corresponding taxable period, rather than the statutory rate. This would ensure that the rule provides protection in cases where diverted profits can be covered by losses brought forward. However, it may be argued that this goes too far if the losses are the results of genuine commercial operations. This is an aspect of the rule that would benefit from further analysis. If the effective rate in the other country is lower than the domestic rate by sufficient margin, then the entity is potentially subject to the DPR charge (bearing in mind that this will be embedded in the overall liability to CIT of the resident entity and/or PE).

Defining the “lower rate” of taxation will give a country one way of adjusting the scope of the anti-diversion rule. Setting the rate at a low level would focus the rule on no or low tax countries and arrangements that largely extinguish taxable profits. This would also make it easier to present the rule as clearly targeted at low tax jurisdictions, or arrangements that exploit gaps in the tax systems of other countries for the purposes of tax avoidance. The scope of the measure can be further limited by setting the level of profitability that is proposed as a trigger for the rule in the next section high.

# Defining diversion

Once the parties and/or transactions to which the rule applies are identified, it would then be necessary to determine if there was tax driven diversion. The DPTs in the UK and Australia do this using the concept of insufficient economic substance, which is in turn linked to the tax driven nature of the transaction, or arrangements. In both the UK and Australia, where it is possible to do so, transfer pricing rules can be used to determine if there has been diversion and the amount involved. Alternatively, the transaction or arrangements can be reconstructed on a just and reasonable basis.

An anti-diversion rule that is incorporated in the CIT will supplement, rather than duplicate the transfer pricing rules that should already be part of the system. The anti-diversion rule should target transactions and arrangements which result in profits that would have been taxable in the country, being taxed elsewhere at an unacceptably low rate. The onus would then normally be on taxpayers to demonstrate that the transaction was not tax motivated, perhaps by showing that the non-tax benefits are greater than the tax saving, following the UK approach.

It may be sufficient to limit the anti-diversion rule to these demonstrably tax motivated transactions and arrangements but, once again, this would involve the exercise of considerable judgement and complex analysis of the facts. How might the rule be simplified to address the needs of developing countries? This could be done by defining the lowly taxed entities that will be subject to the DPR charge more mechanically. Typically, target entities in low tax jurisdictions have unusually high rates of return from relatively low cost and asset bases. This is an inevitable consequence of maximizing the income enjoying low taxation. The DPR could include a rule that entities subject to a low rate of taxation, as defined, and that generate “superprofits”, shall be subject to the DPR charge. Given the way the mechanical approach works, the charge would apply to any related entity, regardless of whether it has any direct dealings with taxpayers in the country.

The definitions of super profits could be set in an absolute way (profits are greater than X times operating costs for example) or in a relative way (profits are greater than X times the profit margin of the MNE as a whole). An analysis of reported results of MNEs could be used to determine the definition of what are super profits, possibly differentiating between key economic sectors. The precise ratio chosen is another way in which the impact of the DPR charge can be adjusted by countries. At its heart is a simple proposition – beyond a certain 18