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.
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 EmpireCommission 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.
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).
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/
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.
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?
Here’s a quickish breakdown of Google UK’s accounting for the HMRC audit which has just been settled. It raises a serious question over how much – if even any – of the £130m actually relates to a challenge against international profit-shifting. And brings us that bit closer to crossing the Rubicon of corporate tax transparency…
Credit where credit’s due: this is entirely down to the digging of Bloomberg’s Jesse Drucker (unless I’ve made any mistakes, which will be my fault alone). It is however almost entirely Jesse’s fault that we’re still seeing headlines about Google (even if they don’t all credit him).
The UK subsidiary’s accounts to 2015 – which include the announced deal with HMRC – became public yesterday, and Jesse’s scoop is based on putting together the notes to the financials over the last few years, to identify a significant inconsistency in the story.
#Googletax: A triumph against profit-shifting?
The spin from Google, and also the UK government, most notably Chancellor George Osborne but also HMRC, has been that the £130m over ten years represents the fruits of a crackdown on international profit-shifting. After all, this is where public anger and policy pressure has been directed. And as a consequence, all the reporting has followed suit.
Google’s Matt Brittin even claimed specifically that the settlement reflected the new tax rules (by implication, the OECD BEPS changes and the government’s introduction of the Diverted Profits Tax) – which, while patently nonsense (neither change is backdated, let alone to 2005), confirmed the impression that this was about profit-shifting.
The first cracks were suggested by the Times’ remarkable story, in which Alexi Mostrous uncovered that HMRC “officials are understood to have concluded that the company’s offshore arrangements were legitimate”, and not subject to the Diverted Profits Tax (or ‘Google Tax’, a name briefed by officials upon its introduction).
The story in the accounts
The short version: some, and quite possibly all, of the settlement does not relate to international profit-shifting.
Here goes. Over the years since 2010 when the HMRC ‘open audit’ (#opennotopen) started, Google made provisions for the tax and interest that they thought they would eventually have to pay. These provisions feature, respectively, in notes 8 (tax) and 5 (interest) of the financial accounts.
First, the accounts to 2012 contain a provision of £24m for tax, and £3.6m for interest. The key point is the language. Google is specific that the provisions relate, indeed, to the HMRC audit – but only for ‘corporation tax in respect of employee share based compensation’. This is presumably a stock option scheme of some sort – nothing whatsoever to do with the widely discussed international structures that Google uses.
The accounts to 2013 show a small increase in the provisions, with the same details.
Finally, the newly released accounts (covering a year and half, after a change of accounting date) show a substantial increase in the provisions, and notes that £33m was the previous provision that now forms part of the overall £130m liability.
Where does that leave us? Google’s accounts show that the earlier provisions, which by 2015 are valued at £33m, are:
The only provisions made in relation to the HMRC audit of tax years from 2005 onwards (with the exception of £1m+, see below); and
Related only to employee share based compensation schemes.
What does it mean?
One possibility is that the £33m, a quarter of the announced settlement, had nothing to do with international profit-shifting – but that the remaining three quarters did. This would imply that Google was sufficiently confident throughout that although it was being audited on everything, it only provisioned in respect of this one element; and was then surprised.
Another apparent possibility is that (more or less) the entire £130m relates to this share scheme, in which case the settlement barely relates to the international profit-shifting issues over which credit has been claimed.
Most remaining possibilities, assuming no errors of accounting or my assessment above, would appear to lie in between these two polar suggestions: on which basis something between roughly a quarter and the entirety of the settlement does not relate to profit-shifting. Jolyon Maugham has neatly pulled out the additional, £1m+ provision for corporation tax that I’ve glossed over above and makes the case that there were indeed two distinct disputes, each eventually settled for liabilities in the tens of millions of pounds.
No, what does it actually mean?
Thought you’d never ask. The main effect of this curious story, and the ongoing reporting, will be to raise even more questions about this deal – and in particular, for the government and the Chancellor about how it was presented to the public. Google have batted back the questions from Bloomberg, but the Public Accounts Committee may have more leverage.
Any further unravelling will of course lead to even greater pressure in two areas: first, for greater transparency in this particular case (which will increasingly appear to violate taxpayer confidentiality – as the pronouncements of the Chancellor and HMRC may be felt to have already done); and second, for a powerful policy response that will provide the public with the kind of reassurance that is currently, painfully absent.
As I wrote previously, this would take the form of committing to publish the OECD standard country-by-country reporting (CBCR). It could come unilaterally from Google (perhaps unlikely, but don’t rule it out); or it could from the government. And in fact, since I wrote about this, and called for the same on the Today programme, the Chancellor has indeed pledged his support for public CBCR. {One to file under ‘correlation is not causation’, but at the deeper level not – public CBCR is the original Tax Justice Network policy proposal, and has gone from being written off as lunacy in 2003, to being on the verge of reality. File instead under ‘Advocacy successes where attribution is actually not unreasonable’.}
What remains is for this pledge to be made specific: for the UK to announce and deliver legislation mandating publication of country-by-country reporting, and to work publicly and privately to ensure that European Commission – currently sitting on the impact assessment they commissioned from LuxLeakstransparency champions PwC – makes the same call. An unparalleled step change in the accountability of multinationals, tax authorities and – in the tax sphere – governments too, is now within reach.
Since news broke that Google has negotiated a deal with the UK tax authority following the latter’s audit stretching back to 2005, criticism has been growing – of the deal, of the UK government and of the company. What might we learn from #Googletax?
1. The world has changed; oh, and life’s not fair
On the face of it, Google may feel a bit hard done by. After years of criticism over your tax bill, you agree to pay £130 million more – and what do get? More criticism. Criticism of your tax bill and, additionally, of your relationship with government.
Well, the world has changed. Nobody quite knew what to say when Starbucks decided in 2013 to raise its tax payment after criticism. Margaret Hodge, famously stern then-chair of the Public Accounts Committee, summed things up by welcoming the payment while stressing that the system still needed sorting.
But the world has changed. Prem Sikka quickly calculated Google’s effective tax rate (given some necessary assumptions on relative profitability of UK operations) at around 2.77%. Richard Murphy suggested tax of around £200 million each yearwould be about right, as did Jolyon Maugham QC (and like Prem, put Google’s new effective rate near 3%).
Now you might point out that none of these three are exactly ‘tax is theft’ flagbearers. But the tax-twittersphere was surprisingly quiet – where normally it likes nothing more than an event like this as an excuse to accuse each other of committing vile, ideological sins while pretending to analyse objectively, this time things were pretty calm. Nobody seemed keen to commend Google’s tax payment, nor to defend their doing a deal.
In fact, I think there’s a marked difference in public attitudes. The depth and breadth of understanding seems beyond any previous peak (not least the important heights of UK Uncut); and the general sense that a distribution of taxable profit between countries in proportion to the scale of economic activity would be about right. Who knows where that might lead?
It seems overwhelmingly clear that Google has come out of this badly, in terms of reputational impact – and that’s before they appear before the now upcoming Public Accounts Committee hearing. They may feel like they’d have been better off to keep their heads down.
So, life’s not fair.
2. Do no evil
On the other hand… A less aggressive tax position would have allowed Google to avoid (the open audit from which this deal, and the attendant bad publicity arises.
Imagine the conversation:
“So, this way we’ll pay tax at about 2.77%. I even think HMRC might go for that.”
“Meh. We can pay much less than that.”
“Really? Isn’t that, like, pushing it?”
“Tax is theft. Tax is evil. And you heard the man: Do no evil.”
No, I don’t suppose it went anything like that. But still: this wasn’t done blind. At some point, someone thought that the position they had was entirely defensible, and any risk (reputational or in terms of subsequent tax assessment) was worth taking; and that’s the position that ultimately got signed off by management and auditors.
As Owen Barder says, CSR means two things: Pay your tax, and don’t be corrupt. With this tax position agreed and hailed as a success by the UK government, there’s presumably no way back on that front. And presumably no corruption to address. So what could Google do now to reclaim its reputation?
I’d say there’s only one thing that might have any impact. And right now, it would still be a long shot. But it’s this: commit in Google’s own, inimitable, data-led way, to publish its full, country-by-country reporting (CBCR).
This would hurt. A lot. As much as Google tax is being picked over now, we’d have much more fun if we had the actual data showing the full difference between where it does business and where it pay tax. But… once it was done, it would be done. And all the pressure would be on Google’s rivals to follow suit, making them the story instead whether they published or not.
Along the way, this might help make Google what it presumably always hoped to be: not just doing no evil, but positively doing a bit of good. If they wanted to go the whole hog, they could even help us knock together the open database which we hope will provide a platform for all the eventually public CBCR data.
3. The Golden Thread is (still) worth following
What of government? After coming out early to announce the Google deal as a ‘victory’, a ‘real vindication of the government’s approach’, Chancellor George Osborne must have spent the rest of his time at Davos kicking himself. But if not, his Conservative colleague Boris Johnson certainly was – writing the next morning that “we should recognise that the fault in the whole affair lies with our national arrangements“. And it got worse for Osborne: a subsequent headline had Prime Minister David Cameron ‘distancing himself‘ from the Chancellor’s triumphal claims.
The government might, like Google, think things are rather unfair. After all, they’ve done a deal to get more tax, not less. But the nature of the deal, and the fact that taxpayer confidentiality would seem to prevent any effective defence against the 3% claim, leaves them exposed at PAC and more generally.
That’s why this is the right time for the government to take the initiative, get back on the front foot, bring out the disinfectant and mix any other positive metaphors it can think of. David Cameron came to power claiming he would usher in a new era of transparency, and in some aspects of international tax he can fairly claim to have delivered a fair bit already.
In May, the UK will host an anti-corruption summit where it had hoped that the Overseas Territories and Crown Dependencies would follow in signing up to public registers of beneficial owners of companies. It seems increasingly unlikely that this will happen – but the Google debacle provides an opportunity for a real policy commitment that would put the UK, too, back on the side of the angels.
Having helped along the OECD’s mandate to develop a country-by-country reporting standard while hosting the 2013 G8, the government then saw the OECD deliver a technically good standard with the minimum (and most unequal) possible transparency.
The tax justice movement lost that round of the argument because OECD members saw the measure’s real value as being about holding multinationals to account (so only tax authorities needed the data); while multinationals lobbied fiercely against publication, even once they had had to accept the compliance costs.
What was lost was the point that CBCR is not just about companies’ accountability – it’s also about governments’ accountability. You can’t show you’re getting a fair share of tax from multinationals if you don’t publish this data. And you also can’t show that other governments, like Ireland or Luxembourg or the Netherlands, aren’t ripping you off.
This would be the perfect time for the UK government to discover that the Golden Thread applies at home as well as in developing countries, and to announce that it will publish CBCR data itself (in open, machine-readable format, natch); and advocate for this to be an EU-wide measure.
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.
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.
The UK has successfully defended the ‘patent box’ against the charge that it is a major avenue for multinational corporate tax abuse. Now everybody wants one, even though the evidence suggests that only multinationals will benefit.
Will countries take the last chance for productive cooperation offered by BEPS; or will the patent box end up as the paradigmatic case of rich countries ‘competing’ themselves down (and taking developing countries with them)?
[I’m grateful to Prof. Sol Picciotto, TJN senior adviser and coordinator of the BEPS Monitoring Group, for flagging this issue, and the Tax Notes coverage referred to, and for commenting on a draft.]
The magic of the patent box (montage from Dreamtimes original images)
Where things stand
The term ‘patent box’ is being used more widely than for patent incentives alone, to reflect a range of preferential tax treatments for intellectual property (IP). Such preferential regimes fall under Action 5 of the OECD’s Base Erosion and Profit Shifting (BEPS) Action Plan, which aims to ‘Counter harmful tax practices more effectively, taking into account transparency and substance’, requiring inter alia ‘substantial activity for any preferential regime’.
The first Action 5 report suggests three helpful questions for considering whether a preferential regime such as the patent box is harmful:
Does the tax regime shift activity from one country to the country providing the preferential tax regime, rather than generate significant new activity?
Is the presence and level of activities in the host country commensurate with the amount of investment or income?
Is the preferential regime the primary motivation for the location of an activity?
In general, pre-BEPS patent box regimes would yield the answers ‘Yes’, ‘No’, ‘Yes’: that is, they are indeed ‘harmful’.
But when BEPS got underway and a number of countries saw their measures to attract profit-shifting come under increasing pressure, the UK led a vigorous defence of the patent box (supported by other then-users, Luxembourg, Netherlands and Spain).
Eventually, however, the UK was forced to give a little ground, in the face of some combination of the logic of the BEPS process, in the initiation of which the UK had played a significant role, and pressure from Germany, where finance minister Schäuble has been an implacable opponent.
As Ajay Gupta’s handy piece in Tax Notes International ($) explains, Anglo-German agreement in November 2014 followed the OECD’s September 2014 paper looking at three possible approaches to requiring ‘substantial economic activity’ in relation to the patent box:
Value creation (tax benefits apply only if specific criteria for development activities taking place in the jurisdiction are met);
Transfer pricing (the UK’s preferred approach, requiring the assessment of functions, assets and risks); and
Nexus (the OECD’s preference, limiting ‘tax benefits to the fraction of IP income equal to the ratio of qualifying research expenditures to aggregate expenditures incurred to develop the IP asset’).
Two things about the OECD’s preference are striking. First, what it means: that even with the BEPS context of defending the arm’s length principle and separate accounting against alternatives such as unitary taxation with formulary apportionment, the OECD came out clearly against relying only on a transfer pricing approach to IP. As critics such as the BEPS Monitoring Group have pointed out, allocating profits according to ‘functions, assets and risks’ is inherently subjective and discretionary, so liable to abuse and likely to produce conflict.
Second, the OECD paper set the context for the UK to retreat, at least a little. The Anglo-German compromise, which was immediately taken up by the OECD, was a modified nexus approach: nexus, but as Gupta puts it, ‘allowing a taxpayer to increase its qualifying expenditures above its self-incurred research expenditures by up to 30 percent, a so-called uplift, to reflect expenditures for research activities outsourced to related parties and IP acquisition costs.’ The UK also bought some time, with June 2016 the last date to introduce new, non-conforming provisions, and June 2021 the date for their elimination, as well as some opportunities to ‘grandfather’ existing provisions.
It should also be pointed out that the BEPS project is likely to propose only a toothless monitoring mechanism, through the Forum on Harmful Tax Practices. This consists of government representatives, and operates in total secrecy. The Forum has been in existence for some 15 years and has been largely ineffective – not surprising, as governments have little incentive to oppose a tax break which they themselves support, or might want to introduce. The ‘nexus’ test will require companies to introduce a ‘track and trace’ procedure to prove their expenditures, but this will presumably be checked only by the country providing the tax break. This is a recipe for sweetheart deals as we have already seen with Ireland’s tax breaks for Apple and others, and the Lux Leaks revelations.
Where things are headed
Gupta, and in a related piece ($) his colleague Marty Sullivan, identify the major impacts of the UK-German agreement. Above all, the patent box has been established as a ‘winning’ BEPS strategy: that is, as a mechanism to attract profit-shifting which is acceptable.
Hardly surprising, therefore, that there is now a stampede to introduce such tax breaks, each one tailored slightly differently.
Current providers already include Belgium, Cyprus, France, Hungary, Ireland, Luxembourg, Malta, Netherlands, Spain and of course the UK. Italy is introducing one (which will especially benefit sectors such as luxury goods and fashion), as well as Switzerland (presumably aimed at watches and cuckoo clocks). There is now also active discussion in the United States about joining the bandwagon. As Gupta puts it:
Don’t look now, but the United States just signaled its willingness to enter a race with the European Union for attracting technology investment — a race that will surely end with multinational enterprises walking away with the top prize. As EU jurisdictions fall over each other to adopt patent box regimes and the OECD seems ready to endorse a modified nexus approach for testing the validity of these regimes, the U.S. Senate Finance Committee’s international tax reform working group has recommended the enactment of its own preferential structure for taxing intellectual property income.
Sullivan, meanwhile, reviews the latest academic research carried out for the European Commission. His conclusion? With my emphasis:
Before Congress adopts a multibillion-dollar tax incentive like a patent box, it should have some inkling as to whether it is effective at increasing research. So far the evidence is very sparse, and what little evidence does exist is not favorable. Yes, a U.S. patent box would be likely to increase patent registrations in the United States. But in most cases that would just be legal maneuvering without any corresponding increase in the stuff we really want: scientists doing research and inventors inventing inside our borders.
While the BEPS Action Plan reflects the need for countries to coordinate further to avoid such an outcome, the modified nexus approach simply confirms the futile notion of ‘competition’ on tax, locking in a race to the bottom. As the BEPS Monitoring Group noted presciently in February:
The OECD approach will simply legitimize ‘innovation box’ regimes and hence supply a legal mechanism for profit shifting, encouraging states to provide such benefits to companies. It will be particularly damaging to developing countries, which may be used as manufacturing platforms, while their tax base will be drained by this legitimized profit-shifting. Such measures should simply be condemned and eliminated.
Last chance saloon
All is not yet lost. The OECD has not finally committed to the modified nexus approach, and the US has not yet taken the step to become a patent box ‘competitor’, which would surely make any global step back impossible in the short-medium term at least.
What would it take for the rich countries to save themselves from the more aggressive struggle for each others’ tax base that BEPS was supposed to redress? Or to limit the extent to which international rules support developing country revenue losses (which are indeed substantial)?
Well, the fine details are still under discussion at the OECD: What chance a piece of genuine international leadership from the UK or US, or a rethink by Germany or others on the acceptability of modified nexus versus complete elimination?
A draft paper by Maya Forstater, circulated by the Center for Global Development in time for the Financing for Development conference in Addis, attacks the integrity of many people and NGOs working on tax justice and illicit financial flows.
The claims include:
that (some?) NGOs have “contributed to unrealistic public expectations and an appetite for an overly simplistic narrative about a corporate tax ‘pot of gold’” (p.31);
that (some?) NGOs tolerate “exaggerated interpretations and misunderstandings”(p.33);
that (some?) NGOs do not “engage honestly with debates over economic trade offs [sic]” (p.33); and
that this behaviour is comparable to “the use of exploitative and prejudiced imagery in charity appeals” (p.34).
Blimey.
This is a (really) long post, as I’ll try to cover the breadth and strength of Maya’s many claims. I should say that I took part in the first of two meetings of the group CGD convened to look at the issues. This was really quite a constructive coming together of different viewpoints. But I stood down when the subsequent blog post seemed to ignore most of the common ground and reiterated some earlier attacks on NGOs instead, making some claims about ‘inconvenient truths’ that resurface here. Comparing back, I’m afraid it seems as if the results of the research exercise were pre-determined.
Some main points from the discussion below:
The draft paper makes a series of claims without providing any serious evidence: most importantly, a ‘complex truth’ that tax losses are not of ‘problem-solving’ scale but ‘relatively modest in relation to development needs’. The existing evidence, e.g. from the IMF or – strikingly! – the author’s own analysis in this paper of ActionAid’s work, clearly supports the opposing view.
In the two other cases where ‘received wisdom’ associated with NGOs is contrasted with ‘the complex truth’, there is in fact no direct contradiction – but the presentation in each case creates an implicit straw man of NGO opposition to the truth.
The paper’s main thrust is that there is no ‘pot of gold’ for developing countries – but no substantial evidence is offered to support this assertion. (I’m sympathetic to the idea that this aspect of the tax justice agenda is sometimes overstated, but simply to deny the existing evidence offers no way forward. Indeed this is why I encouraged this work to focus instead on substantive research issues, albeit to no avail.)
I should point out that I was a research fellow at CGD during 2013-2014, and remain grateful to Owen Barder and colleagues for giving me a great deal of space to pursue research in just this area. I hope it may be possible to revise the final draft in such a way that it can make a useful contribution.
Measuring the illicit
The bulk of the attack in the draft paper is dedicated to three elements of ‘received wisdom’, each of which are contrasted with a quite different ‘complex truth’, so I’ll focus on these before coming back to the overarching claims. First, a little bit of context.
As has often been remarked, attempts to estimate illicit financial flows (IFF) are inevitably fraught with difficulty.
By definition, illicit flows are those ‘forbidden by law, rule or custom’: so whether or not they are technically legal, like large-scale tax avoidance, they are always hidden from view where possible. Add to this the fact that the relevant international datasets are often of less than ideal quality and coverage, or sometimes simply held in private by multilateral organisations who should know better, and the problem is of estimating things that are deliberately hidden, on the basis of anomalies in data that are imperfect in any case.
The development of the research field – which has come into being seriously only in the last 15 years – has been led by NGOs, perhaps because academic researchers felt uncomfortable with the degree of uncertainty, or because those at international organisations didn’t see it as a policy priority. At each stage, NGOs and the few academic researchers have challenged international organisations to use their capacity, and ability to access data, to do better; but until this year, there had been no serious response on any aspect of IFF except that of UNODC and the World Bank in their Stolen Assets Recover (StAR) initiative.
Eurodad’s famous 2009 Illicit Financial Flows report, summarising the research contribution of international organisations
Following the G20 meetings in 2009, however, the issues originally promoted by NGOs in the wilderness rocketed to the top of the global agenda. Then in 2013, the G8 and G20 commissioned the OECD to carry out the Base Erosion and Profit Shifting initiative (BEPS), aimed at reducing the misalignment between the location of multinational companies’ economic activity, and where they declare taxable profits.
This year, the resulting research focus of international organisations has borne interesting fruit. The UNCTAD World Investment Report contributes a study estimating developing country revenue losses to one channel of multinational tax abuse at $100 billion per year. Furthermore, researchers at the IMF’s Fiscal Affairs Department suggest, in their Table 6, that the total developing country losses due to BEPS stands at $212 billion per year (in the long-run), or around three times the share of GDP of the losses of OECD members (around $500 billion). It’s worth highlighting that the developing country losses would on average exceed 10% of existing tax revenues.
None of this is to say that we don’t have a long way to go, not least in terms of collating additional datasets, and making existing ones fully available, and in burying down to the country and then the company level; and in methodological improvements, as in any quantitative research field. (Bring it on!) And just because they come from international organisations, these studies themselves are of course not immune from criticism.
But while many aspects of IFF remain ill-estimated at best, and the leading estimates from GFI for example do not include many of the aspects related to multinational tax behaviour, there is no question that thanks to the recent UNCTAD and IMF reports we are in a better position than ever before in terms of understanding the scale of revenue loss associated with multinational tax behaviour in developing countries.
Assessing the ‘received wisdom’
The main section of the paper outlines three ideas, labelled as ‘received wisdom’, and contrasts each with ‘the complex truth’. The three ideas are not specifically attributed to one or more NGOs; rather, “they are a set of perceptions which are often given and reinforced by the overall flow of media reports, infographics, press releases, case studies and campaign publications on this topic and are influential enough to require clarification” (p.9).
The sub-headings here are taken from the draft paper.
Idea 1: ‘Huge amounts’
Let’s consider first the attribution of this idea to NGOs, and second its truth or otherwise.
Of the three quotes to support the claim that NGOs have promulgated the ‘received wisdom’, one is indeed a clear overstatement of the case, taken from an NGO infographic; one is a newspaper headline (which refers to an NGO report that I’m guessing doesn’t make the claim itself, or would have been used directly); and one is a statement (that strikes me as defensible) from Yale professor of philosophy Thomas Pogge.
Even with this level of cherry-picking, these quotes obviously provide less than compelling evidence if you want to make the case for NGO responsibility for the narrative. But to be fair, I’d say that many NGOs and people (like me!) do indeed think the revenue impact could be ‘problem-solving’, if that means something like ‘with the potential to provide a noticeable human development benefit’; so let’s set the paper’s evidentiary approach aside for now.
To get to the substance of the claim, we need to compare what the paper calls the ‘received wisdom’ and ‘the complex truth’. There are two important ideas being combined here. One is about scale: the difference between ‘huge’, or more usefully ‘problem-solving’ amounts of revenue, and the alternative that these are ‘relatively modest in relation to development needs’. The other is about location: the question of whether the revenues that could be available would appear in richer rather than poorer developing countries.
Maya has made some useful points on the latter before, complaining rightly that the aggregation into ‘developing countries’ can hide a mismatch between revenues and development need. This doesn’t take into account the role of inequalities that mean most people living in extreme income poverty do so in middle- rather than low-income countries, but the broader point holds: aggregation can obscure meaning.
From the summary: “Any potential gains are likely to be higher in middle income emerging economies, and lower in the poorest countries, in line with levels of FDI although extractive industry rents are likely to offer a significant focus for greater domestic revenues in some countries” (p.2).
It might have been better to consider the data on FDI. While it is true in general that bigger economies have more FDI, the pattern is much more mixed – even allowing for natural resource wealth. Here’s a quick figure with an arbitrary selection of OECD and West African countries, just to highlight that risks of sweeping generalisations are not limited to NGOs.
And of course if the claim is about the relationship between FDI and revenues, and we know tax/GDP is strongly correlated with per capita GDP, then lower FDI/GDP in poorer countries might still be associated with higher (relative) potential revenue contribution (i.e. the FDI stock, and hence potential revenues, might still be higher in relation to current tax revenues).
In addition, the paper doesn’t provide any evidence for the claim about the scale of development needs, which seems odd. It does not to provide (nor seek to provide) any proof that the amounts involved would not have powerful effects in low-income countries.
Well; in fact, it does in one particular case.
A box on Malawi (page 12) provides probably the clearest example of why I find this paper so disappointing – what could have been offered as a useful check on use of statistics, descends instead into the absurdity of inadvertently demonstrating the truth of the position being attacked.
The box summarises ActionAid’s work [disclosure: I’m on ActionAid UK’s board] on the mining company Paladin, finding that it cut its tax bill by $43 million, and states that in one year this could have paid for “one of the following: 431,000 HIV/AIDS treatments, 17,000 nurses, 8,500 doctors, 39,000 teachers”.
It is then pointed out, accurately I assume, that the tax revenues relate to six years; and argued that it would be more appropriate to identify what could be achieved annually with the relevant share of the money (rather than offering mutually exclusive alternatives).
The annual bundle of potential services that the foregone tax could pay for, according to the draft paper, is this:
a doubling in the number of doctors, AND
a 10% increase in the number of nurses, AND
enough teachers to reduce average class sizes from 130 to 100, AND
2% of needed HIV treatments.
I guess we could argue about whether or not to call this ‘huge’, though it wouldn’t be a very useful argument. But I don’t see how anyone could deny it is a problem-solving level of revenue.
Would ActionAid have been better to present the statistics this way? Perhaps.
Does it detract from the substantive value of the ActionAid report in any way? No.
Does it support the ‘complex truth’ claim that the amounts involved are modest in relation to need? Quite the reverse – it is stark evidence to the contrary.
The draft paper has taken a potentially useful contribution, dressed it up as an attack, and lost most of its value.
Thinking at the global level, and of the 1.7% of GDP that the IMF sees as long-term annual revenue loss: it is perhaps possible to imagine a distribution of those revenues among countries in which the resulting allocation fails to be ‘problem-solving’ for most; but it’s hardly a claim we could provide evidence for at the moment, and this draft paper certainly does not.
Idea 2: Transfer pricing is tax dodging
The second aspect of ‘received wisdom’ attacked in the paper is a little confused. Per the heading and some of the discussion, it is simply the confusion of transfer pricing with tax dodging. Per the box text, however, and other discussion, it is more about whether or not transfer pricing and related rules allow multinationals sufficient room to manipulate prices, via ‘tax havens’, that curtailing this could generate significant revenues elsewhere.
Again, let’s look first at the attribution. The only quotes provided that support the confusion point come from respected academics, rather than NGOs. My feeling is that there is sometimes a confusion of language here, but the fundamental points (that there are rules in place, and that these may sometimes be abused and may sometimes allow distorted outcomes) are widely accepted by the world’s most senior policymakers.
The more interesting distinction is drawn between ‘received wisdom’ that associated revenue implications are large (for countries on either side of ‘profit havens’, as seen in #LuxLeaks); or the ‘complex truth’ that allocating profits within global value chains is difficult.
I must confess I find this one quite confusing. There’s no obvious contradiction between the ‘wisdom’ and ‘truth’. You rarely hear anyone claim international tax rules are simple or easy to comply with (for either multinationals or tax authorities); and it’s almost equally uncommon to hear a suggestion that there aren’t major revenues at risk in a whole range of countries – see e.g. the details of LuxLeaks, or the IMF results shown above.
There just doesn’t seem much disagreement to be had over whether transfer pricing rules are being exploited, to the benefit of many multinationals and a few secrecy jurisdictions, and the (revenue) loss of many countries (with both higher and lower per capita incomes) – at least not in the absence of some pretty striking new evidence.
The existence of complexity doesn’t reduce the revenues at risk, nor justify taking advantage of complexity (nor indeed lobbying to create or retain complexity). And it certainly doesn’t provide evidence against the ‘received wisdom’ suggested, so I think this section really weakens the draft.
The associated paragraphs largely focus on criticisms of some existing work with commodity trade data (including Maya’s very reasonable criticism last year of a Swiss-Zambia mispricing statistic for which I’m responsible). The discussion of the various broader studies in this draft paper is fairly light touch though. It raises a few questions on individual results, and we can easily agree that there is a good case for being cautious about data and methodologies in this area. But what of all the peer-reviewed, academic analysis that is left out?
The failure to engage with the vast bulk of the literature covered in the OECD’s recent BEPS 11 survey, for example, seems odd. The exclusion of pricing issues in relation to management services, intellectual property and debt – for example – seems doubly so. Even if the commodity critique was entirely valid, this section would not provide evidence against the ‘received wisdom’ that it intends to attack. And in addition there is now a range of analyses of individual multinational groups published by forensic investigative journalists of high quality, which go well beyond anecdote.
If we think of international corporate tax rules as the broader set within which TP rules sit, the entire BEPS process is a reflection of significant political and technical consensus on this problem. Do we have enough consistent data, or sufficient quantity of research as a result, to be precise about the scale and overall pattern of the problem? We do not, and this is the subject of much attention at the OECD, Tax Justice Network and elsewhere. Are we unsure about the broad contours of the problem? We are not. Transfer prices of everything from commodities to intellectual property to intra-group debt are manipulated for tax purposes. The scale is large, and uncertain.
The author is of course entirely at liberty to take a different view, and it would be welcome to see supporting evidence for such a position. But without presenting some pretty impressive new findings, I can’t understand why one would simply dismiss the broad consensus that exists, or seek to build a difference of opinion on the scale of a problem into an argument that the entire thing is a (deliberately?) misleading ‘narrative’ created by NGOs.
Idea 3: Money for nothing
Perhaps anticipating the reader’s scepticism by this stage, this section begins by noting: “Examples of this belief are rarely seen as direct statements” – this much is certainly true – “but often reflected in the implicit assumptions behind calculations of lost taxes…” (p.18).
The TJN quote offered as supporting evidence is intriguing:
“…tax-sensitive investment is by definition the least useful stuff: accounting nonsense and paper-shuffling that does not involve very much employment creation at all.”
Intriguing for two reasons. First, it doesn’t seem to bear directly on the ‘received wisdom’ claim. But second, because the missing start of the sentence is “But as Section 3.3 explains…” And section 3.3 includes a short literature survey with six references on the incidence and impact of corporate tax. Neither the survey nor any of the references are cited in the draft paper.
Instead, the main thrust of this brief section of the paper is to emphasise that (higher effective) corporate taxes can have negative dynamic effects. A selective survey of a few papers supporting some of these leads to the following conclusion:
“These arguments then, are not reasons to give up on taxing corporations, or necessarily to lower corporate tax rates, but underline the need for tax policy to be supported by economic analysis, rather than based on the assumption that there is ‘money for nothing’” (p.18).
If you believe in the existence of this particular ‘received wisdom’, even without any direct evidence being presented, then this is presumably a useful counter-point: we should be more careful to recognise the wider impacts of taxing corporate profits.
In any case, that’s hard to argue with – so hard, in fact, that you want to ask who would argue to the contrary? Here’s the implicit straw man that the paper has constructed:
“Tax policy should not be supported by economic analysis, but instead be based on the assumption that there is ‘money for nothing’.”
There may be a group of people who believe this (or there may not); and if there were, such a group might object to ‘the complex truth’ of policymakers actually having multiple objectives.
But if there is such a group, it presumably has little overlap with those people and NGOs like TJN that have been researching and advocating over the last fifteen years for a tax policy agenda based on economic analysis, rather than one that ignored the growing reality of abusive multinational tax practices; and for the importance of taking into account multiple objectives such as distribution.
It’s disappointing, and difficult to understand, that the paper would seek to attribute this straw man to those people and NGOs.
Summary: Straw men
It’s hard to see the contribution of this main section of the paper. The ‘complex truth’ with respect to idea 1 is a set of assertions lacking evidence, while any remaining objections to the ‘received wisdom’ are questions of scale that must be addressed by serious research. The ‘complex truth’ in relation to ideas 2 and 3 is hardly disputed, but does not contradict the main points of the ‘received wisdom’.
So the overall effect is to suggest that NGOs hold, or have promoted, extreme or unnuanced views that somehow contradict the known facts. That there is, if you like, in fact a received wisdom which the NGO narrative continually contradicts.
There are two main problems with this. First, the paper does not provide any serious evidence either for its own assertions (on which the entire argument hangs), or that any wrong views (disagreeing with an actually true ‘complex truth’) are in fact held or promoted by NGOs.
And second, even if a new draft were to do so – I’m just not sure that this is a useful way to make an argument: defining the righteous view, and implying that others disagree (or perhaps that they dishonestly pretend to).
That pot of gold
Ultimately, the CGD paper makes the argument that NGOs have exaggerated the ‘pot of gold’ that developing countries could obtain by better taxation of multinationals.
To be upfront on this, I share something of this concern. Specifically, I think the balance of attention here, compared to other aspects of tax systems, has not always been right. (At the same time, I can see good arguments for emphasising this aspect in certain policy situations.)
What do we actually know about the size of that pot though? Notwithstanding all the uncertainties discussed, and the importance of new data and continuing to improve methodologies, the best guess at the moment is probably somewhere near the latest IMF researchers’ piece: that developing country annual revenue losses might be around $200 billion, or north of 1.5% of GDP. Given average total tax revenues less than ten times that size, it’s a pretty big pot. (And all without mentioning the trend for rising shares of profits to GDP, and generally stable or falling corporate income tax revenues…)
That doesn’t mean the pot is all obtainable, or that important advances in other areas aren’t also possible, and clearly we need country-level analyses to understand the specific possibilities. But on the CGD paper’s terms, and in respect of its central claim, this is a decent pot of gold. And not one that rests on the work (or the word) of NGOs, if that’s a concern.
So if we put the mischaracterisation of the narrative, and the role of NGOs aside, the central claim of the paper just does not stand up well itself.
My final sadness about the paper is this. The last section proposes some recommendations for NGOs to improve their ways of working that are really worth discussing.
It may be difficult to move towards positive engagement based on their inclusion in a paper that makes this kind of sustained integrity attack, but I hope it may somehow prove possible to take the conversation forward in a different context.
Last thought: Does it matter?
Despite the claim to be serving the cause of better evidence and clearer debate, the draft paper muddies the waters on the potential revenue benefit from improved taxing of multinationals in developing countries – even as the evidence base has recently been further strengthened.
The timing of its being published, at the kick-off of the Financing for Development conference – the best UN opportunity in years (ever?) to lock in greater policy space for the taxing of multinationals by developing countries – is unfortunate.
The Center for Global Development is an important development think tank, and so this paper, even in draft, may well catch the attention of policymakers at Addis. And while CGD publish individual views rather than institutional ones, this may be seen as more than an individual view because it comes from a CGD process with an advisory group.
For the avoidance of doubt, I don’t think there’s any agenda at CGD – so I guess the content of this paper, its timing and any potential impact on FFD progress is just bad luck.
I very much hope that the final draft of the paper, if indeed there is one, will be quite different. A removal of the most polarising claims, where these are made on the basis of limited or no evidence, would be a good start. What would be valuable instead is a concerted examination of the data and methodologies that have been used for various aspects of revenue loss and other IFF estimates, in order to point the way forward to a strengthening evidence base over time. I hope this is a possibility; but I fear the paper may end up as a missed opportunity to contribute to an important policy research debate.
But: be not downhearted: there is substantial policy focus around the world on taxing multinationals, the research field is healthy and the agenda for new work is plentiful!
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.
Finally, the newly released accounts (covering a year and half, after a change of accounting date) show a substantial increase in the provisions, and notes that £33m was the previous provision that now forms part of the overall £130m liability.
