Big economies take aim at the firms running circles around their taxmen
POLITICIANS in the rich world like to splutter about the ever more elaborate dodges that big multinational firms undertake to minimise their tax bills. But doing something about them is trickier. America’s Congress is struggling to agree on ways to stop companies “inverting”—switching domicile to reduce tax bills (see article). The European Union is locked in a protracted debate about whether the favourable treatment that some of its members give to particular forms of corporate revenue are tantamount to illegal subsidies. So the news that the world’s biggest economies have agreed on a plan to limit “base erosion and profit shifting” in corporate tax is something of a watershed.
It has become the norm for multinationals to park themselves or large chunks of their assets—especially intangible ones, such as rights to royalties—in low- or no-tax places such as Bermuda, Luxembourg and Ireland. The wiliest, including Apple, have even discovered ways to re-route funds so as to render income stateless. These transactions are generally legal, or at least exploit grey areas in the tax codes of the countries concerned. But they appear unfair to many in these fiscally strained times, not least because they are beyond the reach of small, domestic firms.
It is only natural that companies take advantage of the gaps. They plough huge resources into doing so, viewing cutting-edge tax arbitrage as a competitive advantage. One study estimated that the resulting tax avoidance could amount to a quarter of total corporate profit-tax receipts in rich countries, and more in poor ones. In truth, the extent of the fleecing is unclear. Corporate tax receipts as a share of GDP, although volatile, do not appear to have declined markedly in the past decade. As a share of profits, however, they have fallen steeply (see chart), though that is partly due to declining rates.
In 2012 the G20, a club of the world’s biggest economies, called on the OECD, a similar grouping which has long overseen international tax standards, to seek consensus on ways to close the loopholes. Its members have agreed on one set of proposals, released this week, and are working on another. The G20 will formally approve the OECD’s plan at a summit in Australia on September 20th. All told, 44 countries accounting for 90% of the world economy are on board.
The proposals aim to reduce the discrepancy, for many firms, between where they do most of their business and where they pay most of their taxes. One target is “transfer pricing”, the rates that subsidiaries of a single firm charge each other for goods and services. By setting these high, firms can spirit profits out of the countries where they do most of their business to tax havens where they locate their intangibles. The proposals would also clamp down on “treaty shopping”, arrangements through which firms obtain benefits from a tax treaty despite not being resident in either country that is party to it.
Another measure attempts to end the absurd practice of “hybrid mismatches”, whereby companies claim double deductions by classifying financial instruments as debt in some countries and equity in others. In a genuine coup, all members will share basic information about multinationals (such as assets, sales, profits and employees), giving authorities a better chance of spotting tax dodging.
In some areas, consensus could not be reached or is slow to emerge. There was, for instance, no agreement on restricting the use of “patent boxes”, favourable tax regimes for patented inventions and other innovations. In a win for America, the countries agreed not to treat e-commerce as a distinct sector, subject to special “Google taxes”, although they did undertake to study the digital economy’s impact on taxes further. The second set of proposals, expected late next year, is unlikely to include anything much more concrete on this. It will, however, tackle a number of other thorny issues, such as the rampant use of intra-group loans to “strip” earnings out of higher-tax countries.
The chief complaint against the OECD’s approach is that it eschews more radical reforms, such as divvying up taxing rights among countries according to the proportion of a firm’s sales or staff located there. Sol Picciotto of Lancaster University and the Tax Justice Network, an NGO, calls the reforms “a patch-up job” that maintains the “fiction” that subsidiaries charge each other market prices and does little for the poor African countries that are among the main victims of profit-shifting. Jeffrey Owens, a former head of the OECD’s tax division, applauds his former employer’s work but thinks policymakers could struggle to keep up as location becomes an ever-fuzzier concept in business.
Moreover, much of what has been agreed requires the amending of laws and treaties. The risk is that countries implement only the bits that suit them. It remains to be seen how Britain, for instance, will square its official support for the project with its desire to be the most tax-competitive nation in the G20. It offers an alluring patent box and generous treatment of interest and has enthusiastically cut its corporate tax rate, to 20%. America often drops multilateral initiatives in favour of its own preferences.
Small wonder, then, that only 23% of the 3,000 firms surveyed recently by Grant Thornton, an accountancy, expect the proposals to win global approval. And even if they do, the next step is even harder: making sure the multinationals’ supremely inventive lawyers and accountants do not find a way around them.
