Global watchdogs take on the corporate tax dodgers
Posted On: September 20, 2014
As the finance ministers and central bank governors from the world’s 20 largest economies gather in a convention centre in the Australian city of Cairns this weekend, anti-capitalist protesters will likely accuse them of doing the bidding of the globe’s all-powerful multinational corporations.
But the Group of 20’s financial chieftains will actually be discussing proposals that even those wearing balaclavas might appreciate: A sweeping plan to squeeze billions of dollars more in taxes from the world’s largest companies.
The proposals, called “revolutionary” and “historic,” aim to plug the gaping loopholes in the international tax system that allow multinationals to slide substantial profits into tax havens or low-tax countries, depriving governments of badly-needed revenue.
The reforms have been developed on a tight timetable and they have largely been agreed to by delegates from 44 countries consisting of member states of the Paris-based Organization for Economic Co-operation and Development and the G20. They have clearly put on notice the cadre of international tax lawyers and tax planners who craft the complex structures companies use to minimize their tax burdens.
“These are remarkable agreements, remarkable decisions,” Angel Gurria, the former Mexican finance minister who heads the OECD, told reporters in Paris this week. “They represent a first concrete, and let me say, historic achievement on the long road to global tax justice. And of course, our aim is to migrate to a world where all corporations pay their fair share of taxes.”
The practices of some global companies to use complex, but legal, techniques to avoid taxes have come under unprecedented scrutiny in recent years, as have the practices of some wealthy individuals who have taken advantage of bank secrecy and offshore jurisdictions to illegally hide money from the taxman.
Political leaders, particularly in the United States and Europe, have angrily accused world-straddling companies such as Apple Inc. and Google Inc. of failing to pay their fair share, demanding the companies explain structures that allow them to funnel profits into low- or no-tax jurisdictions. A nascent global network of non-governmental organizations has sprung up to bash big companies for their tiny tax bills.
The corporations at the centre of the storm all maintain that they pay their taxes and have done nothing wrong. Apple chief executive officer Tim Cook told a U.S. congressional committee last year that his company pays “all the taxes we owe – every single dollar.”
Starbucks Corp., caught in a public controversy in Britain over its use of Dutch and Swiss entities to essentially eliminate paying any British corporate income tax, last year voluntarily committed to paying some £10-million ($17.8-million) in tax in the face of protests and customer boycotts. Senior executives from the coffee retailer, as well as of Google and online retailer Amazon, were all hauled before Britain’s public accounts committee in late 2012 and grilled over their tax-minimization schemes.
When a European Google executive insisted that the company’s tax strategy was legal, Margaret Hodge, the British MP chairing the public accounts committee, responded: “We’re not accusing you of being illegal, we’re accusing you of being immoral.”
Canada has not been immune from the debate. But here, the tone has been more muted than in Europe, partly because the federal government’s budget is in much better shape, and unemployment is much lower here than in many European countries where populations are feeling the pinch from government austerity. Foreign multinationals have not faced the same public scrutiny for their tax tricks, which presumably siphon similar amounts away from the reach of Canada Revenue Agency.
No one knows for certain, but according to estimates from Canadians For Tax Fairness, a citizens’ group, offshore tax avoidance by both companies and individuals costs Canadian governments as much as $7-billion a year in lost taxes. However, some experts warn that overzealous global attempts to crack down on the ability of companies to engage in tax planning, or shift profits to minimize taxes, could also come at a cost to Canada.
Companies in Canada already pay relatively low corporate taxes. A recent study by KPMG ranked Canada as the most favourable tax environment for business in the developed world. And government tax breaks for resource companies and research and development have made this country, if not a “tax haven,” still an attractive destination for foreign capital.
This was made clear in the recent debate around the $12.5-billion takeover bid for Tim Hortons Inc., by Miami-based Burger King Worldwide Inc. The proposed deal is structured as a so-called “inversion,” which is designed to move Burger King’s U.S. corporate headquarters into Canada. One reason for the move is that Canada has a lower nominal corporate tax rate and – unlike the U.S. – mostly allows foreign profits to be brought home tax-free from countries with which Canada has a tax treaty. Amid talk of blocking such moves, U.S. President Barack Obama decried companies leaving through inversions as “corporate deserters.”
There is also the question of whether global reforms could disadvantage Canadian-based multinationals, which have increasingly looking to offshore jurisdictions, most notably Barbados, as conduits to invest overseas. More than $60-billion flows through or is kept in Barbados, where the corporate income tax rate is 2.5 per cent. While some of that is private wealth being stowed offshore, much of the money is being used by Canadian companies doing business in other countries around the world.
Proponents argue that this allows them to better expand and compete worldwide. And this creates not just profits and jobs for Canadians back home, but more international trade links for other Canadian businesses, according to a Barbados-funded study by Professor Walid Hejazi, an associate business professor at the University of Toronto.
Countries without general corporate tax rates
- Bahrain
- Bahamas
- Bermuda
- British Virgin Islands
- Cayman Islands
- Guernsey
- Isle of Man
- Jersey
- Vanuatu
- Wallis and Futuna
Source: Tax Foundation
‘The impact is now’
The OECD proposals, some of which have key details that must be worked out, still have be approved by the G20. And another batch of proposals are due next year before any of the actions are finalized. After that, they must be either written into the domestic tax legislation of participating countries, or renegotiated into more than 3,000 international tax treaties. However, the OECD says a multilateral treaty that would instantly rewrite tax treaties of all nations that signed on to it is feasible, and could make the changes real much sooner.
Still, OECD officials and corporate tax planners say the mere announcement of the plans is already forcing corporations to rethink their aggressive tax-avoidance strategies.
“The impact is now,” said Pascal Saint-Amans, the former French Finance Department official who heads the OECD’s centre for tax policy and administration. “… Companies can face this new reality and they can anticipate.”
The current system is a mishmash of often conflicting, contradictory and massively complex domestic tax regimes that interact through “model” tax treaties drafted and promoted by the OECD. But the focus in the international tax system, dating back to its architects in the League of Nations in the 1920s, has long been on avoiding “double taxation,” or the practice of unfairly forcing companies operating in more than one country to pay taxes on the same profit twice – at home and abroad.
Over time, multinational companies have been able to take advantage of inconsistencies in the tax rules of different countries, and the willingness of some mostly small countries to set themselves up as low- or no-tax jurisdictions. The result has been the growth of “double non-taxation,” or the avoidance of paying tax altogether. It has resulted in bizarrely distorted flows of capital: Tiny Barbados, for example, is the third most popular destination for investment flowing from Canada, just behind more obvious destinations such as the United States and Britain.
2012 Inward Direct Investment vs GDP (billions, USD)
In 2013, an OECD report used Foreign Direct Investment funds flowing into a country for ownership in “lasting enterprises.” Though such investments don’t necessarily equate to profit shifting, they illustrate the potential scale of corporate profit shifting for tax purposes.
SOURCE: World Bank, OECD, IMF
‘Treaty shopping’Understanding what the OECD proposals would do involves diving into the arcane world of international tax planning, which is replete with its own impenetrable cant. Not all of it is as colourful as the “Double Irish with a Dutch Sandwich,” a tax technique that has earned Google and Apple scorn but is used by many other major companies. Under this kind of scheme, profits are routed through low-tax Irish and Dutch subsidiaries and ultimately end up in zero-tax Bermuda.
The OECD says its plan includes draft domestic legislation that would allow countries to “neutralize” what are known as “hybrid mismatch arrangements,” a term that made even the head of OECD exclaim “My god, what the Dickens does that mean?” at this week’s press conference. These essentially involve the creation of two-faced entities that because of differences in two different countries’ tax codes, avoid taxation in either country. Some schemes allow companies to take advantage of a tax deduction twice, once in each country, for the same payment. The OECD says billions in tax revenues are lost through such arrangements.
The proposals could also mean dramatic changes to the way the 3,000 tax treaties around the world are used, or abused. Tax treaties – Canada has signed them with more than 90 countries – vary but most allow money to move around with less tax applied. Canadian companies, for example, are generally allowed to bring profits from tax-treaty countries home tax-free, on the assumption that foreign tax was paid. But sometimes that foreign tax was zero or close to zero. (U.S. companies generally cannot do this, meaning they leave billions offshore.)
Companies worldwide routinely game the system with a practice called “treaty shopping.” This is the practice of setting up shell companies in a low-tax jurisdictions, where little or no actual activity takes place, in order to take advantage of tax benefits in a treaty. For example, a vast amount of global investment in India stops first in Mauritius, with which India has a favourable tax treaty. The OECD says new rules should allow countries to deny treaty benefits to companies setting up empty shell entities solely for tax purposes.
The method many companies use to get their profits out of high-tax jurisdictions and into low- or no-tax ones is called “transfer pricing.” Under tax laws in many developed countries, a multinational must account for transfers of cash or goods and services between its subsidiaries in different countries as though they were transactions between “arm’s-length” companies. But this process can be gamed.
For example, let’s say a Canadian subsidiary of a foreign company sells widgets in Canada that it imports from its parent. And let’s say the patent for those widgets is held in a corporate affiliate in an offshore tax haven. The multinational tells the Canada Revenue Agency that its Canadian subsidiary had to pay a large licensing fee for the use of the patent. By making the fee as high as possible, that transfers money out of the Canadian subsidiary and into the affiliate in the tax haven. The result of this type of aggressive “transfer pricing” is less profit in Canada for CRA to tax. The OECD has proposed allowing tax authorities to take “special measures” to go beyond the “arm’s-length principle” and disallow tax benefits won with abuses of this kind.
But cracking down on this kind of transfer pricing isn’t easy. The CRA has suffered several legal defeats in challenging some of these practices. It lost a battle involving GlaxoSmithKline PLC before the Supreme Court of Canada in 2012, in a case in which the drug maker charged its Canadian subsidiary five times the going rate for a generic version of the drug, with the proceeds sent to an affiliate in low-tax Switzerland. The court ruled that a simple price comparison with the generic drug was not appropriate and that other arrangements between the parent and subsidiary had to be taken into account. It returned the case to the Tax Court of Canada for another review.
Another complicating factor the OECD tried to address is the rapid rise of the digital economy. The global growth of online retailers, for example, raises questions about where sales actually take place and where sales tax should be collected. But in the end, the OECD process concluded that special measures should not be introduced to “ring-fence” digital businesses, since the entire economy is moving online.
Effective tax rate vs top marginal corporate tax rate
A country’s top corporate tax rate often bears little relation to what companies actually pay. The effective rate, shown here in red, includes incentives for activities such as research and development.
SOURCE: KPMG
‘Incredible brand damage’
Perhaps the most dramatic of the OECD proposals, however, is also the simplest: Multinationals, for the first time, would be forced to disclose their profits, and tax paid, on a country-by-country basis to all tax authorities where they operate. This information, which the OECD says would not be made public, would give tax authorities a global picture of a company’s tax bills, and could raise questions about why a certain company locates profits in far-off places where it appears to have few employees or operations. Several observers call this a “game changer.”
Greg Wiebe, the Toronto-based global head of tax for KPMG, says the OECD process will likely produce the largest changes in international tax rules in his lifetime. Just this move to disclose information would have a dramatic effect, he said, as companies re-evaluate their tax strategies knowing that tax authorities will all have access to the numbers. And he predicted that similar information will soon have to be made completely public, as the demand for accountability from big public companies grows.
But already, Mr. Wiebe said, the worldwide storm of controversy around tax strategies has seen multinationals shy away from aggressive planning that would have been standard just five years ago.
“The whole issue on tax has shifted from a behind-the-scenes internal matter to something that is much more public,” Mr. Wiebe said. “… And it can cause incredible brand damage very quickly if you’re seen to be doing something that isn’t in the public interest.”
OECD officials, pointing to support from the G20 leaders who called for the proposals, insist their plans will finally end abusive tax planning and align taxation with where economic activity takes place, and value is created.
But Patrick Marley, a former Canadian Finance Department official and a tax lawyer with Osler Hoskin & Harcourt LLP, said there is a large gap between drawing up grand plans and actually implementing them. “The whole project could result in a major change for all companies engaged in cross-border transactions,” Mr. Marley said. “The reason I am hedging that and saying ‘could’ is because it’s still a bit too early to tell whether the ultimate result of this will go the way of the [failed] Kyoto accord on climate change.”
Activists that have been fighting to raise the issue’s profile are relatively pleased with the OECD’s moves, but also wary of whether governments will actually follow through. “It is encouraging,” said Dennis Howlett, executive director of Canadians for Tax Fairness. “I do think the OECD is quite serious about this. This is a huge project they have taken on, and they seem to be very determined to get somewhere with it. … The danger is that there still a lot of time for it to get watered down.”
