On July 19, the OECD released its recommendations for global efforts to counter the much-publicised phenomenon of “base erosion and profit shifting (BEPS).”1

Base erosion is the use of legal arrangements by members of multinational business groups to shift income from affiliates located in countries where the group conducts business activities, to affiliates in low- or zero-tax countries where the groups conduct relatively little if any activity. The OECD report is straightforward and concise in its presentation, both in explaining the roots of base erosion and in calling for coordinated, global legal changes in order to curtail the phenomenon.

Although the OECD’s membership consists of countries with advanced economies, the OECD has taken efforts to consult with representatives of developing countries, and its report makes special note of the damage that base erosion inflicts on developing economies.2 Much economic activity in developing countries takes place in the informal sector, where the resulting income is largely immune from taxation. Therefore, a large proportion of developing countries’ potential revenue base tends to consist of income generated by multinational enterprises business in the countries.

Related-Party Payments

In practice, however, related-party payments by developing-country affiliates of multinationals, including but not limited to payments of interest, royalties, management and service fees, erode much of the otherwise available tax base. And as the OECD’s report suggests, the social as well as economic implications of the resulting lack of tax revenue are serious for developing countries.

The OECD report recommends numerous legal changes to curtail base erosion. Some of these legal changes–notably strengthened controlled foreign corporation (CFC) rules, which would subject income diverted to low- and zero-tax subsidiaries to taxation in the home country of the multinational group, are by their nature suitable mainly for countries with advanced economies (that is, those that are likely to be the home countries of large multinationals). Other recommendations in the report, however, including proposals for limitations on deductions for various kinds of payments to related parties, are potentially useful to all countries, and are likely to be especially important to the curtailment of base erosion by developing countries.

Base erosion is a serious problem for many developing countries, and the OECD is correct in highlighting this fact.


The OECD, however, is not a lawmaking authority in any country, so OECD’s recommendations are not self-executing. In all countries, of all stages of economic development, the adoption of measures to curtail base erosion is likely to face serious political challenges. These challenges generally relate to the topic of “tax competition.”

Countries with advanced economies have tended, over the years, to permit their multinationals to reduce their global effective tax rates through base erosion transactions, based largely on fear that prohibiting their multinationals from doing so would place them at a competitive disadvantage relative to multinationals based in other countries. Because of this competitive concern, countries that are home to multinationals are likely to curtail base erosion, through such measures as strengthened CFC rules, only through coordinated action with other advanced-economy countries.

Competitive Concerns of Developing Countries

Developing countries, too, face competitive concerns in adopting measures to curtail base erosion, such as limitations on outbound deductions for certain payments to related parties. In particular, officials of developing countries may fear that by eliminating tax avoidance opportunities for inbound multinationals, they might lose inbound investment to other countries which do not adopt anti-avoidance measures. Therefore, developing countries are likely to adopt effective controls against base erosion only in coordination with other similarly situated countries, perhaps in regional groupings to address competitive concerns with respect to regionally specialised industries. This raises a need for regional and also, perhaps, global cooperation among developing countries in order to coordinate their base-erosion policies.

Many developing countries have limited resources to devote to the technical aspects of tax policymaking and tax administration

Policy coordination is not all that developing countries will need to adopt effective measures to prevent base erosion. Many developing countries have only limited resources to devote to the technical aspects of tax policymaking and tax administration. Although the measures that the OECD has recommended generally involve familiar kinds of statutory structures, developing countries will nevertheless face challenging technical demands in designing and implementing base erosion statutes, and they will need expert assistance in doing so.

Without substantial infusions of diligent expert assistance, it is unlikely that developing countries can muster the resources needed to implement the measures that the OECD has recommended.


In sum, although the need is great for developing countries to adopt the kinds of measures to curtail base erosion that the OECD has recommended, developing countries cannot adopt these measures on their own. Developing countries that desire to protect their tax bases from erosion will need to cooperate with other developing countries, regionally and probably globally. Developing countries will also need substantial assistance from regional and global organisations that are able, politically, to assist developing countries in their anti-base erosion efforts, and which either have now or can generate the financial resources to maintain expert personnel who can offer the necessary assistance. Candidates for such work include (but are probably not limited to), at the global level, the IMF, the World Bank, the United Nations, and (in its development-assistance role) the OECD; and at the regional level such organisations as the African, Asian and Inter-American Development Banks.

Impetus for Change

The release of the OECD’s BEPS report should be treated as a rallying cry for these and other appropriate international organisations. These organisations should promptly consult with one another to develop their own action plan similar to that of the OECD, and to begin the necessary work, with developing-country governments, of building a coordinated structure of base erosion rules.

By plainly indicating the belief of OECD (and G-20) member countries that base erosion is a problem that must be addressed, the OECD report provides unprecedented political impetus for developing countries to adopt measures that could generate badly needed public revenues. Developing countries, though, cannot succeed in implementing these measures on their own. The OECD report should be the starting point for a concerted and energetic effort by developing-country governments, and by those global and regional international organisations that are positioned to assist them, to develop effective measures to protect their corporate tax bases. The result of such efforts can be a material enhancement of the financial and social situations of many developing countries.

1  OECD, Action Plan on Base Erosion and Profit Shifting.

2  “In developing countries, the lack of tax revenue leads to critical under-funding of public investment that could help promote economic growth.” OECD Action Plan, p. 8.

Reproduced with permission from Tax Management Transfer Pricing Report. Copyright Bloomberg/BNA 2013