April 24, 2014

Tax Base Erosion: Who Is Guilty?

It is rare that global transfer pricing strategies of multinational enterprises (MNEs) find their way onto front page coverage in financial center newspapers and magazines.  This has been the case in recent periods in a crescendo of criticism that pillories MNEs as the bad guys in the base erosion drama.  It is as if such strategies are responsible for global economic problems. Not surprisingly, the tax authorities of the world, collectively represented by the Organization for Economic Cooperation and Development (OECD) and the United Nations (UN), have announced intentions to address such matters.

A neutral observer might wonder whether existing model treaties provide:  (i) protection for the tax base of the respective countries; and (ii) guidance to MNEs for framing their effective tax rate (ETR) strategies (the “Foundational Questions”)?  The answers are plainly affirmative in the archives of historical record:

  • Tax Base Protection: The existing OECD/UN model treaties do provide protection to the tax base of the residence countries designing the model at the time the policies were adopted in the mid-1920s. The intention of the models was to allocate residual income to allocate routine returns to sourcecountries, residual income to residence countries, and treat interim holding companies as residents(vis-à-vis both source and residence countries).
  • MNE-ETR Strategies:  The paradigm that was anticipated in the League of Nations debates (the “Intended Paradigm”) was as follows:

The Intended Paradigm shows the results sought to be achieved by the founders of OECD/UN tax policy.  The intention was that the source (or colony) country would earn, using current terminology, routine returns, while the residence (or imperial) country would earn the residual income or profits.

One question debated in the 1920s was whether interim holding companies should be treated as residence or source countries.  The answer was residence, because it was assumed that all countries would adopt a common tax base and rates.

In other words, the League of Nations treaty model provided guidance to MNEs, which has been followed in the form of still prevailing MNE effective tax rate strategies.

Need for Reform

It seems reasonable to assume that all parties would, at least grudgingly, agree that the existing treaty policy is in serious need of reformulation to reflect the world of the 2010s, not the 1920s.  There are a variety of grounds for support of such a proposition:

  1. No one benefits from the existing stress.
  2. Treaty protection is critical to all parties.
  3. The danger of double/multiple taxation in BRICS and other source countries is material.
  4. All parties would benefit from updating of the existing model treaties.
  5. The actual history of our tax treaty policy is different than may be commonly understood.
  6. The world has changed dramatically.
  7. Rather than criticizing MNEs, it is time to invest that energy in developing policies that are consistent with the realities of our current world. This could be one element of facilitating global growth.
  8. In evolving MNE-ETR Strategies, these realities (including how to adjust for potential rejection of current planning models in BRICS and other source countries (via bilateral agreement, domestic foreign tax credit, or otherwise) is critical to MNEs.


The crescendo of criticism directed at MNE-ETR Strategies has had the desirable result of highlighting the role of treaty policy in global economic matters. It is inevitable that this crescendo will continue until a policy is formulated that reflects a reasonable balancing of interests of the pertinent parties. 

© 2014 McDermott Will & Emery

About the Author


Cym H. Lowell is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Houston office.

Cym advises multinational companies and high-net-worth individuals based in the United States and around the world on a broad spectrum of tax planning and controversy matters.  He is Vice-Chairman of the International Chamber of Commerce Taxation Commission (based in Paris), as well as a member of the Business and Industry Advisory Committee to the OECD (also based in Paris) and U.S. Council of Business.  On behalf of his clients, Cym has handled...


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