A world upside down? New approach to international tax
A new report from the OECD is contemplating major changes to international tax rules.
This is a progress report on its project on ‘base erosion and profit shifting’ (BEPS), which highlights the large tax revenue losses to countries around the world due to tax avoidance by transnational corporations (TNCs). This interim report was called for by the French, German and UK Ministers of Finance, who asked for it to be discussed at the G20 Finance meeting in Moscow last weekend.
The report analyses the extent and nature of the problem, surveys the attempts made so far to deal with it, and recommends that it must now be tackled by more `comprehensive’ and `holistic’ solutions. These will apparently include changes to the key provisions on taxation of TNCs in model tax treaties (articles 7 and 9), which the report says now impose `constraints’ on necessary measures. The OECD aims to move fast, using three working groups (chaired by Germany, the UK, and France-USA) to produce an Action Plan, which is to be presented to the next G20 meeting in July.
These re-evaluations of the international tax system have been precipitated by political pressures due to the publicity given to large tax losses in both developed and developing countries from tax avoidance by TNCs. Many countries around the world have become concerned about the ability of internet-based companies to avoid taxes by carefully designed company structures. Google alone is reported to have cut its overall tax rate almost in half, saving $2b in taxes, by shifting $9.8b to Bermuda, 80% of its 2011 pretax profits, entirely legally. The problem is not confined to the high-tech sector, similar issues have been identified in sectors such as mining, agri-business and manufacturing, important in developing countries. Most recently, a report by ActionAid claimed that Associated British Foods had made $123m of profits from producing sugar in Zambia, but admitted to paying `virtually no tax’ there. According to this report, the company has found legal ways to siphon over US$83.7 million (US$13 million a year) – a third of pre-tax profits – out of Zambia into tax havens including Ireland, Mauritius and the Netherlands. Academic research, for example by Keuschnigg and Devereux, suggests that avoidance encouraged by current rules produces significant distortions in capital allocation, resulting in global economic welfare losses.
In response, many states, including developing countries, have been strengthening their scrutiny of TNC taxation, such as transfer pricing. For example, Indian tax authorities are reported to have made transfer pricing adjustments of close to $9 billion for fiscal year 2007-2008, and over 3,000 transfer pricing cases are currently pending before the Income Tax Appeals Tribunal, which has now established four special benches to deal specifically with them. A report for the French government recommended that it should take unilateral action to impose taxes on Digital Economy companies, as a step towards concerted multilateral measures. However, there is clearly a limit to what can effectively be done by unilateral action, especially by poorer developing countries, with scarce skilled public-sector capacity. Such moves towards stronger national measures are a major reason for the new urgency for the OECD to find effective multilateral solutions.
Hence the importance of the OECD’s BEPS project. It will apparently include a reconsideration of all aspects of international company taxation. The UK Treasury, which will chair the working group on Transfer Pricing, has been reported as saying that this will include Unitary Taxation of TNCs, which until very recently has been flatly rejected officially by the OECD, although this approach has had many supporters among academics and former OECD and government officials.
This confirms the relevance and timeliness of the Call for Research by the International Centre for Tax and Development (ICTD), made last December, focusing on the relevance and implications of Unitary Taxation for developing countries. Despite the importance of the topic, it has not been researched in depth by any international organization since 1932, which led the ICTD to launch this Call. It has produced a number of proposed projects, which are currently under peer review, and if approved would be coordinated as a joint programme, over 12 months. We hope that research such as this would be taken into account by the BEPS project and the G20, to ensure that any changes recommended to international tax rules will fully take into account the needs not only of developed OECD economies, but also of the poorer developing countries.