Category Archives: Action 5

Harmful Tax Practices: Agreement on the Modified Nexus Approach

We have now published our submission in response to the consultation on the ‘modified nexus approach‘ under the BEPS Action Point 5 on Harmful Tax Practices.

It begins with some general comments on the approach adopted for dealing with tax advantages given by states which damage other countries’ tax base, termed harmful tax practices, and then provides comments on the specific proposals for applying the nexus approach to innovation boxes.


In many ways this issue goes to the heart of the dilemma posed by the approach adopted by the G20 and the OECD to the BEPS problem. Many countries have been tempted to offer special tax advantages or regimes which in effect work in a beggar-thy-neighbour way, and create a race to the bottom in corporate taxation. The mandate from the G20 to reform tax rules to ensure that multinationals are taxed according to `where economic activities take place and value is created’ necessarily entails closer coordination of tax rules. Hence, it could be said to involve limits on state sovereignty, which the G20 has also said should be preserved. Yet without such closer coordination states have been losing their power to tax multinationals effectively. The problem is how to design coordination measures which require the least intrusion into national governments’ regulatory space.

The approach adopted to ‘harmful tax practices’ has been to establish general criteria, and evaluate states’ measures against these. This falls between two stools, depending on the form of enforcement. If the procedure is voluntary it is toothless and ends by encouraging states to devise new measures; but if backed by the possibility of counter-measures (either collective or unilateral) monitoring of compliance would be highly intrusive for both companies and states. This can be seen in particular in the current proposals relating to the economic substance criterion for innovation boxes, which involve complex rules and a ‘track and trace’ system for company expenditure. In our view regimes such as the patent box are unnecessary and undesirable, as encouragement for R&D can already be easily provided through investment allowances.

The OECD approach will simply legitimize ‘innovation box’ regimes and hence supply a legal mechanism for profit shifting, encouraging states to provide such benefits to companies. It will be particularly damaging to developing countries, which may be used as manufacturing platforms, while their tax base will be drained by this legitimized profit-shifting. Such measures should simply be condemned and eliminated.

This issue again clearly shows why a better approach to taxing companies where economic activities take place would be extension of the profit split method. As we have urged in our other submissions, the use of the profit split method applied with concrete and easily determinable objective allocation keys would be much easier to administer and far less intrusive both for states and enterprises, and would also leave states free to decide their own tax rates, as well as investment allowances.