Tag: international tax

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#SwissLeaks – Tax transparency for accountability

hsbcleakMuch of the #SwissLeaks data has been in the hands of tax authorities for 5 years. Many of the questions raised relate to individuals and to particular regulators and governments – but there’s also a broader question that goes to the type of solutions that will address the broader loss of trust in tax authorities’ effectiveness and independence. Clear policy changes are needed to recover trust and accountability.

Last night the International Consortium of Investigative Journalists (ICIJ), and a host of international media organisations from Le Monde and The Indian Express to the BBC and CBS, broke publicly a leak of documents from HSBC’s Swiss bank, dating to 2005-2007. TJN provides a little historical context here, while Richard Murphy poses some highly pertinent questions. Oh, and TJN’s Jack Blum gave a cracking interview to 60 Minutes.

The broader lesson

If there’s a broader lesson here – and there is! – it’s that providing data privately to tax authorities is insufficient. The leaked data provided privately to (mainly European) governments in or around 2010 simply failed, in different ways, to deliver accountable and effective taxation.

  • Exhibit I: UK. Since receiving details of more than 1,000 cases in 2010, the UK has undertaken 1 (one) prosecution. The coalition government that came to power in 2010 also negotiated a very bad agreement with Switzerland that TJN had shown beforehand would not only protect tax evaders from transparency and prosecution but would also fail to bring in anything like the claimed sum of revenue. In addition, the government appointed as a Lord and trade minister Stephen Green, who had been the chief executive and then chairman of HSBC during the entire period.
  • Exhibit II: Greece. Somewhat further down the road of accountability is Greece, where the then minister of finance is now facing charges of “attempted breach of trust at the expense of the state and improperly interfering with a document”, for alleged actions relating to the loss of the list received from France, and the possible removal of relatives’ names.
  • Exhibit III: India. As of last month, The Indian Express reports that 15 people were facing prosecution out of more than 600 names provided by France in 2011. Today, they have published data from #SwissLeaks relating to 1195 names.
  • Exhibit IV: USA. Here the questions relate, once more, to what action exactly followed from the 2010 receipt of leaked data from France – and whether HSBC should have been allowed to maintain its banking licence. As The Guardian notes, no reference to the case features in the HSBC settlement of nearly $2bn relating to sanctions-busting activities.
  • Exhibits V and VI: Denmark and Norway. With thanks to @FairSkat and @SigridKJacobsen respectively, both of these countries with a relatively strong reputation for fair taxation did the ‘inexplicable’ and chose not to request the data from France. In the wake of the #SwissLeaks story, both now seem likely to.

Without confidence in fair and accountable taxation, governments risk the erosion not only of wider tax compliance, but of state-citizen relations and so of effective democracy (see e.g. recent behavioural and cross-country studies on the important role of tax).

That doesn’t necessarily mean that individual taxpayer data should be in the public domain. While some countries go to this length, many consider it a serious violation of privacy.

What sort of transparency is needed for accountable taxation? 

How can governments (re)build trust that the rich and powerful – not to mention the criminal – will not simply go uncounted behind closed doors?

Here’s a suggestion – comments welcome:

  1. Publish data on the aggregate bank holdings in other jurisdictions of residents, as declared by the banks and through automatic information exchange between jurisdictions (in effect, the national components of the locational banking data collected but not published by the Bank for International Settlements, which was called out by the Mbeki panel and African Union last week);
  2. Publish data on the equivalent, as reported by taxpayers;
  3. Publish regular updates on the status towards resolution of any discrepancy, e.g. “three cases accounting for 27% of last year’s discrepancy are now being prosecuted; investigations continue into 154 cases which account for a further 68%; while further work is underway to determine the nature of the remainder of the discrepancy (5%).” Addendum: @AislingTax points out quite rightly that I need another category here: the ‘gap’ which is not a gap, but rather relates to other features of the tax system such as non-doms in the UK.

A parallel case is that of the watering down of proposals for country-by-country reporting by multinational companies. Publication is necessary so that companies are held to account for abuses, but also so that tax authorities (and governments) are held to account for fair and effective taxation.

Private provision of this data to tax authorities may allow them to tax companies more effectively, but does nothing to demonstrate to citizens if such an opportunity is actually taken. Much of the #Luxleaks data was available to tax authorities, in theory or in practice, but only publication has led to a policy response.

As I twoth last night, the lesson of #SwissLeaks is that accountability demands public transparency.

 

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Four Futures for International Tax Rules

This post was first published on Views from the Center.

Consensus on the reform of international tax rules may be splintering under the combined pressures of post-crisis austerity and revelations about cut-throat tax ‘competition’ (see my discussion on thishere). In light of this, I sketch out four possible directions for international rules and one major trend common to all, and then assess the likely implications for developing countries.

1. Staying the BEPS course

The Base Erosion and Profit Shifting initiative (BEPS), led by the OECD at the behest of the G-8 and G-20 countries, aims to create better alignment between multinational profits and the location of their actual economic activity. The OECD’s remit, set out in a detailed action plan, is to deliver progress in a set of largely discrete areas to make the current system function better.

The BEPS approach rests on a commitment to “arm’s length pricing” (ALP) for transactions among members of the same multinational group, which is intended to give rise in turn to the real (market-equivalent) distribution of profit across the group. Setting aside whether this is an economically sensible way of looking at a group of related parties with common control, the approach simply may not be consistent with the aim – there is no evidence to suggest that ALP, if effective, would necessarily align profit with economic activity.

The UK’s proposed ‘diverted profits tax’ embodies the challenge for BEPS. Despite playing an important role in bringing BEPS into being, the UK government’s frustration with the inability of ALP to deliver politically acceptable taxation of major multinationals has led it to take a quite different tack: in effect, to require explicitly some degree of alignment of profits and activity (sales).

Will leading states maintain their commitment to the OECD approach? The answer may depend on a return to stronger economic performance, and the easing of broader fiscal pressure. Continuing anaemic growth may lead to continuing political pressure and proliferation of work-around measures like the Google tax that cut across the ALP by requiring some alignment of profits and activity.

2. A bigger fix for BEPS

A more consensual future for BEPS can also be envisaged (hat tip to a necessarily anonymous official at a major ministry of finance), involving a rather broader fix but maintaining the fundamental nature of the current system.

This would involve countries signing up to three basic principles, which it has been suggested could eliminate 90 percent of the BEPS problem in one stroke:

  • A common tax base (so there is no incentive for arbitrage on the base)
  • Minimum tax rates (limiting, though not eliminating, the incentive for arbitrage on rates)
  • Elimination of preferential regimes (such as the patent box)

This would require a substantial shift in perceptions of the problem. Since some policymakers see this type of harmonization as a threat to sovereignty, progress seems likely only if such a view is eclipsed by the perception of tax ‘competition’ as the greater threat.

3. Unitary tax revolution

The most dramatic change conceivable would involve broad agreement to adopt the major alternative to the ALP, which is unitary taxation with formulary apportionment. In other words, the new approach would take the multinational group as the unit for taxation purposes, rather than individual companies within it, and apply a formula based on the location of economic activity to apportion the group’s tax base between different jurisdictions, where each may apply whatever level of tax they choose.

Given this approach is explicitly designed to align profits with economic activity, progress towards the agreed aim of the BEPS initiative is highly likely, and would benefit lower-income countries. While pressure for lower rates might build over time, the increase in tax sovereignty – the ability to make policy changes that matter – would remain.

However, political opposition has hindered the prospect of a global agreement to rip up the rules and start afresh. EU attempts to move towards an apportionment basis under the Common Consolidated Corporate Tax Base project appear stalled, and major powers like the US (despite its largely positive experience using unitary taxation among its own states), and the vast bulk of the multinational and accounting sectors continue to oppose, rendering a revolution unlikely in the medium term at least.

4. Unitary tax evolution

A more likely scenario is one where the current system evolves gradually towards something more consistent with unitary taxation (UT). There are two main, complementary channels through which this could occur.

First, continuing dissatisfaction with the ALP – and the sense that developing countries’ concerns are not well reflected in BEPS – may give rise to a breakaway. Developing countries will soon be able to examine country-by-country reporting from multinationals operating in their jurisdiction, which will highlight the misalignment between the shares of activity hosted and shares of profits declared.

A single developing country or a regional grouping could reach a tipping point and decide to switch unilaterally to taking as tax base some formulary apportionment of the global profit. The demonstration effect could be powerful and drive others to follow suit.

The second channel is even more gradual. It involves the ongoing growth in the diversity of methods allowed under OECD rules and the use of methods that include some profit attribution on the basis of activity, as distinct from any ALP or other pricing decision.

Between the two channels, the world seems likely – ceteris paribus – to move at least a little further in this direction over time. Again, this scenario would offer the possibility of greater tax sovereignty for many developing countries.

Development prospects and a common trend

Lower-income countries obtain, on average, much smaller shares of GDP in corporate tax revenue. In no small part this is due to a combination of limits to states’ technical capacity and negotiating power with large multinationals, and to the incentives that the international system provides for profit-shifting. As such, the four futures can be considered in terms of their likely impact on these two factors.

Source (columns A and B): McNabb & LeMay-Boucher, 2014; data from ICTD Government Revenue Dataset.

The BEPS course (future 1) address specific weaknesses in the rules, which may reduce profit-shifting incentives somewhat, but at a broader level will do little to diminish the complexity of rules that make technical capacity such a constraint. The ‘bigger fix’ (2) offers the possibility of greatly reduced incentives for multinationals, and so could have an appreciable benefit.

The unitary revolution (3) could change the power dynamic for lower-income countries entirely, both in relation to multinationals but also vis-à-vis higher-income countries – but partly for this reason is an implausible scenario. Evolutionary steps towards UT (4), however, seem likely, and have the potential to sharply reduce the importance of capacity constraints and to change the balance of negotiating power also.

In fact, the common trend in all four futures is in this direction. The presence of country-by-country reporting information, now established as OECD standard, provides a simple risk mechanism by allowing a check on the profit misalignment of each taxpayer. Any tax authority requiring this information from multinationals will be in a position, regardless of the range of possible outcomes under ALP (or directly under UT), to set effective limits on the extent of profit misalignment that they are willing to accept. This has the potential to change the relative negotiating power of even the least well-resourced tax authorities.

Publishing the data would provide a powerful accountability mechanism for both multinationals and tax authorities, in respect of each other and for civil society; but even held privately, this is information that can support substantial change. Not all transparency is equal; in this particular case, information is indeed power.

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#Luxleaks: The Reality of Tax ‘Competition’

This post was first published on Views from the Center.

Aside from lurid revelations about individual companies and the big four accounting firms, the leaks of multinationals’ tax deals with Luxembourg confirm­—and expose to a wider audience­—the true nature of the tax ‘competition’ that prevents the emergence of effective international rules.

#Luxleaks

The International Consortium of Investigative Journalists published the second tranche of leaked files, showing tax agreements the big four accounting firms reached, on behalf of their clients, with Luxembourg. The general pattern is of establishing internal corporate finance companies in Luxembourg and using these to shift in billions of dollars of profits earned elsewhere, after obtaining confidential rulings from officials that ensure a very low effective tax rate — in many cases less than one percent.

The ICIJ’s reporting and detailed analysis of documents on individual companies from Disney to IKEA is outstanding. It clearly shows a systematic pattern of behaviour in Luxembourg, and adds to a range of other evidence suggesting the pattern is systematic across multiple jurisdictions.

Widespread tax base poaching

Several recent examples show other countries doing deals knowingly to shift in, and not (fully) tax, profits that arose elsewhere. The European Commission has initiated proceedings against Ireland for allegedly providing “State Aid” to Apple since the 1990s through unjustifiably beneficial tax treatment. This had effectively capped the level of profit Ireland would recognize as tax base, leaving untouched the vast majority of profit shifted in. Meanwhile, a more formalized version of this approach dating back 10 years, Belgium’s system of ‘excess profits rulings’, has also come under scrutiny.

In all three cases­—Luxembourg, Ireland, and Belgium—the pattern is consistent. Companies, through their big four accounting firm advisers, have obtained advance agreement not to tax profits that arise, but are not taxed, elsewhere.

A less blatant but increasingly common instrument is the patent box, or knowledge box, which provides a very low tax rate in relation to R&D. There are already generous tax breaks for R&D in most countries. A patent box can, controversially, allow one country to capture the tax base associated with the R&D that was supported by taxpayers in another.

Such tax incentives for intellectual property exist in Belgium, Cyprus, France, Hungary, Ireland, Luxembourg, Netherlands, and Spain.  In addition, the UK, which had introduced the measure from 2013, recently bowed to German pressure to phase it out (albeit not fully until 2021). The decision came after initially resisting, along with Luxembourg, Netherlands, and Spain, the suggestion that the tax break should only apply to R&D actually carried out in the country offering the patent box.

Google tax

Less than a month after its compromise over the patent box tax break, the UK government proposed a measure designed to protect its own tax base against similar poaching. The ‘diverted profits tax’ (DPT), now subject to public consultation, seeks to ensure profit arising from sales in the UK do not escape taxation by claiming to have no permanent establishment in the UK, nor through ‘certain arrangements which lack economic substance’. Perhaps unsurprisingly, given criticism of theapparent disconnect between Google’s UK profitability and tax payments, media are calling the measure the ‘Google tax’.

The expected revenue impact is small. Despite a marginally penal rate of 25 percent (compared to a standard 21 percent), the forecast is to raise around £1.3 billion over five years. The highest forecast annual take of £350 million implies a base of £1.4 billion of ‘diverted’ profits, which is equivalent to just 1.4 percent of the most recent quarterly UK corporate profits. (The basis for these estimates hasnot been published.)

The change of direction may nonetheless be important. During his announcement of the DPT, UK Chancellor George Osborne stressed “the government’s commitment to an internationally competitive tax system.” However, the DPT reflects an understanding that, too often, countries are competing not to attract real economic activity but only the taxable profit that arises from activity taking place in another jurisdiction.

The tension between playing this game, while trying to limit the counter-success of others, in large part explains the failure to develop more effective international rules – and hence the tilting of benefits towards multinationals rather than to (especially lower-income) states. Still, pressure is growing, and the eventual direction of travel will have important implications for developing countries. A companion post explores future scenarios for international tax rules, and the implications for developing countries.