LONDON/MOSCOW (Reuters) - The G20 backed a "fundamental" rethink of the rules on taxing multinational corporations on Friday, taking aim at loopholes used by companies such as Apple (AAPL.O) and Google (GOOG.O) to avoid billions of dollars in taxes.
The group of leading economies released an action plan drawn up by the Organisation for Economic Co-operation and Development (OECD) that said the existing system didn't work, especially when it came to taxing companies that trade online.
"It is a major breakthrough and is at the heart of the social contract," France's finance minister, Pierre Moscovici, told a news conference on the sidelines of a meeting of finance ministers from the Group of 20 leading nations in Moscow.
"People and companies have to pay the taxes that are due. It's the only way to operate in a fair and competitive society," added British finance minister George Osborne.
Large budget deficits and public anger at inter-company structures designed to channel profits into tax havens have prodded governments to act.
Google, Apple and others say they follow the law wherever they operate and pay what tax is due but also have a duty to shareholders to organize their affairs in a tax-efficient way.
Business groups welcomed the international approach being taken by the G20, saying unilateral action could hinder cross border trade and investment, but they advised caution in changing the current rules.
British business lobby group the CBI said it supported an examination of the loopholes that the OECD said facilitated profit shifting but questioned whether the OECD had "proven serious base erosion and profit shifting issues caused by these structures".
Mark Nebergall, President of the Software Finance & Tax Executives Council, which represents companies including tech giant Microsoft (MSFT.O), dismissed the accusations of profit shifting often leveled against his industry and warned there was a risk any OECD action would fall foul of "the law of unintended consequences".
But Pascal Saint-Amans, Director of the OECD's Centre for Tax Policy, said the existing rules, which date back to the League of Nations in the 1930s, had led to a "golden era" of tax avoidance.
He said governments' frustration with companies' aggressive tax avoidance provided a "once in a century" opportunity for action.
The OECD, which advises its mainly rich members on tax and economic policy, has two years to come up with specific measures that can be adopted internationally.
The OECD identified a raft of loopholes widely used by companies in the technology, pharmaceutical and consumer goods sectors, and Saint-Amans said the success of the project could be measured by whether there is a rise in the effective tax rates businesses pay.
In future, countries may have more rights to ignore contrived inter-company transactions created to shift profits offshore. New rules will seek to put more emphasis on economic substance, the Paris-based think tank said.
"(Governments) say we cannot be bound by pure contractual arrangements. It's not possible to only allocate the profit through only contractual arrangements," Saint-Amans said.
Business lobby groups such as the CBI and the United States Council for International Business (USCIB) have previously opposed OECD moves that could have tackled tax avoidance, saying the measures would also hit job creation and innovation.
Non-governmental organizations, especially those focused on development in poorer nations, welcomed the OECD's recognition of the shortcomings in the international tax system and the commitment to take action.
But Professor Sol Picciotto of the tax Justice Network questioned whether governments would take action in the face of opposition from business that would likely follow the tabling of any firm proposals.
Nebergall added that the tendency of governments to seek to attract foreign investment by lowering taxes could also make it hard to reach international agreement.
"Tax competition will be an issue," he said.
As if on cue, Osborne announced on Friday that he hoped to lure investment into Britain's nascent shale gas industry by offering a tax regime that was "the most generous for shale in the world".
Some tax advisors questioned whether the U.S. could push through Congress the kinds of changes that the OECD might recommend, given the deep divides on Capitol Hill on taxation.
Senator Carl Levin, whose investigations into Apple Inc and other U.S. multinationals have helped propel corporate tax avoidance to the top of the international agenda, welcomed the action plan and called on his peers to support it.
"And it's long overdue for Congress to close outrageous corporate tax loopholes, increase tax fairness," he said in a statement.
Saint-Amans noted that all OECD members including Switzerland, Ireland and the Netherlands, which have been described as tax havens by lawmakers on both sides of the Atlantic, had backed the action plan.
Among the areas that need to be addressed is the practice of companies avoiding creating tax residences or 'permanent establishments' in countries where they have major operations.
The OECD also criticized the way companies designate units in tax havens as holders of group funds, patents or brands that can then be lent or licensed, for generous fees, to affiliates in countries where customers or factories are located. This ensures little profit is reported in higher tax jurisdictions.
International treaties designed to avoid double taxation of profits earned from cross-border activities but which have been used to avoid any taxation are also under scrutiny. Saint-Amans said protocols to amend existing treaties could be developed to stop such "double non-taxation".
He added that representatives of OECD and G20 members who helped draft the plan had rejected a more radical idea favored by some non-governmental groups that would split multinationals' profits among the different countries where they operate, according to an agreed formula, with each country assessing its share of profit.
Editing by Mike Peacock and Will Waterman