The OECD/G20-BEPS Project and the Value Creation Paradigm: Economic Reality Disemboguing into the Interpretation of the ?Arm's Length' Standard

• Author: Stanley I. Langbein - Max R. Fuss
• Position: Professor of Law, University of Miami School of Law. - Doctoral candidate (Ph.D. equivalent) at the Institute for Tax Law, University of Cologne, Germany; visiting research scholar at the University of Miami School of Law, 2016-17 academic year.
• Pages: 259-409

The OECD/G20-BEPS-Project and the Value

Creation Paradigm: Economic Reality

Disemboguing into the Interpretation of the

‘Arm’s Length’ Standard

S

TANLEY

I. L

ANGBEIN

* & M

AX

R. F

USS

**

The rules and concepts which govern “international taxation” among the

major trading nations derive from work in the 1920s by the League of

Nations.

1

The principles first enunciated there are widely seen as having

generated a remarkably durable and stable regime, lasting nearly a century to

the present day.

2

In the first half of this second decade of the twenty-first

* Professor of Law, University of Miami School of Law.

** Doctoral candidate (Ph.D. equivalent) at the Institute for Tax Law, University of Cologne,

Germany; visiting research scholar at the University of Miami School of Law, 2016-17

academic year.

The authors are grateful to the German Academic Exchange Service (DAAD) for their

generous support to the preparation of this article.

1. The major documents in this initiative are collected in 4

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TAFF OF

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AXATION

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EGISLATIVE

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ISTORY OF

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NITED

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TATES

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AX

C

ONVENTIONS

3997, 4151–94 (1962) [hereinafter Conventions Legislative History]. For early

literature describing or discussing this work, see H. David Rosenbloom & Stanley I. Langbein,

United States Tax Treaty Policy: An Overview, 19

C

OLUM

. J. T

RANSNAT

’

L

L.

359 (1981) (See Part

II for discussion of the work of the League in the 1920s and 1930s); Stanley I. Langbein, The

Unitary Method and the Myth of Arm’s Length, 30

T

AX

N

OTES

625 (1986); see also Michael J.

Graetz & Michael M. O’Hear, The ‘Original Intent’ of U.S. International Taxation, 46

D

UKE

L. J.

1021, 1022–28 (1997).

At the current time the rules and concepts that undergird such international “system” as exists

are embodied in “model conventions” of international organisations, principally that of the

Organisation for Economic Co-operation and Development (OECD), an organisation

comprising of mostly developed countries and headquartered in Paris. Org. for Econ. Co-

operation and Dev. [OECD], Model Tax Convention on Income and Capital (2014) [hereinafter

OECD Model Convention]. That Model is largely designed for use between two developed

countries. There is also a model convention designed by the United Nations for use between

one developed country and one developing country.

U.N. D

EP

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. & S

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FFAIRS

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OUBLE

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AXATION

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ONVENTION

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ETWEEN

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EVELOPED AND

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EVELOPING

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OUNTRIES

(2011) [hereinafter UN Model Convention].

These Model Conventions are advisory only, although they are quite influential. What actually

governs the taxation of transnational enterprises (TNEs), as of all taxpayers, are bilateral

conventions executed between the nations of the world. In all but unusual cases, these

conventions include clauses that closely follow, if indeed they do not literally incorporate, the

provisions set forth in the Models.

2. See, e.g., Victor Zonana, International Tax Policy in the New Millennium: Developing an

Agenda, 26

B

ROOKL

. J. I

NT

’

L

L. 1253, 1255 (2001)

(system a “flawed miracle”); Reuven S. Avi-

Yonah, The Structure of International Taxation: A Proposal for Simplification, 74

T

EX

. L. R

EV

.

1301

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260 THE INTERNATIONAL LAWYER [VOL. 51, NO. 2

century, the major economic powers of the world undertook an initiative

widely seen as aimed at, or having the potential to, substantially revise this

existing but aging regime.

3

The initiative was called the Base Erosion and

Profit Shifting project, or, by its acronym, BEPS.

4

Undoubtedly the most significant single facet of the historic regime are

the rules governing “transfer pricing,” which allocate the tax base generated

by the profits of transnational enterprises (TNEs) among the national

jurisdictions within which those enterprises operate.

5

And despite the

stability of the overall system, the “transfer pricing” rules have always proved

neither durable nor satisfactory. The rules operate under the so-called

“arm’s length” principle—the idea that allocation of profits among countries

should be accomplished by treating the TNEs as if the enterprises in

different jurisdictions were separate enterprises engaged in transactions at

prices that would be charged between independent enterprises.

6

However,

this standard, though constant over decades, has undergone three formative

or transformative changes in eighty years.

7

The first was when it emerged in

the 1930s;

8

the second, when the United States issued the first detailed

interpretation of the standard in the 1960s;

9

and the third, finalized in the

1990s, when the regime of the 1960s encountered difficulties and

engendered controversy in the late 1980s and early 1990s.

10

However, the regime of the 1990s, at least by about 2010, had proved at

least as problematical as its predecessors. Central to its difficulties was a

practice among TNEs, which became widespread in the early twentieth

century, of concentrating “functions” risk and asset ownership, which under

the 1990s rules underlie the right of jurisdictions to tax corporate profits, in

subsidiaries organized in low-tax jurisdictions (or “tax havens”), resulting in

(1996); H. David Rosenbloom, The David R. Tillinghast Lecture: International Tax Arbitrage and

the “International Tax System”, 53

T

AX

L. R

EV

.

137 (2000).

3. See infra Part I.A and note 17. The initiative was undertaken by the Group of 20 (“G20”),

the membership, but the technical work was assigned to and borne by the OECD, all as

discussed therein.

4. Itai Grinberg, The New International Tax Diplomacy, 104

G

EO

. L. J.

1137, 1138 (2016).

5. Article 9 of both Model Conventions referred to in note 1 concerns the allocation among

the state signatories to a convention of the profits of an integrated group of companies

operating in both jurisdictions, the “transfer pricing” problem. The application of Article 9 is

the subject of comprehensive “Guidelines” which are an important element of the extant

international system. OECD, Transfer Pricing Guidelines for Multinational Enterprises (2014)

[hereinafter 2010 OECD Guidelines]. As in the case of the models themselves, these

Guidelines are subject to a separate set of principles as applied to a convention between a

developed and a developing country, promulgated by the UN.

U.N. D

EP

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TOF

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CON

. & S

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.

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, U.N. P

RACTICAL

M

ANUAL ON

T

RANSFER

P

RICING FOR

D

EVELOPING

C

OUNTRIES

(2013) [hereinafter cited as UN Transfer Pricing Manual].

6. This standard is mandated by Article of both the UN and OECD Model Conventions.

7. See infra notes 8-10.

8. See infra Part II-C.

9. See infra Part III-A and III-B.

10. See infra Part IV.

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2018] THE OECD/G20-BEPS-PROJECT 261

the disproportionate allocation of taxable profits to those low-tax countries.

11

The income so protected from major-country taxation came to be called

“stateless” income.

12

And this core problem of the existing international

system lay at the heart of the decision by the major economic powers to

undertake the BEPS initiative—and accordingly lies at the core of the BEPS

initiative itself. Thus, just as transfer pricing is the most significant facet of

the historic overall system, it is also the key element of the contemporary

BEPS initiative.

13

The BEPS initiative was undertaken through fifteen so-called “Action

items” (or “Actions”), four of which directly involve “transfer pricing.”

14

The Actions were effected largely through “final reports” which were

finalized for the most part during 2015,

15

and which were based on various

“discussion drafts” and preliminary “deliverables” issued for the most part in

2014.

16

The final reports under Actions 8 through 10 have stirred both

confusion and controversy in the United States and elsewhere.

The principal point of both confusion and controversy in the transfer

pricing reports concern the relationship of their key concept—“value

11. Edward D. Kleinbard, Stateless Income, 11

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LA

. T

AX

R

EV

.

699, 722–724 (2011).

12. The phrase was coined in two articles by Professor Edward Kleinbard, which articles are

among the most useful descriptions of the legal basis of the process. See Edward D. Kleinbard,

Stateless Income, 11

F

LA

. T

AX

R

EV

.

699 (2011); Edward D. Kleinbard, Lessons of Stateless Income,

65

T

AX

L. R

EV

.

99 (2011).

13. The authors are in general agreement with the position of Professor Richard Vann that

“transfer pricing is the dominant international issue as compared to” the congeries of other

issues addressed by the Model Conventions. Richard J. Vann, Taxing International Business

Income: Hard-Boiled Wonderland and the End of the World, 2

W

ORLD

T

AX

J.

291 (2010)

[hereinafter Vann Hard-Boiled WonderWorld].

14. See infra app. at 349–50. These are Actions 8 through 10 and 13. As many as six of the

other Actions involved areas not strictly part of transfer pricing, but which significantly overlap

it. These include Action 1 (addresses the challenges of the digital economy); Action 4 (limits

base erosion via interest deductions and other financial payments), Action 5 (counters harmful

tax practices more effectively, taking into account transparency and substance), Action 7

(prevents the artificial avoidance of PE status); Action 11 (establishes methodologies to collect

and analyze data on BEPS and the actions taken to address it), and Action 14 (makes dispute

resolution mechanisms more effective).

15. The Final Reports governing Actions 8 through 10 are set forth in OECD, Aligning

Transfer Pricing Outcomes with Value Creation, Actions 8–10 - 2015 Final Reports, (2015)

[hereinafter Final Actions 8–10 Reports]. Those governing Action 13 are set forth at OECD,

Transfer Pricing Documentation and Country-by-Country Reporting, Action 13 - 2015 Final Report,

(2015) [hereinafter Final Action 13 Report]. See infra Part V.B. The Final Actions 8–10

Reports is discussed in detail at Part V.B. We sometimes use the singular because, although the

documents are styled “Final Reports,” and discuss matters that were discussed separately in

seven separate preliminary deliverables or discussions drafts, it was issued as a single document.

The Final Reports are for the most part set forth as amendments to what had been the 2010

OECD Transfer Pricing Guidelines, which with the amendments were reissued as the 2017

Guidelines.

16. See infra Part V.B. (discussing the relevant preliminary deliverables and discussion drafts).

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