As tax havens disappear, global revenue wars begin

We are entering a new world of tax revenue wars, and no one can say who will emerge as the victor.

All we know is that there will be tension over the next five years as governments seek to implement the global plan to end to tax havens from Luxembourg to Bermuda.

The Organisation for Economic Co-operation and Development plan – known as Base Erosion and Profit Shifting (BEPS) – will put an end to non-taxation.

From the OECD’s perspective, in a world where there’s no longer zero tax, everyone’s a winner. In practice, there’s likely to be winners and losers.

Tensions will arise because there’s still no clear guidance on where or how much profit should be taxed.

BEPS action item 1 (there’s 15 parts) said it was impossible to ring-fence the digital economy. It stopped short of recommending whether profits should be taxed where the customer is and value is created (source), or the country where the product originated (residence).

Clayton Utz tax partner Niv Tadmore said part of the problem was the US was not fully on board with this part of the plan. “The United States see it as an attack on their businesses, and so the recommendations in action item 1, are quite soft,” he said.

A report by a coalition of civil society organisations including the Global Alliance for Tax Justice, Tax Justice Network, Christian Aid, Action Aid, Oxfam and Tax Research UK, also criticises BEPS saying it will be a recipe for disagreement and conflict.

It said there would be “continued scope for fragmentation of production functions and their location in jurisdictions where the profits would be lightly taxed”.

BEPS action item 7, discusses the concept of a “permanent establishment”. Under old tax rules, if you had a physical location in a country, that’s where you had a PE and paid tax. As we know, most digital companies don’t have a physical presence.

The OECD said further work on the allocation of profits to PEs would take place next year. PwC said in a recent note to its clients, “it seems likely that these finalised PE rules will lead to significant dispute in practice”.

That brings up the next issue: How to resolve disputes when they happen.

The OECD itself acknowledges there could be conflict, which is why action item 14 is dedicated to “dispute resolution”. This will be in the form of “mandatory arbitration”.

The civil society group report raises worthwhile questions about how such an arbitration process will be set up and policed. Is it smart to entrust decisions involving often hundreds of millions of dollars to a “secret and unaccountable procedure of third party adjudication”, it asks, or to force smaller countries into arbitration?

That brings up another source of tension surrounding BEPS; who benefits? There’s been much criticism of the OECD and G20 for leaving some developing countries outside of the debate. The OECD has said it’s going to spend the next year getting more developing countries on board. There’s about 90 countries that have signed up so far.

Even if more people get on board, there’s questions about whether there is a big pot of gold waiting to be collected. The OECD estimates that there could be up to $US240 billion ($325 billion) in revenue being lost due tax avoidance. But that’s likely to be tied in with bigger problems such as money laundering.

Another area of tension lies in how much information goes public. The country-by-country reporting rules are all about closer information sharing, but that information is being kept out of the public eye.

Tax experts and the OECD say putting out too much information can be misleading. But NGOs and tax transparency groups, say more, not less, public disclosure is needed.

The final source of tension is in the bid to tax multinationals more aggressively; do you end up becoming less competitive?

KPMG’s global head of tax Greg Wiebe said that BEPS had succeeded in wiping out aggressive tax behaviour. “There’s not that same demand to push the envelope,” he said.

Since there were no longer tax havens, most countries would become more tax competitive. Countries that failed to compete would lose out. “Businesses will change their model and move to lower-tax jurisdictions,” Wiebe said.

Even the civil society group report said the proposals would largely retain the scope for countries to offer tax breaks.

“The consequence of weak co-ordination will be an acceleration of unilateral measures,” it said. “Some have already been initiated by countries such as the UK and Australia, and other countries are likely to follow, to protect their tax base.”