Researchers estimate the US loses more than US$90 billion annually in corporate income tax revenues from tax loopholes and tax havens, also known as base erosion and profit shifting (BEPS). With a growing perception that multinationals consider income taxes voluntary, international tax reform is on the agenda.
However, prospects for significant reform are dim as large, well-funded groups successfully lobby the US – where corporate tax reform has stalled – to maintain the status quo. At the OECD, proposals to replace current toothless transfer pricing rules are off the table.
In the most developed nations, lobbying statutes are enacted to promote transparency. In the US, both the firms that lobby and their lobbyists are required to register with Congress and publicly disclose their clients, fees earned, and lobbying issues. But the lack of lobbying disclosure requirements at the OECD creates an army of ghost lobbyists who are invisible to the public and yet are shaping international tax policy.
Paying to fall between the cracks
The corporate players behind the scenes of OECD tax reform proposals use associations and law firms to hide their identity from the public.
During 2013, lobbying expenses in the US were US$3.21 billion. But there is no doubt it is a good investment – a recent study found a return of $220 for every $1 spent - a boggling 22,000% - on lobbying expenses for firms seeking a one-time tax holiday on international earnings.
OECD tax policies are not just important for its 34 member nations. These policies have implications for developing nations’ ability to raise revenue and create a level playing field for local businesses.
One of the most successful of the groups lobbying the OECD is the Digital Economy Group (DEG), fronted by the prominent US law firm Baker & McKenzie, which has had considerable success in pressuring the OECD to maintain favourable tax rules on web-based sales, and sourcing of income from intellectual property.
At Baker & McKenzie, former OECD staffer Mary C. Bennett represents DEG, and Caroline Silberztein, who headed OECD’s transfer pricing unit for 10 years and initiated their intangible transfer pricing work, gives DEG members backchannels to the OECD staff.
While not individually identified, DEG members also belong to the Business and Industry Advisory Committee to the OECD (BIAC), an association with a strong, formalised connection with the OECD, and charged with advocating business perspectives.
The public database maintained by the US Senate shows no record of DEG or BIAC. In the US, BIAC members lobby individually and through other groups like the Business Roundtable which spent US$12 million lobbying in 2013.
The public remains in the dark about DEG membership. The OECD does not require lobbying disclosures by association members and Baker & McKenzie won’t identify the firms bankrolling their lobbying efforts. Amazon, Google and other large US internet-based firms are speculated to be key players.
Firms use trade associations or coalitions to lobby. The benefit of lobbying in a group includes building greater constituency with Congress, increasing economies of scale and more importantly, providing cover.
Like tax law, the US lobbying disclosure laws are also riddled with loopholes. Trade associations’ lobbying expenses are public but linking expenses to specific firms’ contributions is impossible. Further, membership lists which are required to be public disappear from websites after the group disbands.
Public trust is eroded when relationships between private corporations, rule making bodies and regulators appear to be too cozy. In fact, the OECD has asked governments to increase lobbying transparency and prevent conflicts of interest that arise from the “revolving door” between public service and private employment.
Ironically, neither information on the OECD’s own lobbying guidelines nor public disclosure of lobbyists are readily available on their website.
The lobby’s lobby
Historically, the US has played an outsized role in international tax policy at the OECD, being the organisation’s single largest funder, providing over one-fifth of the OECD budget. It is unsurprising then, that US policymakers are engaged in the OECD at the behest of their constituents. The OECD’s earlier work to eliminate tax havens changed from a “bombshell to a damp squib” after US interests intervened.
Ebay’s 2013 Q3 lobbying disclosure lists, for instance, includes meeting with US Congress members, the Internal Revenue Service and the US Treasury department on “OECD proposals to modify international tax rules” among other items reported for the US$565,265 in lobbying expenditures during the period.
If international tax reform went ahead, resulting in worldwide tax harmonisation and the elimination of transfer pricing loopholes, firms would likely see increased tax liabilities but reduced tax risk and uncertainty.
Vodafone shareholders are aware of the cost of tax uncertainty. The firm is losing a tax dispute with India worth US$2.6 billion, related to sales through a tax haven subsidiary. Two months after the Indian Supreme Court ruled in Vodafone’s favour, the government retroactively changed the tax code back to 1962 to ensure the transaction would be illegal.
But in most cases, multinationals don’t want to give up the secrecy provisions and the transfer pricing policies for uncertain tax reforms. In other words, better the devil you know.
State by state
The long-term prospects for tax reform are not entirely dim. Recent actions by some US states suggest a growing impatience with the federal and international tax reform efforts.
Hearings before the US Senate and House of Commons Public Accounts Committee have made the public aware of spectacular tax avoidance strategies. But it’s not just public ire that has been the impetus for state tax reform. The reasons for expanding state corporate tax revenues are two part.
US states are unable to borrow to fund government deficits, so when tax revenues decline, they enact austerity measures which face considerable backlash. In a lawsuit brought by local school boards, for example, the Kansas State Supreme Court found the school funding reductions there to be so severe as to be unconstitutional.
Local government officials are also concerned that the deck is stacked against local businesses that do not buy complicated international tax strategies from well-heeled tax lawyers and accountants.
Three types of state laws are effectively closing down the most aggressive tax planning strategies. First, states are moving away from separate company reporting (similar to that used in international taxation) and instead are adopting combined, or unitary, reporting. Unitary or combined reporting eliminates the benefits of shifting profit to subsidiaries in no-tax states.
Second, states are also enacting “economic nexus” laws which subject firms to tax based upon an economic, not physical, presence in the state. Digital economy firms and others with significant intangible property are aggressively fighting these laws, but the US Supreme Court has decided not to hear their pleas.
Third, states are enacting legislation to impose tax on corporate revenues earned in tax havens, even if this income is not subject to tax at the federal level. A recent study shows that California would raise US$3.3 billion by taxing corporate profits sent to tax havens.
But states are being lobbied as well, and not just by corporations. Representatives from Luxembourg and Lichtenstein have written to Maine – population 1.3 million – to argue against a bill that would have closed a loophole allowing multinationals to use tax havens to evade tax.
No change soon
According to a PricewaterhouseCoopers survey, 81% of US CEOs believe the current international tax system has not changed to reflect how multinational corporations operate today. Yet, only 7% believe the OECD will achieve substantial reform of the international tax system within the next couple of years.
Due to successful lobbying efforts, US tax reform has stalled and now US multinationals believe the OECD is merely studying BEPS, rather than doing something about it.