Tag: OECD

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Base erosion and profit-shifting: What do we know?

[From the Tax Justice Research Bulletin 1(4)]

The OECD was mandated by the G8 and G20 to revise its international tax rules in order to combat multinational corporate tax dodging – known in OECD jargon as “Base Erosion and Profit-Shifting (BEPS). The final deliverables due later this year, and because of the complexity of international tax, it has been broken down into 15 “Action Points.” (On Monday, TJN blogged Action Points 3 and 12, as discussed by the BEPS Monitoring Group, or BMG.)

The geeks’ Action Point of choice has always been number 11, which requires the collation of baseline data on how far profits are misaligned away from genuine economic activity: e.g. by being shoveled into tax havens where nothing really happens. Action Point 11 also involves continuous tracking of progress in this area.

The team working on BEPS 11 has now published a discussion draft, which sets out not only their thinking on questions of data and measurement (check back later with the BMG for our response to these) but also a broad survey of the literature on the scale and channels of BEPS.

A Banque de France researcher found that measured deviations from the Arm’s Length Principle may have cost France $8 billion of its revenuetax base in 2008 alone – and this is just one aspect of profit-shifting

Some of the main findings:

    • There is broad consensus (regardless of time period, country or data source) that there has been widespread tax-motivated BEPS activity by multinationals — though the intensity varies.
    • BEPS via manipulation of debt and interest payments is particularly important (and relatively well-studied: e.g. Huizinga, Laeven and Nicodeme (2008).)
    • Transfer pricing studies of various kinds show consistently, again, that prices are manipulated for tax reasons; and that intangible assets are important here. We might also point to the more recent study by Banque de France researcher Vincent Vicard, finding that the deviation between intra-firm pricing and true arm’s length prices may result in a revenuetax base loss to France of $8bn in 2008, having grown over the decade – and this remains just a part of estimated total profit-shifting. [Phew!]
    • Treaty shopping is estimated to reduce withholding tax rates ‘by more than five percentage points from nearly 8% to 3%.’
    • Transparency: evidence on the role of disclosure and transparency – i.e. measures such as BEPS 11 itself – is limited but striking. Most obviously, Dyreng, Hoopes and Wilder (2014) found that ActionAid’s revelations about FTSE100 companies failing to meet a rule on disclosure of subsidiaries resulted in greater disclosure, a reduction in ‘tax haven’ subsidiaries and a reduction in avoidance [Kudos to Actionaid!].
ActionAid’s revelations about FTSE100 companies failing to meet a rule on disclosure of subsidiaries resulted in greater disclosure, a reduction in ‘tax haven’ subsidiaries and a reduction in avoidance
  • Developing country scale: only two studies provide a comparative assessment of the likely scale of BEPS in developing as opposed to higher-income countries. The first, by authors including long-standing critics of NGO estimates in the broad area, finds that profit-shifting (in this case, only that of German multinationals and via debt manipulations) is roughly double the size in developing countries. The IMF, meanwhile, recently presented evidence that the revenue losses of developing countries may be several times higher than elsewhere (as a share of corporate tax revenue).

Without wishing to prejudge the BEPS Monitoring Group’s analysis (oh go on then), it is clear even from this chapter of the OECD study alone that the authors have reached a point very similar to that which motivated Richard Murphy to elaborate the first TJN proposal for country-by-country reporting back in the day: namely, that existing data sources can only provide parts of the picture, and to develop a comprehensive understanding of BEPS will require consistent and comprehensive data on global multinational activity. [Well done Richard!]

To this we might add, in the spirit of Uncounted, that current data availability has “non-random weaknesses” which will systematically result in disproportionately lower tax revenues in lower-income countries. BEPS 11, if it delivers that comprehensive data, might just be the greatest contribution to fairer international tax that is compatible with the insistence on separate accounting.

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3 ways to remove obstacles to effective taxation: #FFD3ECE

Update 24 March:

An interesting conference, including Amina Mohamed’s stressing of the urgency for development finance of tackling tax evasion and illicit financial flows. Of the three elements I discussed, it was governance that generated the most interest (perhaps in part because the suggestions on norms and transparency fall more clearly under post-2015 targets).

There felt to be quite broad consensus that simply upgrading the UN tax committee to intergovernmental standing would not do – resources are crucial if this is to become the globally representative, rule-setting body. To think about how much resourcing is required, think of the OECD’s current capacity on tax – and then scale up to global level.

But much supportive capacity already exists, if so mandated – for example, James Zhan of UNCTAD was on the same panel and spoke impressively about the work they have done on ensuring investment is not pursued for its own sake, nor maximised in terms of quantity, but rather seen as an important tool in the pursuit of the sustainable development. UNCTAD’s expertise in, for example, assessing investment and tax treaties in terms of their overall development benefit can be of value.

Is the required level of resourcing realistic? I’m not sure. But one suggestion from IBIS seems the right starting point: to hold a ministerial panel on the subject during the Financing for Development summit in Addis in July. If there is sufficiently broad desire to address the failed international governance of taxation, it should start in Addis – and if nobody turns up, I guess that’s the signal that the same failure will be accepted for the next wee while…

The pdf of my slides, in case the viewer below is too fiddly.

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Here are the slides I’m presenting at the UNECE regional consultation on Financing for Development in Geneva today (click on them to see the controls to move forwards). I’m arguing for a bit of focus in FfD on changing norms, governance and transparency at the international level, in order to open up space for effective taxation at the domestic level.

The slides are a little basic, because (a) I am, and (b) I’ve only got 7 minutes. With those excuses in place, comments are very welcome. And the hashtag is #FFD3ECE…

Alex-Cobham-UNECE-Geneva-FfD-230315

A couple of bits of related reading:

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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.