Base Erosion: What the BEPS Fight Is Actually Against

Definition

Base erosion is the practice of shifting profits out of a jurisdiction’s tax base — the profits earned (or the intangibles valued) in one jurisdiction, priced (the transfer price, the royalty, the fee) so that the taxable profit lands in the other jurisdiction (the lower-rate one, the treaty-favourable one) — the base (the jurisdiction’s taxable-profit base) eroded (the profit shifted out, the base reduced, the tax collected reduced). It is the BEPS project’s target — the OECD/G20 Base Erosion and Profit Shifting project is named for it (the base erosion and the profit shifting, the two faces of the same practice) — and the [BEPS initiative] (/docs/fundamentals/beps-initiative)’s 15 actions are the response (the Action 1-15 the measures: the hybrid mismatch (Action 2), the aggressively structured intangibles (the Actions 8-10 — the intangibles, the DEMPE, the residual profit), the documentation (Action 13 — the CbCR, the Master File, the Local File — the transparency the base erosion’s detector), the Pillar Two (the 15% floor — the base erosion’s final defence, the GloBE computation the top-up on the sub-15% base)). The mechanism the base erosion works through is the transfer price (the [arm’s length] (/docs/glossary/alp) price the test — the price that shifts the profit out of the base is the price that is not arm’s length, the comparability the failure) — which is why the base erosion is, at its core, a transfer pricing question (the price, the profit, the base — the three the BEPS project’s thread), and why the TP team is the base erosion’s front line (the documentation, the benchmark, the defence — the TP audit defense the base erosion’s examination). The [BEPS initiative guide] (/docs/fundamentals/beps-initiative) carries the 15 actions (the overview, the Actions 7/8-10/13/14/15, the India implementation status) — the base erosion’s response map.

Base erosion, in one mechanism:
  1. The base (the jurisdiction’s taxable-profit base — the tax collected on it)
  2. The shift (the profit shifted out — the transfer price, the royalty, the fee — the price not arm’s length)
  3. The erosion (the base reduced — the profit out, the tax collected reduced)
  4. The response (the BEPS actions — the documentation (Action 13), the intangibles (Actions 8-10), the floor (Pillar Two) — the detector, the correction, the defence)

The element	The content
The base	The jurisdiction’s taxable-profit base — the profit taxed in the jurisdiction, the tax collected on it
The shift	The profit shifted out — the transfer price, the royalty, the fee — the price not arm’s length (the comparability failure, the profit out of the base)
The erosion	The base reduced — the profit shifted out, the tax collected reduced (the erosion — the base’s reduction)
The response	The BEPS actions — the documentation (Action 13 — the CbCR/Master File/Local File, the detector), the intangibles (Actions 8-10 — the DEMPE, the residual profit, the correction), the Pillar Two (the 15% floor, the defence)

The working read (the BEPS initiative guide): base erosion is the BEPS project’s target, and the 15 actions are the response — the thread: the hybrid mismatch (Action 2 — the treaty / the domestic mismatch, the double non-taxation, the structural base erosion), the aggressive intangibles (Actions 8-10 — the IP the profit’s carrier, the [DEMPE] (/docs/glossary/dempe) the value creation the allocation, the residual profit the entrepreneurial return the priced — the intangibles the base erosion’s vehicle), the documentation (Action 13 — the CbCR, the Master File, the [Local File] (/docs/glossary/local-file-rule-10d) — the transparency the base erosion’s detector, the data quality the discipline), and the Pillar Two (the 15% floor — the final defence, the GloBE computation the top-up on the sub-15% base, the base erosion the last response). The core is the transfer price: the base erosion works through the price (the arm’s length price the test, the not-arm’s-length price the shift, the [comparability] (/docs/glossary/comparability) the failure) — and the [TP team] (/docs/fundamentals/what-is-transfer-pricing) is the front line (the documentation, the [benchmark] (/docs/benchmarking/benchmarking-study-guide), the [defence] (/docs/documentation/tp-audit-defense) — the base erosion’s examination the TPO / the authority’s scrutiny, the audit the base erosion’s detection). The BEPS initiative guide the 15 actions (the overview, the Actions 7/8-10/13/14/15, the India implementation status) — the base erosion’s response map, the Pillar Two the floor the response’s end.

Example

A group: the Indian manufacturing sub (the production, the real economic activity — the payroll, the PP&E, the substance) and the overseas IP holding (the IP, the intangibles — the value the IP carries). The base erosion (the pre-BEPS structure): the Indian sub pays the IP holding a royalty (the IP use fee) at a high rate (the royalty the Indian sub’s profit shifted out to the IP holding — the low-rate jurisdiction, the base the Indian eroded). The BEPS response (the post-BEPS scrutiny):

The layer	The BEPS response
The documentation (Action 13)	The CbCR (the Indian row, the IP holding’s row — the profit the allocation visible, the data quality the discipline) — the detector (the shift the CbCR’s rows the anomaly)
The intangibles (Actions 8-10)	The DEMPE (the value creation the Indian sub’s production — the DEMPE the Indian performed, the IP holding’s exploitation the residual the allocation) — the correction (the royalty the DEMPE-based rate, the value the creation the priced)
The floor (Pillar Two)	The GloBE (the IP holding’s jurisdictional ETR — the low (the royalty income, the low tax) — the top-up the sub-15% the charge) — the defence (the base the floor the protected)

The point: the base erosion (the royalty the profit shifted out of the Indian base) is detected (the CbCR’s rows, the anomaly), corrected (the DEMPE the royalty the value creation the priced), and floored (the Pillar Two the low-ETR jurisdiction the top-up) — the three layers, the BEPS response the base erosion’s end (the [BEPS initiative guide] (/docs/fundamentals/beps-initiative) the 15 actions, the [Pillar Two guide] (/docs/pillar-two/pillar-two-guide) the floor).

See also

• BEPS
• The BEPS Initiative — What TP Teams Must Know
• GloBE
• Intangibles TP Guide

FAQ

What is base erosion, and how is it different from profit shifting? They are the two faces of the same practice (the BEPS project is named for both — the Base Erosion and Profit Shifting): base erosion is the effect (the jurisdiction’s tax base reduced — the profit shifted out, the base eroded, the tax collected reduced); profit shifting is the act (the profit moved — the transfer price, the royalty, the fee — the profit from the high-tax to the low-tax jurisdiction). The shift (the act) causes the erosion (the effect) — the two, the one practice’s mechanism and consequence. The [BEPS initiative guide] (/docs/fundamentals/beps-initiative) the 15 actions (the response to both — the shift the corrected (the intangibles, the pricing), the erosion the floored (the Pillar Two, the 15%)).

How does base erosion work through the transfer price? The base erosion works through the transfer price (the [arm’s length] (/docs/glossary/alp) price the test): the profit shifted out of the base is the profit the price shifted (the royalty the high rate — the profit out of the base, the royalty the shift’s vehicle; the service fee the high — the same); the not-arm’s-length price (the [comparability] (/docs/glossary/comparability) failure, the price not what an independent would charge) is the shift (the profit out, the base eroded). The core: the base erosion is, at its core, a transfer pricing question (the price, the profit, the base — the three the BEPS thread) — and the TP team is the front line (the documentation, the benchmark, the defence — the TP audit defense the examination).

What is the BEPS response to base erosion — the actions? The [BEPS] (/docs/glossary/beps) 15 actions (the [BEPS initiative guide] (/docs/fundamentals/beps-initiative) the map): the hybrid mismatch (Action 2 — the structural base erosion, the double non-taxation), the aggressive intangibles (Actions 8-10 — the DEMPE the value creation the allocation, the [residual profit] (/docs/glossary/residual-profit) the entrepreneurial return the priced — the intangibles the vehicle the corrected), the documentation (Action 13 — the CbCR, the [Master File] (/docs/glossary/master-file-rule-10da), the [Local File] (/docs/glossary/local-file-rule-10d) — the transparency the detector), and the Pillar Two (the 15% floor — the GloBE computation the top-up on the sub-15% base, the final defence). The thread: the shift the corrected (the pricing, the intangibles), the erosion the detected (the documentation) and floored (the Pillar Two) — the base erosion’s response the 15 actions’ end.