Base erosion and profit shifting: techniques, the 15 OECD actions and country-by-country reporting

A group owns a famous brand through a small company in a low-tax country. Every operating company in the group pays that company a royalty for using the brand. Each royalty is deducted from profit in the country where the product is sold, and each is taxed lightly where it is received.

A second group funds its Nigerian subsidiary almost entirely by loans from a sister company, so the subsidiary’s profit disappears into interest. Neither group breaks a rule in any single country. Together the structures empty the tax base of the countries where the sales are made.

This topic covers base erosion and profit shifting (BEPS), the players that use it, the main techniques, what makes it possible, the 15 actions of the Organisation for Economic Co-operation and Development (OECD), and Nigeria’s country-by-country reporting (CbCR) rules. The previous topic covered transfer pricing. The next covers regional integration and trade blocs.

Key terms in plain English

Syllabus check

This topic is in syllabus area C (international taxation, 20% of marks). It covers:

• the meaning of base erosion and profit shifting and the players and techniques involved;
• the factors that contribute to it and the OECD actions against it;
• country-by-country reporting in Nigeria.

CAMA 2020 and tax-driven structures

The Companies and Allied Matters Act 2020 (CAMA 2020) is the company law of Nigeria. The sections below apply to this topic.

The rules in more depth

Base erosion and profit shifting

Base erosion is the use of financial measures and tax planning to reduce the taxable profit of a company in a country, by giving income a better tax treatment or writing off expenditure against it. Profit shifting is the payment of money to other group companies to move profit from high-tax to low-tax countries.

The payments are often royalties and interest, because they are deductible and some countries tax them lightly in the receiver’s hands. Together they are called BEPS: the tax base of the higher-tax country is eroded and the profit is shifted.

The players

Multinational groups are best placed to use BEPS because their operations form a ready network of companies through which funds can flow, they have the capital to set up and keep entities used for tax reduction. Their income is large enough to pay for advice, to put a structure in place and to update it as laws change.

The techniques

1. Trademark and technology licensing. The group’s brands, designs and patents are held by a company in a low-tax country that charges royalties to the other members.
2. Thin capitalisation. A subsidiary is set up with little share capital and funded by a group finance company. The large debt produces interest, which is treated differently by different countries and can lower the group’s tax if it is structured well.
3. Hybrid mismatch arrangements. The same instrument is debt for the payer (so interest is deducted) and equity or exempt income for the receiver, which leaves the income untaxed anywhere.
4. Assets in an entity without substance. A country offers a preferential regime to attract business, but the benefit is a trap if the profit sits in a company with no real activity; it only erodes the tax base of the country where the work is done.

Other forms are over-invoiced goods, management fees and head office charges, shifting risk to a low-tax company, avoiding a permanent establishment through commissionaire arrangements and treaty shopping.

What makes it possible

• The digital economy. Services can be delivered from anywhere and produce sales everywhere with no physical presence, so it is hard to say where tax belongs.
• Weak international cooperation. Tax is levied by each country on its own, so there is no agreed answer on what is taxed where, and no exchange of information to check it.

The OECD actions

Under the Inclusive Framework, over 140 jurisdictions work on BEPS. The OECD issued 15 actions.

The OECD minimum tax of 15% under Pillar Two is part of the same effort. Nigeria’s own minimum effective tax rate (s. 57 NTA 2025) is its response, and the earlier topics on transfer pricing, the digital economy and treaties each apply a BEPS action.

Country-by-country reporting in Nigeria

The Income Tax (Country-by-Country Reporting) Regulations 2018 were published on 8 January 2018 to give the authorities information on a group’s global activity, profit and tax, improve transparency and stop avoidance through BEPS.

• An ultimate parent entity resident in Nigeria with consolidated group revenue of ₦160 billion or more files a CbC report in the prescribed format each year, within 12 months after the last day of the group’s accounting year. The OECD threshold is €750 million.
• A constituent entity that is not the parent may have to file if conditions are met. It need not file if the report has been filed through a surrogate parent entity.
• Every Nigerian resident constituent entity notifies the NRS whether it is the parent or a surrogate, or names the reporting entity and its residence, by the last day of the group’s accounting year.
• The report covers revenue, profit or loss, tax paid and accrued, capital, retained earnings, staff and tangible assets for each country. The NRS guidelines follow the OECD guidance and use the International Financial Reporting Standards consolidation rule to decide which entities belong to the group.

With CbC data, the NRS can compare a group’s profit with its activity in Nigeria, so more audits and more transfer pricing disputes follow. A group in Nigeria should review its transfer pricing practice before the reports are filed.

Worked examples

1. Excess royalty.
   200 − 120 = ₦80m, which is not allowed as a deduction because it is not at arm’s length.
2. Extra tax at 30% = ₦24m.
3. Withholding tax on the royalty at 10% of ₦200m = ₦20m is deducted at source.

1. Interest paid.
   15% × 990 = ₦148.5m.
   Arm’s length interest = 10% × 990 = ₦99m.
2. Excess interest = ₦49.5m, which is added back in computing profit.
3. Extra tax at 30% = ₦14.85m.

1. The payment is deducted once and taxed nowhere, which is double non-taxation.
2. Action 2 answers it with a rule that denies the deduction where the receiver does not include the income.

1. Revenue is above ₦160bn, so it must file.
2. Late filing.
   ₦10m + (3 × ₦1m) = ₦13m.
3. Failure to notify.
   ₦5m + (20 × ₦10,000) = ₦5.2m.

How to score full marks

• Separate base erosion from profit shifting in the first lines.
• Give each technique a one-line example with the tax effect.
• Link each action to its number and aim.
• Quote the ₦160 billion threshold, the 12 months and the penalty figures.
• Tie the answer to Nigeria: ss. 191 and 192, the minimum tax and CbCR.

Common mistakes in the exam

• Treating base erosion and profit shifting as the same thing with no distinction.
• Listing action 1 twice and missing a different action.
• Giving the CbCR threshold as €750 million only, for a Nigerian parent.
• Forgetting the monthly and daily parts of the penalties.
• Calling thin capitalisation a tax on companies with high gearing, when it is a planning technique.

Quick revision

• Base erosion shrinks the base; profit shifting moves the profit.
• Four techniques: licensing, thin capitalisation, hybrids, entities without substance.
• 15 OECD actions; action 13 is CbCR; action 15 is the multilateral instrument.
• CbCR: ₦160bn or €750m; file within 12 months; ₦10m + ₦1m a month; ₦5m + ₦10,000 a day.
• CAMA 2020: ss. 54, 119, 377(1), 378, 426, 427, 433.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

Recent ICAN papers are written, although older papers such as May 2014 included multiple-choice questions. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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