising differences between the positions of individual industrialised and emerging economies. These findings pose more questions than they answer, and it is hoped that this paper and the dataset it accompanies will stimulate new research on tax treaties.

Nadia Harrison and Lovisa Moller produced a report based on the dataset, entitled Mistreated: The tax treaties that are depriving the world’s poorest countries of vital revenue. Here is the abstract:

Women and girls in the world’s poorest countries need good schools and hospitals. To pay for this, these countries urgently need more tax revenue. A little-known mechanism by which countries lose corporate tax revenue is a global network of binding tax treaties between countries. This report marks the release of the ActionAid tax treaties dataset – original research that makes these tax deals made with some of the world’s poorest countries easily comparable and open to public scrutiny.

 ActionAid also produced an interactive map showing overall treaty effects by country.

These are tremendous resources for anyone studying international tax policy. Bravo to Martin and ActionAid for devoting time and resources to getting this important work out into the world.

Thinking about the OECD's New World Tax Order

Last week I presented a work in progress on the OECD's newest global forum, which is being created to fulfill and further its BEPS initiative, as part of the BYU symposium "The Cutting Edge Of International Tax Reform." I tentatively titled my paper (ok, outline) "Not So Soft Law: The OECD Tax Regime" but I don't think I will stay with that title because soft law is still a fairly obscure notion among tax academics and practitioners, at least, in North America (it seems somewhat better-understood elsewhere). In any event I don't have a working paper yet but here is my working abstract:

Tax jurisdiction gaps and overlaps are inevitable in a world economy powered by constant cross-border flows of capital and income. States have long sought to overcome issues thus created by engaging in consensus building over nonbinding “soft law” norms via the Organisation for Economic Cooperation and Development (OECD). But with its most recent exercise, the Base Erosion and Profit Shifting initiative, the OECD is hardening these norms into a genuine global tax regime. It is doing so with model legislation, peer monitoring, and institutions that supplant its more inclusive policy rival, the United Nations, bringing in non-OECD countries as "BEPS Associates". This Article argues that the implications of these developments include building a new international tax organization (or world tax order) to avoid the encroachment of the United Nations as a potential tax policy rival, thus ensuring the continuing global tax policy monopoly of a core set of OECD nations.

I'm still thinking through all of the fascinating institutional changes taking place as part of the BEPS process, and don't have any grand conclusions. International tax governance has become infinitely more complicated over the past several years, with multiple institutions popping up as potential rivals for the OECD's monopolistic grip on global tax policy norms and processes.   I welcome the OECD's desire to develop an inclusive forum to enable more effective participation in global tax norm development. However I am wary about whether and how inclusive the proposed institution can be in light of the observation that agenda-setting is such an important aspect of effective participation. BEPS Associates don't quite seem like full partners yet, hence their title unfortunately seems all too apt.

If non-OECD countries set up a new forum, to which they invited OECD countries as Associates, would the major action items be those covered in BEPS? I am not convinced. A serious study of formulary apportionment as an alternative to transfer pricing seems like a topic that a truly inclusive forum would insist upon immediately. That is not to say that formulary apportionment is wonderful or great or a panacea--I am not sure it is. But there are so many calls for it, it seems to me impossible to understand the continued insistence by the OECD to quash the discussion. If it's not a great idea, fine: study it and reveal its weaknesses. If it is a great idea, why suppress it? Perhaps there are good reasons, but in general I favour studying things to not studying them, especially when not studying them looks like an attempt to intentionally thwart progress. Similarly, I would expect such a forum to tackle items of interest especially to "less developed" countries (as far as that term may be adequately defined), such as the longstanding source/residence compromise and the expansion of the permanent establishment regime to deal with services.

If these items were to become topics of attention and study within or because of the new OECD forum, I think I would reflect on this new tax order as a success story in developing the means for effective participation of more countries in the global tax dialogue. If not, I would be less sure that progress has been made. At this stage I have far more questions than answers.