The hollowing out of tax collected for public purposes by rich and poor nations is not confined to technology and mining companies, according to a major leak of secret tax agreements covering more than 340 companies around the world.
The documents, published by the International Consortium of Investigative Journalists, include many international companies and the Future Fund with surprising levels of transactions in Luxembourg, raising questions of tax justice and the ethics of corporations and the professionals who advise them.
The G20 is seeking to tackle what’s known in the industry as base erosion and profit shifting (BEPS) in a variety of ways. But 100 years of guerrilla war between revenue authorities and those who seek to outsmart them has meant many tax systems have had their integrity compromised, failing to reflect any coherent set of principles. BEPS has also reduced the integrity of national tax systems by undermining their fundamental role of funding public goods and the welfare of their citizens.
Scoping the G20 tax agenda
The G20 discussion to date includes four different levels of response to global tax avoidance:
Increasing transparency to clarify who is the beneficial owner of all assets transferred across borders and all assets held within complying countries. This is aided by common reporting standards.
Setting standards on some of the key issues such as transfer pricing, interest deductions and management fees.
Moving from bilateral tax treaties to a multilateral instrument (reflecting the debate over bilateral/multilateral trade negotiations).
Global taxation of companies and division of taxable income over the various countries in which they operate based on a mix of sales, assets, employment and production.
These responses are by no means mutually exclusive but generate issues of scope, timing and direction of reform. The OECD BEPS Action Plan has elements of each, with greatest emphasis on the first two.
Beyond the above points, there are three more potential agendas.
The first would be reconsidering some basic issues about the source or “locus” of income. For example, should intellectual property (IP) income be considered earned in the jurisdiction in which the ideas were generated, in the jurisdiction to which IP has been transferred (increasingly a tax haven), or the jurisdiction in which the legal right to IP was created (without which no income can be earned)?
Basic tax principles would suggest the last but tax treaties have emphasised the second, opening up many opportunities for tax avoidance.
Similarly, should interest be taxed in the lender’s jurisdiction or the borrower’s jurisdiction where the activity that pays the interest and the legal system that will enforce it are located? Again, basic principles suggest the latter but tax treaties mandate the former, opening up yet more opportunities for avoidance. Reversing such tax treaties needs collective state action following a realisation of their common interest.
Some forms of tax appear increasingly uncollectable at a national level – including inheritance taxes and corporate taxes. If so, the question is whether such forms of taxation should be abandoned or taxed under a global regime.
There is also a need for simplicity. Most national tax systems have become more complex in response to earlier attempts at tax avoidance and minimisation. Simpler systems can be understood, justified and followed on the basis of principle. International tax is even more complex and even more in need of simplicity.
Greater transparency of the details of complex arrangements by which tax is minimised is required. It is often asserted that tax avoidance is “all legal”. Many of these arrangements may be validated if tested in court. But if the details of the arrangements and the means by which they minimise tax are unknown, they cannot be tested. Most of them could be subject to legislative change when the regulator found out what was being done and the consequences – especially if that change was implemented across jurisdictions.
Beyond state powers
The further down this list of approaches we travel, the longer the project and the greater the need for leadership and co-ordination. Is the G20 capable of doing this? Is anyone else?
The G20 certainly provides an opportunity for collective action in the joint interests of members – not least in eliminating tax havens in non-member countries.
But, the state (or states) should not have the sole responsibility. Others have critical roles.
Sovereign wealth funds
The Future Fund has attempted to justify its actions on the basis that everyone else is doing it. But if a sovereign wealth fund discovers a large number of companies are minimising their tax, it should provide this information to the government, which might use it either to pursue others for illegal practices or to change the law. This could increase the wealth of their sovereign by more than the tax saved.
Corporations
Is the sole responsibility of corporations to shareholders to minimise the tax they pay? Or is part of their “licence to operate” paying tax on their activities within the territories in which they operate?
And if profit shifting by corporations leads to base erosion in those territories, will they have a long-term future in that territory? Finally, should tax be seen as a cost of the protection of property (including, and perhaps especially, IP)?
Where some corporations seek a competitive advantage by minimising their taxes, should other corporations seek to emulate them, or should they assist individual states and groups of them to devise strategies for ensuring that all pay their fair share?
Where corporations incorporate in tax havens or locate non-physical assets there but are otherwise inactive, most people would presume the primary motivation is to avoid tax or regulation. Most would rightly be sceptical of other reasons given for locating there. But if the corporations say they did not do it for tax and that there is another legitimate reason, then they cannot complain if they pay the same tax as if they had not.
Investors
Corporations defend tax minimisation on the basis of a claimed duty to their shareholders’ interests. But is it in their interests?
First, is it a long-term viable strategy – especially relevant for those who invest through or for superannuation? Second, is it in their interests to marginally increase the returns on their investments if their other economic interests are adversely affected? And does such tax minimisation accord with their values?
If corporate boards believe this is what their shareholders want, they should put these arrangements before their shareholders and ask if they endorse it.
Professional services firms
What is the role of lawyers and accountants when advising global corporations keen to minimise their tax (as well as those organisations tempted to follow suit to avoid competitive disadvantage) and reduce the overall tax collected in the higher tax jurisdictions in which they operate?
Should tax professionals continue the hunt for “loopholes” (more properly seen as unintended consequences) and drive as much of their clients’ money through them? Or should they draw these to the attention of authorities to check whether they are intended before doing so? How do such professions reconcile their duties to their clients and the more general public good which the professions claim to further as a justification for their privileges?
The question for each of the above groups is whether they want to be part of the problem or part of the solution – and what sovereign states individually and collectively (through bodies like the G20) should do with those who want to remain part of the problem.
This article is based on a background paper for the Global Integrity Summit held on 8-9 September at Griffith University. For full background papers see www.integrity20