The G20 has a range of topics on its agenda (see here). In 2014, as in the last couple of years, international taxation of multinational corporations is a big part of it.
Base erosion and tax arbitrage
A key focus will be further work on the OECD Base Erosion and Profit Shifting (BEPS) project which the G20 “fully endorsed” at the September 2013 St Petersburg Summit. As I’ve explained, the OECD BEPS Action Plan states that company tax bases of governments are at risk because tax rules “may not have kept pace with changes in global business practices” and “the tax practices of some multinational companies”. The OECD, and Australia, are throwing considerable resources at the BEPS project.
Many BEPS reforms will be unilateral country tax law “fixes” that aim to prevent international tax arbitrage, resulting from the mismatch in country tax treatment of corporate financial and business arrangements (for a discussion, see here).
Successful international tax arbitrage does not breach any one country’s tax rules. It reduces a multinational enterprise’s global tax burden by exploiting the mismatch in tax treatment - for example, for hybrid finance instruments as illustrated here. The aim is to deliver co-operative international tax approaches to prevent arbitrage and align key company tax rules. Unilateral tax change is hard enough in this complex area. More challenging is the BEPS goal to establish multilateral rules or treaty provisions that all G20 countries could sign up to, so as to ensure consistent taxation of hybrid instruments.
Another big issue is “thin capitalisation” or “debt loading” by multinationals. For example, debt loading occurs when a multinational corporation that is foreign-owned with Australian operations or Australian-owned with foreign operations, leverages high levels of debt in Australia, and this debt carries interest that is tax-deductible in Australia. The interest deduction reduces the net profit subject to Australian tax, contributing to “erosion” of the company tax base.
The previous Labor government had announced law reform to limit the scope for debt loading. Most countries cap tax-deductible interest by limiting the debt to equity ratio of multinationals (although specific rules vary widely). Australia allows a generous debt: equity ratio of 3:1, that is, 75% debt to 25% assets, compared to many other countries. Former treasurer Wayne Swan proposed to limit this ratio to 1.5:1, that is, 60% debt to 40% assets. Swan also planned to eliminate a deduction for Australian debt that finances foreign investment. These BEPS measures were expected to raise A$1.5 billion over the next four years.
New Coalition treasurer Joe Hockey will continue with the policy of reducing debt loading, setting a debt:equity ratio of 1.5:1, but has abandoned the other reform proposed by Swan. He says this is too difficult to administer - it’s too hard to trace Australian debt that finances foreign investment - so instead he will introduce a targeted anti-avoidance rule to address abuse of debt deductions. According to the estimates, this will still raise about A$900 million to help the budget bottom line.
The G20 appears to be well on the way to strengthening international tax cooperation in tax administration and information exchange as well as joint country tax audits and enforcing tax debts. The “new standard” of automatic exchange of tax information and enhanced cross-country assistance in tax enforcement and collection have been widely accepted. The G20 expects to begin to exchange tax information automatically by the end of 2015.
Many G20 countries including Australia are signing agreements for their banks to provide financial information to the US under its strict Foreign Account Tax Compliance Act (FATCA) regime. Meanwhile, in Jakarta, the November 2013 meeting of the Global Forum saw tax havens Liechtenstein and San Marino become the 62nd and 63rd signatories to the Multilateral Convention on Mutual Administrative Assistance in Tax Matters.
While the legal architecture for international tax cooperation is developing rapidly, not all taxpayers will be comfortable knowing that their tax information may be provided automatically to countries, including previous G20 president Russia, where individual freedoms are often under attack. Russia ranks 133 out of 174 countries in Transparency International’s latest Corruption Index. It’s crucial for legitimacy of the system that G20 countries demonstrate that the rule of law will be respected in tax matters.
The G20 also says that fixing global tax regulation is key to fighting poverty. A 2012 UN General Assembly Resolution 66/191 calls on the international community to develop effective international company tax rules and to increase participation of developing countries in tax policy processes. But as I explain here it is only recently that OECD member countries have begun to acknowledge that their own tax rules and harmful tax competition are making it more difficult for developing countries to raise adequate taxes.
There may be some tensions in the G20 about how to reform our fundamental international tax principles for the future. The OECD BEPS project mostly aims to protect the residence basis of taxation for multinationals. This will help prevent corporate tax base erosion for rich, capital and intellectual property-exporting countries. Current OECD profit shifting rules, which emphasise the arm’s length transfer pricing principle, can be strengthened. But these current rules for allocation of the right to tax business profits between countries are under attack from capital importing countries who seek to protect and enhance source taxation of business activity.
India, South Africa, Brazil and China may benefit more from a “formulary apportionment” approach, which has also been called for by activist organisations such as Oxfam and Christian Aid. We might begin to see cracks in the G20 on these fundamental international tax principles in 2014.