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.

Continue reading “Tax justice, the new Washington consensus?”

05/04/2017

#CaymanTax transparency conference: speaking notes

Here are my speaking notes (3 pages) for the Cayman government’s conference on Tax Transparency in the Global Financial Services Ecosystem, 5 April. Live-tweeting when I’m not talking, at #CaymanTax.

The talk will lay out briefly the emergence of civil society voices on the issues of international tax transparency and wider tax justice, how far things have come and the challenges ahead – as well as a brief discussion of Cayman’s position. Oh, and the US emerging as the biggest global financial secrecy threat…

Cayman-speaking-notes-Apr17

17/11/2016

Tax Justice Network: A transition

Cross-posted, of course, from TJN.

After 13 years, our founding executive director John Christensen is stepping down. We’re delighted that John will stay on and become our new board chair. And I (Alex Cobham) am honoured to accept the role of chief executive at TJN.

Since I took up the post of Director of Research at the start of last year, I’ve had the chance to look back and think about the achievements so far of John and the network. In changing the political weather on these issues, those achievements are nothing short of extraordinary.

Behind the success of this radical agenda has been the use of high quality research and excellent communications to take clear, innovative solutions into the policy mainstream. The piece below sets out some of the dramatic changes that have taken place, some of the ways that John and TJN have achieved this, and a hint of the work that’s to come. (John would never be so immodest, incidentally – but please forgive me, because the achievements are far from modest.)

Continue reading “Tax Justice Network: A transition”

24/08/201625/08/2016

The US Treasury just declared tax war on Europe

Update: here’s an interview I did with Share Radio which goes through the key points.

Cross-posted from TJN.

On this quiet August day, the US Treasury has fired the first shots of a tax war with Europe. And while it’s wrapped up in a claim to defend international tax cooperation, it looks more like an attempt to prevent an effective measure against international tax-dodging – carried out, not least, by US companies. This may be a good time if you have any tax concerns to approach a company like TRS Consulting for advice, as at the same time, the US continues as the leading hold-out against the automatic exchange of individuals’ financial information; and to resist the growing tide of public registers of the beneficial ownership of companies. The stage is set for a prolonged battle. If you have a business that works internationally, someone similar to this Chicago international tax accountant may be of some assistance to your business.

By publishing a white paper titled ‘THE EUROPEAN COMMISSION’S RECENT STATE AID INVESTIGATIONS OF TRANSFER PRICING RULINGS’ (h/t @RichardRubinDC), the US has signalled an end to a period of quiet tension. This long post considers why this matters; then sets out the main contents of the white paper; before concluding with an assessment of what is possible in the ensuing hostilities.

Implications

We explore the white paper’s main points below, but note first its significance. For one thing, it confirms just how bad relationships between the US and the Commission have become on the subject of corporate tax. The white paper is the opposite of gentle diplomacy – and quite close, in parts, to an outright threat.

Second, it confirms (once again) that the OECD BEPS process has failed. Failed to rescue international tax rules by somehow making the arm’s length principle into a coherent, working approach; and failed to defuse the tensions over tax abuses, even among its own member states. (Non-members had swiftly learned not to expect their views to be given much weight; for the members to see their own agreement fall apart so quickly is less expected.)

Prior to this publication, there had been two main views on the US Treasury’s approach to corporate tax abuses. One was that Treasury was so firmly in the pockets of the more aggressive multinationals that it had effectively led their lobbying against more progressive BEPS measures such as the publication of country-by-country reporting. The other view was that Treasury was walking a line, allowing others (like the Commission) to take the blame for being aggressive but happy to see a real reduction in the misalignment of profits relative to the location of real economic activity via a voluntary disclosure procedure, or indeed by other methods.

In that second view, the Treasury is fully aware of the evidence showing that by far the biggest loser from the tax-dodging of US-headquartered multinationals is… the US itself. In the first view, this knowledge is either overlooked or seen as of only secondary importance compared to the perceived value of ensuring a competitive advantage for these national champions. And it is the first view for which the white paper appears to offer support.

What is undoubtedly the case is that the unveiled threats in the white paper represent a major escalation in hostilities, triggered by frustration with the Commission’s continuing pursuit of the state aid cases.

Main points

The Treasury paper contains three main elements: a rationale for its own existence, a set of arguments against the Commission’s approach to state aid, and a bargaining position for an end to the conflict. We consider each in turn.

Rationale

Were the white paper not such an aggressive document, it would be almost curious to see such a justification laid out. But here it seems necessary. The argument made is that the ongoing cases have “considerable implications for the United States-both for the U.S. government and its companies”. A number of specific implications are discussed, including that the cases:

Undermine the BEPS project;
“[C]all into question the ability of Member States to honor their bilateral tax treaties with the United States”;
May lead to tax repayments that ” effectively constitute a transfer of revenue to the EU from the U.S. government and its taxpayers”;
May have “a chilling effect on U.S.-EU cross-border investment”; and
Set “an unwelcome precedent for tax authorities around the world to take similar retroactive actions that could affect U.S. and EU companies alike.”

It is tempting to dismiss (1) by noting that BEPS has already been substantially undermined – first by the US-led refusal to countenance inclusion of unitary approaches, and second by the ‘competitive’ approaches of major members such as the UK in protecting their own favoured mechanisms to attract BEPS activity from elsewhere. But, the Treasury does have a point here: if the EU had wanted to curtail such activity as is being revealed in the state aid cases of Apple, Fiat, Starbucks and Amazon, why not ensure that BEPS did so? Unless the concern was only backward-looking?

On the other hand, the US was an important blocker in key areas of BEPS – not least, around corporate transparency. So it is unsurprising if the EU wishes to pursue at home some of the aims it could not achieve through the OECD.

Points (2), (4) and (5) constitute forms of threat. If the Commission pushes ahead with further cases, it risks seeing the US question member states’ bilateral tax treaties; discourage US companies from investing; and consider retaliatory, retrospective action against EU companies. Food for thought, certainly, for the Commission and member states.

The key point, in terms of ‘Implications for the United States’ (which is the section heading), is 3. In full, the white paper states:

There is the possibility that any repayments ordered by the Commission will be considered foreign income taxes that are creditable against U.S. taxes owed by the companies in the United States. If so, the companies’ U.S. tax liability would be reduced dollar for dollar by these recoveries when their offshore earnings are repatriated or treated as repatriated as part of possible U.S. tax reform. To the extent that such foreign taxes are imposed on income that should not have been attributable to the relevant Member State, that outcome is deeply troubling, as it would effectively constitute a transfer of revenue to the EU from the U.S. government and its taxpayers.

Aside from the multiple conditionality of this statement, it is hard not to see the Commission reflecting on this with considerable scepticism. First, because the US already tolerates a very high degree of tax-reducing behaviour by its own companies. If this was the real concern, why not address it directly – rather than seek to prevent any inadvertent collateral losses due to action elsewhere? Why not, for example, take steps to reduce the major misalignment that exists between the shares of global activity and global profit that US-headquartered multinationals currently attribute to their home jurisdiction? Or simply abrogate the deferral rules that have led to the creation of a two trillion dollar offshore cash pile?

Second, even if the repayments did give rise to reduced US tax payments, if the repayments are themselves correct (as the Commission would argue they will be), then any US losses would simply reflect a the rightful reallocation of taxing rights – as opposed to a snatch and grab raid. The culprits would be the previously unrecognised profit-shifters, rather than the Commission.

In reality, of course, the likelihood of significant tax implications for US coffers seems small – hence the conditional statements. In particular, the likelihood that companies arranged low-to-zero effective tax rates in Europe, in order to repatriate the proceeds and then pay tax at (difference to) the US rate, seems exceedingly low. Much more likely is that such funds were held offshore and never triggered a US liability.

If this is accurate, then the US interest rests either on its genuine concern over the fate of BEPS, and the general degree of international cooperation; or on the likely implications for US companies, facing not only an end to some lucrative profit-shifting arrangements, but also retrospective penalties. (Whether the US should consider such arrangements affecting European tax liabilities as being in its own enlightened national interest is, of course, another question entirely.)

Legal arguments

The legal arguments make up the bulk of the paper, in two sections. The first, no doubt entirely coincidentally, looks rather like the basis of a legal brief for companies that might wish to mount a challenge to the Commission. The argument is made, by case law, that:

“[T]he Commission has collapsed the concepts of “advantage” and “selectivity,” which are distinct requirements under State aid law. In the State Aid Cases, the Commission simply examined whether the measures at stake conferred a “selective advantage” on the companies under investigation, rather than separately assessing the existence of an advantage and the selective character of the measure, as it had done in prior decisions”; and
The new approach means that economic advantage for a multinational would be sufficient: “The Commission’s position that individual transfer pricing rulings are selective when given to a particular multinational company, even when other multinational companies could have obtained them, constitutes a new approach that has not previously been applied. “

The second section then makes the case that, if a new approach to state aid has indeed been applied, there can be no legal basis for retrospective action:

With no indication of the Commission’s new approach, U.S. companies have been receiving transfer pricing rulings from EU Member States for decades and had no reason to doubt their legality. Under these circumstances, recovery of past allegedly unpaid tax would be inconsistent with EU legal principles and the Commission should avoid retroactive enforcement.

Whether these arguments constitute a powerful shot across the Commission’s bows or not is hard to know at this point. We would not, of course, be surprised to hear echoes of these in individual companies’ appeals…

Negotiating stance

The white paper goes on to lay out further detail in support of the ‘rationale’ points discussed above, including the threat to BEPS and international consensus on transfer pricing. The conclusion is short and direct:

V. Conclusion

The U.S. Treasury Department continues to consider potential responses should the Commission continue its present course. A strongly preferred and mutually beneficial outcome would be a return to the system and practice of international tax cooperation that has long fostered cross-border investment between the United States and EU Member States. The U.S. Treasury Department remains ready and willing to continue to collaborate with the Commission on the important work of ensuring that the international tax system is fair, efficient, and predictable.

Shorter version: ‘Change course, or we will take action.’

Really short version: ‘Bang!’

The outlook

Where do things go from here, now that the US has tipped the growing tensions into outright tax war? Will the ~~Empire~~Commission strike back? They certainly have a few options…

Hold the line, or back down?

First, there is a question of how the Commission responds on the immediate issue here. Backing down would presumably mean accepting the outcome of the current cases, and deciding not to pursue a further raft – a possibility the white paper refers to several times, with obvious concern.

We assume that pushing ahead with further cases would indeed trigger the Treasury’s unknown, threatened responses. Through quiet soft power alone, the discouragement of US companies’ additional investment in some prominent EU member states is quite possible. Raising of issues over member states’ bilateral tax treaties would take the conflict to quite a new level.

In no scenario does it now seem likely that we will see further cooperation to salvage some of the potential gains from the BEPS process, at least not any time soon. That leaves the EU to push ahead with its own agenda – and raises the possibility of some interesting tax policy ‘spillovers’…

Spillovers

First, the EU position on whether or not to require public country-by-country reporting should be watched closely. To the extent that US lobbying was a factor preventing a straight decision to go ahead and require publication of the full OECD standard data, policymakers may feel either that the gloves are off, and go ahead; or that holding off on this might be the diplomatic move until tensions calm. Given the strength of feeling in the European Parliament, early movement should not be ruled out.

Two further areas are of interest. While there may be some sense that European countries have not done this right, given their acquiescence in BEPS, the boot is very much on the other foot in respect of beneficial ownership and the automatic exchange of financial information.

The US has long been a laggard on beneficial ownership transparency, as its states compete increasingly aggressively with each other to offer the kind of anonymous company formation services that lay behind the Panama Papers. (Here’s a great new Reuters report, by the way, on Delaware’s role in the effort to defeat the great efforts of former Senator Carl Levin – h/t Jo Marie Griesgraber.)

Might the Commission choose to take a more aggressive stance on this now? It’s a possibility, as member states begin to introduce their own public registers of company ownership. But perhaps it’s too early in that process to begin prodding others.

Where Europe has long held the lead, however, is in the area of automatic information exchange. Here the Savings Directive has required members to provide information automatically for more than a decade; although only with US embrace of the principle of automaticity through Obama’s FATCA laws, was the resistance of major secrecy jurisdiction like Switzerland defeated. From that moment, the creation of an international standard for automatic exchange was inevitable.

Less expected, however, was the US U-turn which led to them (currently) being set to provide information to almost no other state – despite demanding it from each and every one. Whether the US Treasury’s first shots in the tax war are enough to swing European opinion remains to be seen; but one of the main political reasons against developing a ‘tax haven’ blacklist based on the automatic exchange of information, was that it would have caught the United States. And TJN’s proposal for counter-measures – a withholding tax on US financial institutions, based on FATCA – is still in the drawer.

Whatever the eventual result, the US Treasury has taken a major step today. A step which identifies it much more closely with defending the ability of its own multinationals to go untaxed, than with the support for international agreement in which the claim is cloaked. The openly confrontational nature of the white paper is surprising, but reflects longstanding tensions as European countries have sought genuine progress.

The first shots of what may become a major tax war have been fired.

22/03/2016

The inexorable approach of country-by-country reporting

Cross-posted from taxjustice.net

The full publication of multinational companies’ country-by-country reporting took a step closer today. A begrudging step, which as it stands would negate most of the benefits; but an important one nonetheless, because of the direction of travel.

A long road travelled

A little background. Public CBCR, as proposed by Richard Murphy and John Christensen for TJN way back in 2003, is a tool for accountability:

First, by making public the distribution of companies’ activity, and that of their declared profits and tax paid, public CBCR makes multinationals accountable for the extent of their profit-shifting and tax manipulations.
Second, public CBCR makes jurisdictions such as Luxembourg accountable for their role in siphoning off profits from elsewhere (without the underpinning economic activity).
And third, public CBCR makes tax authorities accountable for their ability and willingness to ensure companies pay an appropriate rate of tax on their activities.

After ten years of building the case for public CBCR – including the crucial support of international development NGOs such as Christian Aid and ActionAid and our partners in the Financial Transparency Coalition, and the emergence of a global network of civil society organisations, the Global Alliance for Tax Justice – success! The G8 and G20 groups of countries mandated the OECD to produce a standard as part of the international tax rules.

Private CBCR: A measure for tax injustice

Then, a setback: aggressive lobbying led to the OECD taking its broadly robust standard and making it as unhelpful for accountability as possible. Specifically, the decision was taken to make the reporting private to tax authorities – at a stroke, eliminating all the accountability benefits with the exception of multinational accountability to tax authorities. (This, of course, is the accountability that was by far the strongest beforehand, since tax authorities could already demand very substantial additional information from corporate taxpayers; and hence the benefit arising is likely to be the smallest).

This move also reversed the development direction. Among tax authorities, public CBCR would disproportionately benefit those which are:

politically least able to demand information, i.e. those from lower-income countries; and
technically least able to resource long, technical battles over transfer pricing and other elements of the international rules where tax manipulation is common, i.e. those from lower-income countries.

As such, public CBCR is a measure that challenges the major inequality in the global distribution of taxing rights – an inequality that means the resulting tax losses may be several times larger as a proportion of existing revenues in non-OECD countries, on the basis of IMF research findings.

The OECD reversal was exacerbated by a decision that reporting would only be provided to headquarters country tax authorities, i.e. overwhelmingly to those in OECD countries and not elsewhere. This necessitated the development of resource-consuming, additional instruments to provide that information to other tax authorities; along with various criteria to exclude those that might have the temerity to make the data public, or to use it for non-OECD-approved tax approaches.

At this stage, then, the overall effect has been to worsen rather than to curtail the global inequality of taxing rights – exactly the opposite of what public CBCR would ensure.

Leaked European Commission proposals

Unsurprisingly, the policy discussion now centres on delivering TJN’s original proposal, and making CBCR public – with the expressed support of various European Commission officials and of UK Chancellor George Osborne. The compliance costs are now locked in for companies, and there would likely be an overall cost saving from switching to open data publishing, so that counter-argument has long gone.

Today, European Commission documents leaked to Politico and to the Financial Times show a step in this direction. The FT (£) summed up the main flaw:

In a significant disappointment for tax-justice campaigners, the scope of the disclosure rules will be limited to activities within Europe, leaving a lack of transparency on profit shifting to non-EU tax havens such as the Cayman Islands and Bermuda.

As Richard Murphy pointed out directly, this is not country-by-country reporting. It’s not only that we don’t see the likes of Bermuda; we also lose all developing countries too, and instead get a single number capturing both. Rolling together the jurisdictions where profit is likely to be shifted to, with those where profit stripping may be most egregious, is of course to negate the entire point of CBCR – which is to understand the disaggregated distributional picture.

As it stands, the proposal would support accountability of European tax authorities for LuxLeaks-type abuses – that is, it would make clear where EU members were receiving much higher shares of profit and/or tax than activity. To an extent, it would support accountability for authorities in terms of their obtaining a fair share of multinationals’ global tax base (albeit without explaining the full picture extra-EU). It would provide only limited accountability for multinationals, since the bulk of their inward and outward profit-shifting might well be hidden.

What the proposal would dramatically fail to deliver is any direct benefit for developing countries. Since their information would not be disaggregated, there would likely be little more value than from what is currently possible by comparing national tax returns with consolidated global accounts of the taxpayer’s group – except, perhaps, where the Commission proposal might reveal a particular jurisdiction risk relating to an EU member state (e.g. seeing the global scale of profit-shifting into the Netherlands might help the Ghanaian revenue authority to focus on particular transactions). Indirectly, the proposals might allow developing countries more space to pursue their own public CBCR approach; but at the risk of locking in the same weaknesses.

In addition, the proposal would fail to identify or support accountability for any non-EU profit havens – with the potential effect that their share of global shifted profits would actually increase. The Commission would be creating, deliberately, a playing field unbalanced against their own member states.

Rubbish proposals – rejoice!

Overall, then, the leaked proposals seem to fail when assessed against any realistic aims. They do not deliver full accountability within the EU; they disadvantage member states against others, to the extent that overall profit-shifting and tax losses may not be reduced; and they deliver nothing for developing countries. The proposals are, in short, a clear step back from the European Parliament’s support for a fully global approach.

And yet the proposals remain a step in the right direction. The only discussion is about how to make CBCR public; not whether to. Given the heavy lobbying against the OECD standard – to say nothing of the ten years that it took us to bring the measure to the top of the global policy agenda – it was to be expected that there would be some bad proposals for public CBCR. And the leaked Commission document is certainly one!

More work is clearly needed to educate policymakers and their technical advisers on the specific benefits of public CBCR, in order to inform a more sensible set of proposals. (Not least in the US.) And it may be that some jurisdictions pursue bad proposals before others (and perhaps some forward-thinking multinationals) lead the way with good ones. But we are on the road, inexorably, to the global delivery of TJN’s first policy proposal: public CBCR and all the accountability benefits.

The Commission’s proposal is rubbish – let us rejoice.

Photo by Harald Groven, https://www.flickr.com/photos/kongharald/

02/03/201602/03/2016

Open Data for Tax Justice: Launch! #OD4TJ

Cross-posted from Tax Justice Network.

Every year countries lose billions of dollars to tax avoidance, tax evasion and more generally to illicit financial flows. According to a recent IMF estimate around $700 billion of tax revenues is lost each year due to profit-shifting. In developing countries the loss is estimated to be around $200 billion, which as a share of GDP represents nearly three times the loss suffered by OECD countries. Meanwhile, economist Gabriel Zucman estimates that certain components of undeclared offshore wealth total above $7 trillion, implying tax losses of $200 billion annually; Jim Henry’s work for TJN suggests the full total of offshore assets may range between $21 trillion and $32 trillion.

We want to transform the way that data is used for advocacy, journalism and public policy to address this urgent challenge by creating of a global network of civil society groups, investigative reporters, data journalists, civic hackers, researchers, public servants and others.

Today, Open Knowledge and the Tax Justice Network are delighted to announce the launch of a new initiative in this area: Open Data for Tax Justice. We want to initiate a global network of people and organisations working to create, use and share data to improve advocacy and journalism around tax justice. The website is: http://datafortaxjustice.net/ and using the hashtag #od4tj.

The network will work to rally campaigners, civil society groups, investigative reporters, data journalists, civic hackers, researchers, public servants and others; it will aim to catalyse collaborations and forge lasting alliances between the tax justice movement and the open data movement. We have received a huge level of support and encouragement from preliminary discussions with our initial members, and look forward to expanding the network and its activities over the coming months.

What is on the cards? We’re working on a white paper on what a global data infrastructure for tax justice might look like. We also want to generate more practical guidance materials for data projects – as well as to build momentum with online and offline events. We will kick off with some preliminary activities at this year’s global Open Data Day on Saturday 5th March. Tax justice will be one of the main themes of the London Open Data Day, and if you’d like to have a go at doing something tax related at an event that you’re going to, you can join the discussion here.

02/03/2016

Debating corporate tax avoidance and incidence

From ‘The Newsmakers’, hosted by Imran Garda, a debate on corporate tax avoidance between me and Tim Worstall from the Adam Smith Institute.

The full piece is linked at TJN.

On the subject of incidence, we each made competing claims about the evidence, as you’d expect. To add a little light to the heat, here’s a TJN round-up of economic research findings on this important question; and some interesting points raised from a different perspective by David Quentin.

22/02/201625/06/2020

Benchmarking #Googletax – 2% in the UK?

The Tax Justice Network has just released a new analysis of Google’s UK tax position. Rather than speculate on the nature of the deal reached with the HMRC, the UK tax authority, we simply compare the outcome to the stated aim of policymakers, and the common feeling of the public: namely, the alignment of taxable profit with the location of actual economic activity.

As we’ve written, repeatedly, the observed degree of misalignment is a product of current international tax rules – because it is based on the logic-free approach that each entity within a multinational group be treated as if it were a separate profit-maximising company. The only viable solution is to treat firms such as Google in accordance with the economic reality that they are unitary firms: that is, they have a common global management which takes the decisions, and it is at this level only that profit is maximised, and tax liabilities should be assessed.

Once that decision is made, what remains is to apportion the global profits as tax base between countries – which could of course, and should, be done on the basis of the location of real economic activity. Where this system is already in place (for example among the states of the US, the provinces of Canada and the cantons of Switzerland), the common measures used include sales; employment (wage bill and staff headcount); and (tangible) assets. The European Commission’s long-standing proposal for intra-EU apportionment is an equally-weighted combination of the three, while the Canadian formula is simpler: half sales, half wages.

Here’s the basis for the calculation. [Until such time as there is public country-by-country reporting of consistent data, such an exercise depends on some digging and some judgment calls.]

Sales

Google Inc’s most recent 10K filing (and their last, having become Alphabet Inc), includes a breakdown of revenues by major market: the USA, UK and the rest of the world. UK revenues for 2014 were $6.483 billion.

There is one puzzle here. We tried to check the figure with Google UK’s accounts, and found that the company has simply not reported it. The relevant line from the accounts is ‘turnover’, which is defined in the Financial Reporting Standard applicable in the UK as follows:

“The amounts derived from the provision of goods and services after deduction of:

(a) trade discounts;

(b) value added tax; and

(c) any other taxes based on the amounts so derived.”

When we look at Google UK’s accounts to June 2015 (p.12), however, it turns out that they’ve defined it as something completely different:

“Turnover represents the amount of fee payable in respect of services provided during the period to Google Inc., Google Ireland Limited and Nest Europe Limited. The Company recognises revenue in accordance with service agreements.”

Rather than the Google Inc.-reported $6.5bn of sales (or £4.6bn, give or take), this measure is much smaller – around £1.2bn. This is broken down specifically in the notes to the financial statements (p.15), showing that around a quarter is a payment from the US for R&D, and three quarters from Ireland for marketing and services, similar to those you can see when you click now. This is commonplace in their industry.

For apportionment purposes, it is sales by the group, within the jurisdiction that matter (so the claim that they are technically made by a different part of the group doesn’t enter); but we include this UK ‘turnover’ in some of the analysis below for comparison.

Tangible assets

Tangible assets – the stuff you can touch, and know the location of – are in the books of both Google UK and Google Inc., albeit somewhat differently expressed due to the inevitable differences in accounting standards. For the UK, we have ‘Tangible assets’; for the Inc, ‘Property and equipment, net’.

Employment

Employment is straightforward in one aspect, and currently impossible in the other. For headcount, the data are each in set of accounts (the only possible complication is that Google UK accounts shows 2329 staff, while the company told the UK’s parliamentary Public Accounts Committee that they have more than 4,000. Busy hiring since July, it would seem).

Wage bill is a different matter. The costs are broken out for Google UK in note 6 to the accounts, while in the US accounts they are amalgamated under business headings (R&D; sales and marketing; general and administrative; and ‘cost of revenues’). We wrote to Alphabet Inc to ask for the global total, but have had no reply at all – not even a confirmation of receipt – so we’re left with headcount. We’ll have to guess that a portion of this spending was dedicated to the advancements in FinTech and investments in lending companies throughout Sweden, like the most recent investment in Sambla AB and their revolution låne penger service.

Profit

Finally, we take Google UK’s ‘Profit on ordinary activities before tax’, and Google Inc’s ‘Income from continuing operations before income taxes’, being in each case the relevant variable used to show tax reconciliation.

To get to 2014 figures for the UK, we are required to assume that activity was constant over the 18-month period covered in the accounts to 30 June 2015. On that basis, we scale the relevant values by 2/3. In addition, we convert the sterling figures to dollars using the prevailing exchange rate at 31 December 2014.

Benchmarking Google UK

We proceed in three steps. First, we show the proportion of each measure of activity for Google, Inc which relates to Google UK. Next, we show the implied volume of UK profit for 2014. Finally, we calculate potential tax implications.

The first table shows that for any of the measures of economic activity, Google UK’s share of the global, Google Inc total is much higher than its share of pre-tax profit: from 2.6% to 9.8% of activity, compared to just 0.64% of profit. Even if we take Google UK’s definition of turnover at face value, so that the company only provides sales services to Ireland and R&D to the group, the share of profit would still be three times higher. The second table shows the implications for UK-taxable profit, and UK tax revenues, were the misalignment of activity to be eliminated (or a formulary approach adopted). As well as individual factors of activity, we show the results for the two multiple-factor formulae mentioned above, the European and Canadian (using headcount).

The only single factor formula which has been proposed in the current debate is sales, which also shows the most extreme misalignment. Current taxable profits are just 6.5% of that implied by alignment with sales, and the tax bill for 2014 would have come in at £230 million. There are two good reasons against a sales-only basis, however. At a theoretical level, it ignores production entirely, rather than balancing production with consumption as each of the Canadian and European formulae seek to do; and at a practical level, a sales-only basis is likely to be the least valuable in terms of addressing the structural inequality in the allocation of taxing rights to developing countries. [Thanks to Iain Campbell for flagging a typo in this table, now corrected.]

The Canadian and European multiple-factor formulae provide a broader base of economic activity against which to consider profit misalignment, and provide a closer range. The implied tax bill for 2014 is £131-£166 million; while current declared profits are 9-11% of the implied tax base.

Were the OECD BEPS process to achieve its aim, or were a unitary tax approach with formulary apportionment adopted, Google could expect to pay in UK tax each year an amount equivalent to or greater than the settlement reached for the entire period back to 2005.

Google UK’s taxable profits for 2014, after the deal with HMRC, are about 10% of what would be expected if their profits were aligned with the UK share of Google’s real economic activity – which is the stated aim of policymakers, and the clear demand of the public. With statutory corporate tax rates set to fall below 20%, the real effective rate may end up lower than 2% of the actual profits attributable to UK economic activity. By any reasonable benchmark, the Google deal highlights the comprehensive failure of international tax rules.

The bigger picture – and the solutions

The Google UK case is not an isolated aberration, but part of a consistent, broader picture. But it is perhaps the paradigmatic example of the failure of international tax rules.

The UK government was so seized of the importance of this particular case that a new measure, the Diverted Profits Tax, was briefed to the media as the ‘Google tax’. The tax authority, HMRC (Her Majesty’s Revenue and Customs) dedicated between ten and thirty skilled staff to this one case, every day for six years. And yet the outcome is that the UK will tax just a fraction of the proportionate profit that policymakers have aimed for, and that the public expects.

HMRC has dedicated more capacity to this one case, for six years, than most revenue authorities in developing countries are able to devote in total to all multinationals. There is no prospect that the current rules can be made to work, whether in high-income countries like the UK or in those countries where the revenues are most badly needed to fund basic education, health and public investment.

Previous research from the Tax Justice Network (http://taxjustice.net/scaleBEPS) shows that 25-30% of the global profits of US multinationals are now shifted to low- or zero-tax jurisdictions, away from where the real economic activity takes place – compared to just 5-10% as recently as the 1990s.

This is not about the particularly egregious behavior of one multinational, but about a system that is unfit for purpose. In 2013, the OECD was mandated by the G8 and G20 groups of countries to reform the system under the Base Erosion and Profit Shifting (BEPS) Action Plan. It is already clear that the BEPS plan will not bring the fundamental changes needed.

Policy recommendations

There are two immediate priorities for policymakers.

First, multinationals must be required to publish their country-by-country reporting data, under the new OECD standard, to reveal where their economic activity takes place, where profits are declared and where tax is paid. At a minimum, this will allow the public to hold multinationals and tax authorities accountable for their performance. We welcome the recent support for this original Tax Justice Network policy proposal from European Commissioner Pierre Moscovici, and UK Chancellor George Osborne – but that support must now be turned into legislation.

Second, recognising that the OECD BEPS process has failed to meet the scale of the challenge of profit shifting, policymakers should urgently convene an independent, international expert-led process to explore alternatives – starting with the taxation of multinational groups as a unit, rather than maintaining the current pretence of individual entities within a group maximising profit individually. This will allow full consideration of formulary apportionment approaches, including as recommended by the Independent Commission for the Reform of International Corporate Taxation (ICRICT); and detailed analysis of possible practical steps to move towards a functioning system. Such a process would sit well as the first major responsibility of an intergovernmental tax body, as recommended by the majority of developing country governments and by global civil society at the Addis Financing for Development meeting in 2015.

And here’s one more to ponder, as Jolyon Maugham flagged the other day and the Financial Times (£) has picked up: will public country-by-country reporting be enough, or should we have corporate tax returns in the public domain?

22/02/201610/08/2018

Counted, sort of: IFF estimates

If you’re in London on 9 March, I’ll be giving a seminar at King’s College on the range of approaches to IFF estimates (illicit financial flows, that is) and tax losses. All welcome, just email [email protected].

IFF estimates

Unrelated #humblebrag: recent social media rankings, are they worth anything?

CityAM Top 100 UK economists

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#economia50 (Finance)

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18/02/2016

Breaking the vicious circles of illicit financial flows, conflict and insecurity

Cobham, A. 2016. Breaking the vicious circles of illicit financial flows, conflict and insecurity. GREAT Insights Magazine, Volume 5, Issue 1. February 2016. Republished with permission of the European Centre for Development Policy Management (ECDPM).

Illicit financial flows (IFF) not only thrive on conflict and insecurity but exacerbate both, by undermining the financial and political prospects for effective states to deliver and support development progress. Policies to meet the Sustainable Development Goals’ target of curtailing IFF will also promote peace and security.

In 2014, the Tana High-Level Forum on Security in Africa took as its theme the impact on peace and security of illicit financial flows (IFF). Leading figures from across the region, including a range of current and former heads of state, discussed the nature and scale of illicit flows and the policy options available.

The subsequent report of the High Level Panel on Illicit Financial Flows out of Africa, chaired by Thabo Mbeki, cited the Tana Forum background study (Cobham, 2014) and reiterated its analysis of the linkages with security; and so it was no surprise that the IFF target in the Sustainable Development Goals (SDGs) appeared under Goal 16: ‘Promote peaceful and inclusive societies for sustainable development, provide access to justice for all and build effective, accountable and inclusive institutions at all levels’:

16.4 By 2030, significantly reduce illicit financial and arms flows, strengthen the recovery and return of stolen assets and combat all forms of organized crime…

The linkages between IFF and insecurity are not necessarily well understood, however. Assessing how the two issues interact can help to identify the range of policy responses that will support powerful progress.

Illicit financial flows

There is no single, agreed definition of IFF. The Oxford dictionary definition of ‘illicit’ is: “forbidden by law, rules or custom.” The first three words alone would define ‘illegal’, and this highlights an important feature of any definition: illicit financial flows are not necessarily illegal. Flows forbidden by “rules or custom” may encompass those which are socially and/or morally unacceptable, and not necessarily legally so. Multinational tax avoidance (as opposed to illegal tax evasion) might come under this category.

This particular example also shows why a legalistic approach may introduce an unhelpful bias. Commercial tax evasion affecting a low-income country where the tax and authorities have limited administrative capacity is much less likely either to be uncovered or successfully challenged in a court of law, than would be the same exact behaviour in a high-income country with the same laws but with relatively empowered authorities. A strictly legal definition of IFF is therefore likely to result in systematically – and wrongly – understating the scale of the problem in lower-income, lower-capacity states. For this reason above all, a narrow, legalistic definition of IFF should be rejected.

Figure 1: Main IFF types by nature of capital and transaction

The central feature of IFF – and incidentally a major reason their measurement is so difficult – is that they are deliberately hidden: financial secrecy is key, in order to obscure either the illicit origin of capital or the illicit nature of transactions undertaken (or both). As illustrated in Figure 1, four main types of behaviour are captured: 1) market/regulatory abuse (e.g. using anonymous companies to conceal political conflicts of interest, or breaches of antitrust law); 2) tax abuse; 3) abuse of power, including the theft of state funds and assets; and 4) laundering of the proceeds of crime. Figure 1 also highlights that there is a broader distinction between ‘legal capital IFF’ (tax abuse and market abuse, types 1 and 2) and ‘illegal capital IFF’ (the abuse of power and laundering of criminal proceeds, types 3 and 4).

Security and state ‘fragility’

There is growing agreement that the concept of fragile states – as a binary division against all other, ‘non-fragile’ states – is an unhelpful one for analysis. Instead, it is more useful to think of all states as occupying some position on a spectrum of (risk of) fragility. As the High Level Panel on Fragile States (2014) put it:

Fragility comes about where [pressures such as those stemming from inequality and social exclusion, or from new resource rents and resource scarcity] become too great for countries to manage within the political and institutional process, creating a risk that conflict spills over into violence – whether interstate or civil war, ethnic or tribal conflict, widespread criminality or violence within the family. Countries that lack robust institutions, diversified economies and inclusive political systems are the most vulnerable. In the most acute cases, violence has the effect both of magnifying the underlying pressures and eroding the institutions needed to manage them, creating a fragility trap from which it is very difficult to escape.

The risk of fragility is then closely related to a state’s ability to provide citizens with ‘negative’ security (to prevent personal, community, political and environmental insecurity) and with ‘positive’ security (to provide the conditions for economic, food and health security and progress). These two forms of security exhibit potentially mutually reinforcing relationships with particular types of IFF.

Two vicious circles

Figure 2 shows a vicious circle linking illegal capital IFF and problems of negative security. Where IFF derive from abuse of power – say, for example, the extreme behaviour of a kleptocratic leader – the cycle follows almost tautologically. The nature of the IFF itself undermines state legitimacy and both the capacity and interest to provide security, or indeed to act to curtail IFF.

When the rise in IFF reflects laundering of the proceeds of crime, it is the underlying crimes where the linkages are likely to emerge. Most dramatically, Cockayne (2011) finds that drug and human trafficking has led to little less than the criminalisation of governance itself in West Africa and the Sahel. He identifies two hubs that grew strongly after Caribbean counter-narcotics efforts in the 1990s pushed the trade elsewhere: one around Gambia, Guinea and Guinea-Bissau, and the other around Benin, Ghana and Togo. In addition, Cockayne highlights important services provided in other states – namely money laundering in Senegal, and transit in Mali, Mauritania and Niger. The growing involvement of the state in criminal activity (including IFF), and the growing power of criminality over the state, make the vicious circle somewhat inevitable again.

Figure 2: The vicious cycle of negative security and illegal capital IFF

Much of the problems of conflict and negative security arise in countries characterised by low levels of institutionalisation of authority, a heavy reliance on patronage politics and an accordingly high level of allocation of state rents to unproductive activities (patronage, to maintain the political machine). For a rent-seeking patronage order to function, it must resist or evade the pressures to institutionalise state finance – through, for example, an incentive structure in which senior officials have a personal interest in financial opacity and the misuse of public funds, and fiscal policy is subordinated to the ‘political budget’ (the state allocation for patronage purposes). Major sources of funds such as natural resource companies may be rewarded through the opportunities to evade tax with impunity, and may maximise net profits through bribery.

In turn this kind of state structure creates structural incentives for violence. Kleptocracy will tend to require violence to protect the position of privilege; those outside may resort to force to extort rents from those in power, or to challenge for the prize of (illegitimate) power itself.

All four IFF types shown in Figure 1 are likely to result in reductions in both state funds and institutional strength – that is, they undermine governance as well as domestic resource mobilisation. While little research has sought to quantify the governance impact, and some attention has been given to the theft of state assets, a growing body of literature seeks to assess the financial scale of flows and the revenue losses associated with particular elements. Consistently, the scale of IFF and of revenue losses from corporate profit-shifting and from individual evasion through undeclared offshore assets is greater in lower-income countries; and often material in respect of countries’ GDP. Indicative estimates of the resulting impacts on basic human development outcomes such as child mortality suggest these too are powerful indeed – potentially bringing African achievement of the Millennium Development Goal target forward from an estimated 2029 to 2016, for example (O’Hare et al., 2014).

Figure 3: The vicious cycle of positive security and legal capital IFF

Figure 3 illustrates the vicious circle that can arise between these largely legal capital IFF, and problems of positive security. Bluntly, revenues are undermined where they are most needed; and further institutional damage follows from the weakening of the state-citizen relationship that is built on effective taxation.

IFF and security: Policy implications

At the Tana Forum in 2014, President Salva Kiir of South Sudan told how the ‘vultures’ had circled the new state even before it came into existence, building relationships with soldiers and others, so that when the moment came they were poised to create a web of contracts that channelled away oil revenues into anonymity – without delivering on the contracts:

When peace was signed, the vultures that were hovering over Sudan landed. We have learned in our cultures that when you see vultures hovering around, there must be a dead animal – or something is going to die… They knew there would be a vacuum of administration there… That [oil] money was disappearing day by day to where you cannot trace it.

The central feature of IFF is that they are hidden, typically by the financial secrecy provided by other jurisdictions. The secrecy in question relates primarily to the provision of vehicles for anonymous ownership such as shell companies; to the refusal to provide information on foreigners’ assets and income streams to their countries of tax residence; and to the type of corporate opacity that obscures the worst excesses of multinationals’ profit-shifting. As shown by the Tax Justice Network ranking of tax havens, the Financial Secrecy Index, this includes many of the leading economies – not least the USA, ranked third.

States can protect themselves to a degree, by ensuring greater transparency of public contracts for example, and public country-by-country reporting by multinationals; and by engaging fully in the multilateral process for automatic exchange of tax information. But while other states insist on selling secrecy, major obstacles will remain.

Success in the Sustainable Development Goals target of curtailing illicit financial flows would contribute to reducing risks of state fragility across the board – and to achieving many human development targets too. But such progress depends on international progress against financial secrecy. A significant step would be the adoption of indicators for target 16.4 that will ensure individual states are held accountable for the secrecy they provide globally – and the IFF they stimulate as a result.

The following indicators (Cobham, 2015) draw from the agreed policy positions in the Sustainable Development Goals and the Financing for Development declaration from Addis, July 2015:

For each country and jurisdiction, on what proportion of foreign-owned assets and to the states of what proportion of the world’s population, are they providing tax information bilaterally to others?
For each country and jurisdiction, from which countries and jurisdictions are they receiving tax information bilaterally?
For each country and jurisdiction receiving information, what proportion and volume of revealed assets were already declared by the taxpayer, and what resolution has reached each year in respect of the remainder?
For each country and jurisdiction, for multinationals making up what proportion of the declared multinational tax base is country-by-country reporting publicly available?

The harder it is for vultures to hide, the fewer may be the unnecessary deaths suffered.

Figure 4: Overview of IFF and security linkages

References

Cobham, A., 2014, ‘The impact of illicit financial flows on peace and security in Africa’, Tana High-Level Forum on Security in Africa Discussion Paper.

Cobham, A., 2015, ‘Uncounted: Power, inequalities and the post-2015 data revolution’, Development 57:3/4, pp.320-337.

Cockayne, J., 2011, ‘Transnational threats: The criminalization of West Africa and the Sahel’, Center on Global Counterterrorism Cooperation Policy Brief (December).

High Level Panel on Fragile States, 2014, Ending Conflict & Building Peace in Africa: A call to action, African Development Bank: Tunis.

High Level Panel on Illicit Financial Flows out of Africa, 2015, final report.

O’Hare, B., I. Makuta, N. Bar-Zeev, L. Chiwaula & A. Cobham, 2014, ‘The effect of illicit financial flows on time to reach the fourth Millennium Development Goal in Sub-Saharan Africa: a quantitative analysis’, Journal of the Royal Society of Medicine 107(4), pp.148-156.