Tax justice, the new Washington consensus?

Cross-posted from Tax Justice Network.
I had the honour of giving a keynote address at the World Bank/International Monetary Fund annual meetings on 15th October 2017, for an event entitled ‘Technical challenges and solutions for taxing wealth in developing countries’ – which gave the impression that a new Washington consensus on tax justice may be emerging.

My slides and the video, kindly provided by the Bank, are below. Following a fascinating speech from Brooke Harrington of Copenhagen Business School on the role of wealth managers in creating anonymous, un-taxed assets, I ran through the development of the tax justice movement and the rise of the core policy platform (the ABC of tax transparency), highlighting the progress that has been made but also the extent to which lower-income countries remain excluded from the benefits – and what is necessary to enable effective wealth taxation.

The event, and the discussions with a variety of experts and senior figures from the two Bretton Woods institutions (BWIs), made clear just how far both the Bank and the Fund have moved towards tax justice – and also highlighted some key areas where they need to make progress now.

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EC tax ruling: Belgian opportunity, big 4 at risk?

There’s been a good deal of coverage of the European Commission decision that Belgium’s ‘excess profit’ tax scheme is illegal, and so it must claw back unpaid tax from companies that were able to achieve double non-taxation on profits shifted into the jurisdiction. The focus has largely been on the implications for specific companies. It’s worth thinking more about different jurisdictions involved, and the possible risks facing the big 4 audit firms.

Basis of the EC tax ruling: Guaranteed double non-taxation

First, the ruling seems pretty clear cut, in principle at least, because the ‘excess profit’ approach is so transparently designed to engineer double non-taxation. Much like Ireland’s bad Apple agreement which accepted that the jurisdiction was not entitled to a share of profits that were shifted in but resulted from activity elsewhere, the Belgium scheme determined that any ‘excess profits’ would be exempt from tax.

The scheme defined excess profits as those bigger than an equivalent, purely domestic business would report – in other words, the result of a multinational’s activity elsewhere. Since these were by definition being reported in Belgium and not elsewhere, double non-taxation was the aim and indeed the guaranteed result. Bingo!

Whereas other cases (e.g. LuxLeaks) involved tailored responses to individual companies, the Belgium approach was consistent leading the Commission to conclude simply that:

We did not have to investigate the specific tax rulings to each company that are based on the scheme. They are automatically illegal.

Why Belgium? Who else?

As I said in various interviews, ‘België is niet de grote vis’ (Belgium is not the big fish), and the ruling is fascinating more because of the potential scale if a similar demand for clawbacks were applied to the bigger EU players in the profit-poaching business.

Our study of US multinationals, which we find to shift 25-30% of their global profits, shows that the majority of shifted profit goes through six jurisdictions: outside the EU Bermuda, Singapore and Switzerland; and inside, Ireland, Luxembourg and Netherlands. [New work from the US Joint Committee on Taxation, with access to firm-level rather than aggregate data, puts Cayman ahead of Singapore in the top six; ut the EU jurisdictions remain central.] Using global balance sheet data (predominantly capturing European multinationals), our earlier study confirmed the same three EU jurisdictions and also highlighted the roles of Belgium and Austria.

The figure, drawing from the results of Cobham & Loretz, 2014 using Orbis data, shows the share of declared profit which would be stripped away from each jurisdiction, if profits were to be aligned with each of the measures of multinationals’ economic activity (which was the declared aim of the OECD BEPS initiative). Belgium would stand to lose 25-50% of its declared profits under any measure of activity except intangible assets, a relatively extreme position.

Cobham Loretz 2014 tab4fig-Bel

Consistent with this view of Belgium as a location for profit-shifting by European multinationals in particular, the European Commission states that the clawback will amount to €700m, of which the bulk – around €500m – relates to European multinationals.

So while Belgium may not be such a grote vis internationally – it doesn’t register for US multinationals in the aggregate, for example – it’s certainly big enough for the European Commission to have bothered with.

But the really big money would be at stake if the same type of decision were to be taken with respect to the profit-shifting into Ireland, Luxembourg and the Netherlands. Of these, the relative complexity of mechanisms in the Netherlands (using trusts and special purpose entities for example, rather than blunt rulings) may make it a harder target. But rulings in Ireland and Luxembourg are already in the Commission’s sights. If the doubly non-taxed profits here were required to be retrospectively taxed at applicable statutory rates, the effects would be substantial indeed.

Company calculations

What would that look like from the point of view of companies involved? Consider the Belgian case. Gross profit that might have faced an effective rate of 15-20%, say, in the countries where the underlying economic activity took place, was shifted into Belgium and declared as ‘excess’ and therefore not subject to tax – in any jurisdiction.

Applying the unmitigated Belgian statutory rate instead will have two main results. First, the overall tax paid will almost certainly (assuming interest is dealt with appropriately) be higher than if neither the scheme itself, nor any alternate profit-shifting arrangement, had been used. The Commission notes that for the Belgian companies used, 50-90% of profits were ruled as ‘excess’; so it’s unsurprising that companies like AB InBev are assessing their options.

The second effect is a more forward-looking one: the changes that the Commission decision may imply for current and future profit-shifting strategies. If the possibility exists for retrospective taxation on shifted profits, do companies become less aggressive? Or is there simply a premium put on the more complex and/or iron-clad methods – for example, will Netherlands structures become even more dominant? Will it favour the UK’s CFC and patent box mechanisms, now with the OECD BEPS mark of acceptability, over other (smaller) jurisdictions?

Big 4 risks

A further impact is that on the big 4 and other professional services firms that may have provided the advice on which basis multinationals made the particular profit-shifting decisions – and themselves profited substantially in doing so. If there is a case for companies to sue over bad advice in the Belgian case, imagine the exposure – for example – of PwC, if a substantial share of LuxLeaks cases were equivalently unwound? If so then at some point, given the vast scale of profit-shifting and the potential tax liability if statutory rates rather than 0-1% were to be applied, a question of financial viability could even arise.

Looking forward again, will multinationals approach such tax advice differently if the possibility of retrospective action remains? Does this simply reduce the value of the advice, or change the willingness to consider it?

And for the big 4 and their staff, with the nature – and some of the risks – of selling profit–shifting advice now impossible to ignore, what are the ethical considerations?

An opportunity for Belgium?

Finally, what can Belgium do? Not such a big fish perhaps, but definitely on the hook. The immediate upside is unexpected tax revenue; the downsides are many.

First, the country stands clearly exposed for antisocial behaviour: profit-poaching in a time of austerity, when the social costs of lost revenues in EU partner countries could not be clearer. Second, trust: how will business view the jurisdiction after this reverse? And third, the stability of the model: given the substantial share of profit booked in the country that appears to have been unwarranted, what are the tax implications of losing the right to tax the non-‘excess’ element?

Here’s the opportunity. The one-off revenues from forcible clawbacks should be sufficient to cover for some time the losses from reduced inward profit-shifting. The question is whether Belgium aims to retain a role in profit-shifting – if it tries to appeal the ruling, struggles to regain credibility with multinationals, introduces and promotes new (OECD- and EC-compliant) mechanisms… or if instead, it takes the opportunity of being ‘caught’, and decides to chart a path towards less anti-social fiscal behaviour.

This could, for example, involve taking a lead in pushing for greater transparency of tax rulings; and in advocating for full enactment of the proposed Common Consolidated Corporate Tax Base (CCCTB) and associated proposal for formulary apportionment within the EU, which would eliminate much of the current profit-shifting; and of course publishing country-by-country reporting of multinationals, which would make the extent and direction of it transparent.

Tax Justice Research Bulletin 1(6)

June 2015. Surprising everyone by actually arriving within the stated month, here’s the sixth Tax Justice Research Bulletin – a monthly series dedicated to tracking the latest developments in policy-relevant research on national and international tax, available in full over at TJN.

This issue looks at a new paper in The Lancet on the potential links between direct taxation and health outcomes including child mortality; and at research on the suitability or otherwise of accounting data for tax purposes. The Spotlight falls on tobacco taxes, the shameful manipulation of economic arguments by Big Tobacco, and a paper entitled The Single Best Health Policy in the World: Tobacco Taxes. If this issue was any more health-y, you could put a vest on it and send it out to do a half-Iron Man with Owen Barder.

June’s tune, via Sarah Knott, is Jawad Ahmad’s ‘Bhola kya karey – Wo jiay ya marey’. 

The main research event  of the month, nay the year, is the TJN annual research workshop at City University, which you’ve either just attended (great to see you!) or just missed (boo).

This year’s thematic focus was on the flawed notion of “competition” between nation states, and there’s a cracking set of papers from a whole range of disciplines (from philosophy to accounting) and backgrounds (including practitioners, civil society researchers and academics from universities from Hong Kong to Barcelona); and touching on all sorts of tax and non-tax aspects of ‘competition’, with insights into everything from Guernsey’s dominant investment position in annexed Crimea, to the ‘voluntariness’ of migration; and from regulatory responses of commodity traders to the role of KPMG in systemic regulatory arbitrage.

The workshop ended with a really engaged discussion about the relative merits of taking on the entire logic of state competition, versus the practical value of keeping focus on tax.

There’s certainly an important challenge in reclaiming the word ‘competition’ in this context, which has been used almost as a synonym for ‘no government intervention’ – when ensuring competition may well require greater intervention, in order to prevent power abuses leading to further concentration. The creators of the ‘Global Competitiveness Index’, for example, probably don’t see themselves as advocates for a world regulatory body, preventing unfair competition between states…

Submissions for the Bulletin, including tax-related melodic suggestions, are most welcome.

 

Is accounting data any use (for tax)?

From the Tax Justice Research Bulletin 1(6).

One of many happy things about the Tax Justice Network is the range of experts involved, by discipline and by professional background. And one of the great things this gives rise to is analysis that is often so far ahead of the immediate public policy discussion that you might not even be able to see it from over there. For example…

Two TJN stalwarts from the accounting side – one an academic, Prof. Prem Sikka, and the other practitioner-turned-campaigner, Richard Murphy – have come together to address the prickly question of whether accounting data can actually be part of the solution to the corporate tax base erosion and profit shifting of multinationals.

Their working paper is published by the International Centre for Tax and Development, in its important series addressing unitary taxation. [Full disclosure, just in case it’s not completely clear already that I’m biased: I have an unrelated paper in that project, and am working with the ICTD on other stuff too.]

A little background: TJN started up in 2003 with a project to promote country-by-country reporting by multinationals (notably, Richard’s draft standard), as a major transparency tool to limit tax abuse. Since then this esoteric proposal has moved steadily from the extremist fringes to centre stage, with the 2013 meetings of the G8 and G20 directing the OECD to produce such a standard for global use.

One effect of this is that accounting data has probably become more central to high-level political proposals (and scrutiny) than – well, perhaps ever. (I still remember a meeting of the International Accounting Standards Board in the mid-late 2000s, marked by the then-revolutionary presence of NGOs which pointed the way forward to that greater public interest. Happy days…)

The tendency, conscious or otherwise, has been to assume that accounting data is accurate (though not necessarily addressing the right things), and at least broadly consistent across jurisdictions. As such, it can provide the basis for powerful measure such as country-by-country reporting (for both red-flagging by tax authorities, and holding to account by civil society).

Sikka Murphy 2015 tab1 abridgedBut if there’s one, top line message from the new Sikka & Murphy (2015), it’s this: accounting data does not at present provide a good basis for this greater understanding of tax. Rather, accounting data not only provides a means by which tax positions can be obscured from view; it also provides an additional vector by which tax positions can be manipulated.

How so? The abridged Table 1 gives a sense of it (scroll down or click for larger version). The differences around the world in accounting treatment for tax purposes are manifold and fundamental. The opportunities are legion for multinationals to exploit differences in national treatment, in order to achieve preferred global tax outcomes.

Now since “no jurisdiction which we can identify relies upon unadjusted traditional accounting profit as a basis for the taxation of corporate income”, and reliance on International Financial Reporting Standards would exacerbate not ameliorate the problem, the authors argue that “tax-specific measures of income and expenses for taxation purposes need to be defined” – not least, for any proposal for a full shift towards unitary taxation of MNEs. Their specific suggestion is this:

“[W]e think it possible that a taxation base for unitary taxation that is broadly, but not precisely, equivalent to the accounting concept of EBITDA (Earnings Before Interest, Taxation, Depreciation and Amortisation) could be developed. This resulting tax base before offset of locally-determined allowances could then be apportioned in accordance with a formula that is likely to exclude assets, because relief for expenditure on capital will be given locally and capital costs do not therefore need to be considered for formula purposes.”

Even more than usual, this summary is nowhere close to doing justice to the deep and rich set of questions that the paper raises. It’s a difficult paper, technically challenging in more than one way and requiring the reader to think well ahead. And it’s an important paper. We may not hear much about it for a while, but it wouldn’t be at all surprising to see it being referred back to as a foundational piece of problematisation in years to come.
Sikka Murphy 2015 tab1 abridged

Tax professionals: Who makes the international rules?

From the Tax Justice Research Bulletin 1(5).

Last month, TJRB 1(4) looked at the OECD’s review of research on base erosion and profit-shifting (BEPS) by multinational enterprises (MNEs). That review revealed a dearth of findings in a number of areas, as well as broad consensus on the importance of the problem. Untouched in that review, and little researched in generally, is the process by which policy on BEPS is made.

The historical record, back to the League of Nations and beyond, has been laid out by Prof. Sol Picciotto. Sol, one of our senior advisers, now leads the BEPS Monitoring Group, the hub for technical submissions to BEPS from civil society.  And the BEPS process itself has now been subject to a detailed process analysis, in a seriously impressive Copenhagen Business School Master’s thesis by Rasmus Corlin Christensen.

The main focus is on BEPS 13, which deals with transfer pricing documentation including country-by-country reporting (CBCR), and the findings reflect many interviews as well as analysis of submissions and consultations. The summary of literature, and detail of the methods, are well worth the time.
BEPS 13 comment letters - Corlin Christensen figs1-2Figures 1 and 2 show the simple range of submissions to BEPS 13, in terms of organisation type and geographical origin. There’s little surprise to find that less than 10% of submissions came from academia and civil society; and even less from South America, Africa and Asia combined.

Similarly, figures 3 and 4 confirm that business groups and professional services firms expressed preference for much more restricted transfer pricing documentation than did academia or civil society. Figure 5 shows tax practitioners with the greatest intra-group variation of views expressed, compared to other private sector groupings, with business lobbies the least; while academia provided the most varied range of views, and civil society the least. The latter point is perhaps unsurprising given the technical nature of the process (hence relatively limited engagement); and that BEPS 13 addresses an area in which civil society consensus has emerged over a decade or so. {Indeed, the content of BEPS 13 is in good part a product of successful influence by civil society in non-specialist, political processes, not least in the UK – but that would be a whole other study.}

BEPS 13 comment letters - Corlin Christensen figs3-5The analysis goes to a much more detailed level, tracing the paths of leading individuals in the process, identifying ‘professional competition’ as a key factor, where “influence in highly technical policy discussions is contingent upon expertise (being able to speak authoritatively) and networks (being listened to)… I distinguish two types of influential professional: career diverse professionals (“octopuses”) and well-connected specialists (“arrows”). The former are influential because of their varied expertise, the latter because they are respected through key tax/transfer pricing networks.”  In figure 16 (click to expand, as ever), the red dots indicate organisations with a ‘managing professional’ who is influential in the process.

BEPS 13 comment letters - Corlin Christensen fig16The full thesis contains a great deal more, including on the career paths of influentials. These are just some of the broad conclusions:

[A]nalysis of the BEPS Action 13 consultation shows that it was dominated by Western tax advisers and business representatives, that there was a general preference for a limited [transfer pricing documentation] package, and that there was significant variation in attitudes between similar participating organisations. Furthermore, the discussions were highly complex, requiring substantial technical expertise, and thus limiting the range of participating organisations… Looking at the pool of BEPS Action 13 professionals’ expertises, I find that while legal and private sector views are important in the reform, several other expertises are also relevant, signifying the need for varied expertise in order to obtain policy influence…

Finally, the significance of access to the right expertise and networks is visible in another articulation of professional competition in BEPS Action 13: lobby centres. Lobby centres are specific interest groups where different professionals and organisations collectively engage the policy process, spearheaded by one particular professional, who most often is influential. Peripheral professionals and groups without access will use this lobbying strategy to leverage the expertise and networks of influential professionals. This strategy highlights the importance of being able to access the right professional expertise and networks in order to make engage successfully in policy debates. However, this importance is not sufficiently recognised by the interest group literature, which emphasises organisational finances or issue attributes.

Tax Justice Research Bulletin 1(3)

March 2015. The third Tax Justice Research Bulletin is out, catch it in its full glory (with backing track suggested by Christian Hallum) on its TJN home.

Mahon2015 fig2This issue looks at new papers on the responsibilities of tax professionals in respect of abusive tax behaviour and corruption; and on the parallels between the 1974 banking crisis and that of 2008, and policy lessons that emerge. The Spotlight considers contrasting views on tax and freedom.

One thing to flag: a call for papers from UNU-WIDER, who are stepping up their interest in tax. The call is open until 30 April, and is part of WIDER’s new project on ‘The economics and politics of taxation and social protection’ which is also worth a look (includes call for research proposals and researcher vacancies).

As ever, ideas for the Bulletin are most welcome – including suggested music.

PS. Congratulations to tax lawyer @jolyonmaugham on formally becoming a QC this month – now so silky he could feature in Barcelona’s midfield.

On the moral responsibilities of tax professionals

Why is abusive tax avoidance the prerogative of wealthy individuals and large corporations? Primarily because a very high level of technical expertise is required to establish and manage an effective tax avoidance strategy, and that expertise does not come cheap. A large and multifaceted industry of professionals – including lawyers, accountants, finance specialists, bankers and offshore service experts – thrive on creating ‘tax benefits’ for those who can afford their services…

Our primary aim is to argue that tax professionals […] have specific responsibilities to help reduce the incidence of abusive tax avoidance and remedy its negative consequences.

This is the basis for a new paper, ‘Abusive tax avoidance and institutional corruption: The responsibilities of tax professionals’, by Gillian Brock and Hamish Russell. Brock is one of the world’s foremost cosmopolitan philosophers, and an earlier version of the paper won the Amartya Sen prize.

The paper builds on Lawrence Lessig’s work on institutional corruption, defined as the illegitimate weakening of an institution, and especially of public trust in it. The paper highlights the role of various tax professionals in corrupting fiscal institutions, creates a framework for assigning remedial responsibilities, and applies it to three groups in particular: accountants (the big 4 firms), lawyers and financial advisors.

brock russell 2015 - big4In each case, Brock and Russell explore the causal contribution of each group of professionals, the extent to which they benefit, and their capacity to bring about remedy. The figure outlines the structure of the argument, for the case of big 4 firms, and points to the type of collective action that might be fair to expect, as a moral response to the situation.

Some may query the actual scale of abusive avoidance in which big 4 firms are complicit, or the benefits they derive. Others will question the policy recommendations: if part of the weakness of tax rules results from lobbying activities of tax professionals, is it reasonable to expect the same professionals to act from their position of power to reduce the opportunities that exist?

But the paper provides a logical clarity to what many will already feel: that (some/too many) tax professionals have (sometimes/for too long) benefited from exploiting the weakness of tax systems; and that ultimately any important steps towards progress will need to be taken with the acquiescence, if not the active leadership, of at least some professional groups.