INTERNATIONAL TAXATION-----HOW FAR WILL BEPS SUCCEED?
By Minoru Nakazato
Professor of Law,
Graduate School of Law, the University of Tokyo《Professor J. Mark Ramseyer of Harvard Law School has kindly translated
the Japanese version of this paper into English. I thank him for thiselaborate English version.》
Two men stand at the center of Raphael's fresco, "The School ofAthens." Plato points his finger to the sky. Aristotle extends the palm of
his hand facing down. Through their gestures, Raphael contrasts theirrespective approaches to philosophy.
Plato looked to an idealized,incorporeal world. Aristotle focused the material realm.
Through history, humans have shifted between the two poles.
Gothic cathedrals soar toward the heavens, for example, but stand rooted in
the Aristotelian focus on the concrete and particular. On the basilica ofSaint Denis (housing the tombs of generations of French monarchs and theirfamilies) are chiseled the words: "mens hebes ad verum per materialia
surgit." As translated by the German art historian Erwin Panofsky, thesentence reads: "The dull mind, through material things, rises to truth."1So it is with the Aristotelian spirit behind Gothic aspirations: To reach thedivine truth, imperfect human beings must follow the path that leads throughthe material world.
At a far more mundane level, so too is it with the international taxstructure. The effect that the structure has or does not have turns firmly -if not exclusively -- on the material world. Through the massive BEPS
(Base Erosion and Profit Shifting) project, OECD officials are attempting toreform those international structures. To gauge their likely success, weneed fundamentally to understand the shape of the human institutions that1

Erwin
Panofsky,
Abbot
Suger,46-47,availableat:
http://ldysinger.stjohnsem.edu/@texts2/1140_suger/02_suger-txt1.htm. [We shouldcheck the citation against Panofsky's actual book if the lecture is to be published. -MR]1

structure the material world within which governments, firms, and individual
taxpayers pursue their activities.
I.

Introduction
BEPS represents the attempt by the OECD member nations to stanch
the erosion of their corporate tax revenue. Acting collectively, thesenations now seek to reform their institutional rules and procedures. The
project has been a topic for discussion at the G8 and G20, and is a matter
about which President Obama has spoken passionately. OECD officials haveworked hard on the project for several years now, and are scheduled todisclose their remaining plans this fall.
The Japanese government has involved itself heavily in BEPS.
Deputy Prime Minister Taro Aso spoke in impassioned tones about theproject, and as chair of the OECD Tax Committee (and Vice Minister ofFinance for International Affairs at the Japanese Ministry of Finance),
Masatsugu Asakawa worked hard to implement Aso's hopes. In significant
part because of Asakawa's efforts, the difficult project will come toconclusion this fall. It will mark an epoch-making event for Japan, but
carries potentially significant consequences for other developed countries aswell.
Practitioners need to know what impact BEPS will likely have on
government and business behavior. On the the realizability of BEPS' goals,
however, opinions differ. In part, the disagreement reflects the very breadthand ambition of the program. Through it, OECD hopes to addressinternational tax evasion comprehensively. Consistent with that ambition,
it will soon publish a wide range of actual proposals. The sheer scale of theoutput, however, suggests that the plans will include two very different setsof proposals: carefully planned, substantively implementable measuresthat reduce specific types of international tax avoidance, and congenitally
unworkable proposals that reflect little more than blind hope.
Today, I will outline several factors that I believe may interfere with
the OECD's attempt to limit international tax avoidance. Please understand,of course, that I speak only from personal observation, and can offer only
speculative conjectures. To date, however, most observers have discussed
the core elements of BEPS. Yet whether BEPS effectively cabins tax
avoidance does not just depend on its core elements. It also depends on the2legal and institutional context within which countries implement the BEPS
proposals. In the lecture that follows, I will focus on that institutional
context, and explore several elements that I (speaking personally andspeculatively) believe may threaten the effective scope of BEPS.
II. Threats to the Realization of BEPSA. National Sovereignty
The biggest obstacle to BEPS lies in the nature of nationalsovereignty itself. Through BEPS, the OECD promises a revolution ininternational taxation. Unfortunately for BEPS' proponents, one classic
maxim continues to describe the political world in which we live: "Rex est
Imperator in Regno suo." The king rules his own kingdom; he rules nowhere else.
Sovereignty first took ideational shape in the 16th century work ofJean Bodin, but took concrete form in the 1648 Peace of Westphalia.(1)The treaty ended the Thirty Years' War, brought peace between Spain andHolland, and dismantled the Holy Roman Empire (never holy, as Voltaireobserved, and not even Roman or an empire). Vertically, the Peaceestablished that each prince ruled his own state, and chose the state's religion.
Horizontally, it established that each kingdom was the legal equal of every
other kingdom.
The sovereignty that Bodin envisioned and the Peace implemented
lies at the heart of modern international law. Under basic international law
principles, all nations stand as legal equals of all others. When they wish
to bind each other legally, they do so only by entering treaties at the nationallevel.
The right to tax falls within the general scope of this nationalsovereignty. Governments can tax, but only within their national bounds.
One nation's tax office, for example, may not collect revenue within anothernation. It may not conduct investigations within another nation. It may
not levy taxes on a neighboring government. It may not levy taxes on thesovereign (e.g., the prince) of a neighboring government. It may not evenlevy taxes on another country's diplomatic corps, on internationalorganizations (e.g., the International Court of Justice), or on workers at
international organizations (e.g., U.N. bureaucrats working at UNESCO).
These Westphalian principles are basic to the modern international
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legal order. OECD and the BEPS will not likely change them anytime soon.
Even after BEPS, some people will remain tax-exempt.
Someorganizations will still be tax-exempt. And the basic national structure to
the tax system -- even to the taxation of international transactions -- will stay
as it is.
Westphalian sovereignty also lies behind the inter-state competition
that plagues the international tax order. Legally the equal of each other,modern nations routinely compete for private investment by offering lowertaxes. The competition between the wealthy developed countries and thepoorer developing countries has proven especially intense. Even afterBEPS, it will take many years before countries can tame this competition
through the requisite networks of bilateral tax treaties.
B. The International Economic Order
Seeking as it does to transform the international economic order, theBEPS project will also encounter resistance from the many parties with aninterest in that order. Under this order, public finance in the wealthy
democracies is closely tied to the private financial institutions. In Japan(see Constitution, Arts. 84, 85) as in most such democracies, the government
can neither levy taxes nor borrow money without the consent of thelegislature. In effect, when the government borrows, it offers lenders asecurity interest in its future tax receipts; in effect, because only thelegislature can tax or borrow, the legislature guarantees the repayment of thenational debt. Precisely because the legislature controls both debt and taxes,
the government can credibly promise repayment.(2)This connection between debt and taxes traces its origins to the 17thcentury English "Glorius Revolution." It is this event that both transformed
public finance and laid the institutional structure for private finance. And
by placing English public finance on a stable basis, it generated the funds
necessary for British military success. It is this revolution, in other words,
that gave rise to the English "fiscal mlitary state."(3)For our purposes, the significance of the Glorious Revolution lies in
the way it reallocated control over the English fisc.
Through theRevolution, Parliament deposed the Stuart (and Catholic) King James II, andinvited to the throne his (Protestant) daughter Mary and her Dutch husband
William of Orange. Simultaneously, Parliament took control over both4

taxes and debt. After the Revolution, English kings could neither levy taxes
nor borrow funds without Parliament's consent. Because Parliamentcontrolled taxation, it could raise the revenue necessary to repay the nationaldebt. In turn, investors who held national debt instruments could now relyon the Parliament's promise to repay the debt through future revenue.
By tying taxes to debt and placing both under the control of thelegislature, the Glorious Revolution dramatically reduced the cost of Englishdebt. The English government now presented lenders with a lower default
risk. Necessarily, it could borrow more cheaply. Rivals like France in the
18th century colonial race could not as credibly promise to repay what theyborrowered, and could not as cheaply raise funds. Able to finance its
military force more efficiently than France, England won the colonialcompetition.
In tandem with this new institutional order for public finance,
England found itself with the infrastructure necessary for private finance.
As institutions and markets developed to fund the government efficiently,
private parties found that the same institutions and markets facilitated private
investment as well. The 19th century industrial revolution and spectacularEnglish economic growth ensued. I present here only a thumb-nailsummary of English economic history, but I urge anyone with an interest tofollow the literature in the "new institutional economics" and the pioneering
work of the 1993 Nobel Prize recipient, economic historian Douglass North.2
To the extent that the BEPS reformers seek to restructure theinternational economic order, it is this 300-year tradition that they hope tochange.
The modern economic structure dates from the GloriousRevolution. It funded the British navy, it funded the industrial revolution,and it funded economic growth. It will not be an easy structure to change.
C.

International Organizations
In its attempt use BEPS to police international tax avoidance, theOECD also faces limits inposed by a variety of tax-exempt organizations.
Many non-business organizations promote religious activities and sports, ofcourse.
Others promote education, cultural activities, scholarship,2

See especially Douglass C. North & Barry R. Weingast, Constitutions andCommitment: The Evolution of Institutions Governing Public Choice in SeventeenthCentury England, 49 J. Econ. Hist. 803 (1989).
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environmental causes, and so forth. Many are tax-exempt under domestic
law, and for some organizations that tax-exemption has a broader
international basis.
The principle of "international religious freedom",(5) for example,exempts religious organizations. Yet some of these groups control massive
financial assets, and sometimes control private financial institutions as well.
They may enjoy tax-exempt status (by this international principle), and findthemselves blocking BEPS' attempts to cabin tax avoidance strategies. In
this context, note that the Vatican and U.S. governments recently concluded
agreements that obligate the Vatican's organizations to provide banking
information to the U.S.(6)This year, sports organizations have proved especially problematic.
Many democracies provide tax-exempt status to some organizations
conducting sporting events. In doing so, they follow their domestic legal
and constitutional principles. This year's problems, however, arise from thefact that the men and women administering these organizations are not allhonest. Consider the recent news about corruption among officers of theSwiss-based FIFA soccer league.(7) In bringing charges against theofficials, the Swiss authorities apparently responded to a long-standing (andapparently ever-expanding) U.S. investigation. The case does not justinvolve allegations of bribery. If the officials took bribes but did not reportthem as income, they also committed tax fraud. If the accounting firms
auditing FIFA deliberately or negligently missed evidence of the corruption,
they may be complicit in the tax-related crimes as well.(8)Similar questions plague many other tax-exempt organizations.
They purport to pursue a charitable purpose, but actually pursue other goals
too. From time to time, democratic governments rightly investigate theiractivities. One should not approach all these organizations with only
cynicism. Yet neither should one let corruption continue unchecked -- andthis is the unfortunate context within which the OECD finds itself pursuing
its reforms.
D.

Problems of Implementation
In attempting to constrain international tax avoidance, OECD
officials involved in BEPS face a set of other obstacles. First, some tax
specialists profit from the BEPS project itself. These men and women may6

have developed and marketed the very tax avoidance strategies targeted byBEPS. Although some of them may organize to fight the BEPS reform
efforts, others may find in the proposed reforms advantageous business
opportunities. For a fee, they can convey to their clients information about
the status of the BEPS proposals.
Second, transfer pricing remains a hard problem. Until the OECDannounces its proposals we will not know exactly the approach it will take.
Probably, however, it will adopt something close to the "commensurate withincome principle" as an ex post approach to the problem.
Third, tax havens present their own difficulties. Within Japan, several
economic organizations strongly oppose any attempt to police the havens byadopting an income approach rather than the entity approach (taxing only
"tainted income"). Through BEPS, the OECD may try to apply an income
approach to the problem, at least on an exceptional basis. That effort itself,
however, may then create problems of coordination with the network of tax
treaties that OECD members maintain.
Fourth, the payoff from the BEPS proposals regarding "mandatory
information disclosure" is unclear. Some OECD countries may impose
tighter disclosure requirements, but disclosure will not translate directly intohigher tax revenues. Nonetheless, the potential burden to the firms
involved can be massive. Perhaps the tax authorities believe that if they
can obtain accurate information about income now, they will be able to tax
it effectively someday in the future.
To date, the BEPS project may have augmented national tax revenues
in at least the following ways. First, to tax the local branches of foreign
corporations, Japan has adopted the "attributable income principle" (roughly
equivalent to the "effectively connected income principle"). This would
not have happened without BEPS. Second, proposals have been advanced
to apply the consumption tax to consumers and firms who download musicor other content from the internet. Third, taxpayers who take appreciatedshares of stock with them when they move abroad now pay tax on their
unrealized appreciation at the time of the move.
Fourth, the BEPS-inspired public disclosure(9) of the identify of
firms that avoid tax, and of the measures that they use has subjected the firms
to reputational sanctions. This may cause some of them to change their
behavior. Through this disclosure, for example, the public learned that7

firms like Google used a "double Irish with a Dutch sandwich" to skirt theJapanese corporate tax. They learned that Amazon avoided the Japanese
corporate tax by treating sales contracts as involving a Luxembourg
corporation rather than a Japanese corporation -- on the grounds that it
maintained only a warehouse in Japan rather than a branch office that would
qualify as a "permanent establishment." They learned that Starbucks useda Swiss trading company to restrict its corporate tax liability.
Firms have begun to worry about the resulting reputational penalties.
No longer can they employ the nominally legal tactics without cost.
Consumers disapprove. To placate their customers, some have begun torestructure their transactions. Amazon, for example, has establishedbranch offices in the U.K. and Germany. It now complies with thecorporate tax regimes there.
III.

Conclusion
The OECD officers who control BEPS do not write on a clean slate.
They propose their reforms to countries whose governments, firms, andmarkets are firmly rooted in the institutional structure established by thePeace of Westfalia and the Glorious Revolution. In proposing the changes,
they do not bring with them the power to dismantle that institutional structure.
Perhaps developments within the Peoples Republic of China will
begin to weaken that basic institutional structure.
Perhaps thosedevelopments will begin to change the three-centuries-old international legal
and economic order. Perhaps -- but that is not something that most of us in
the middle of events can readily judge. Once in great while, an observer
appears with the journalistic talent necessary to disentangle massively
complex current events. At the time of Louis-Napoleon Bonaparte's 1851
coup d'etat, Karl Marx published "The Eighteen Brumaire of Louis
Napoleon." There, he displayed a rare journalistic ability to disentangle theprofound significance of events at the very time they unfolded. But I am
not Marx, and do not claim his journalistic instinct. I would not purport toexplain the events of the day, and even less their significance for the future.
Let me suggest instead a modest conjecture: the current international
structure will continue for the immediate future. The OECD officials
behind the BEPS project do not have the political power or intellectual
resources to change existing patterns of national sovereignty. Neither do8

they have the power or resources to change public and private finance.
Probably, they do not even expect to change those fundamental institutionalstructures. But they apparently do hope to do what they can to reduce
international tax avoidance. They have published a list what they would
like to see BEPS accomplish. Some of the items on their list are matters ofeasily accomplished detail; others simply embody their hopes for the future.
We would do well not to expect major changes to the international legal andeconomic order. But we would do well not to underestimate the likely
effect of BEPS either.

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