Post No.: 0512
We want to avoid juridical (the same item taxed by multiple states) and economic (multiple people taxed on the same item) double taxation, as well as double non-taxation. For example, a person works in Country A, gets his/her earnings taxed there, then passes what’s left to his/her spouse in Country B, but then this money gets taxed again. Probably most of us believe that it’s not fair to be double-taxed like this.
In the above scenario, what most people believe would be a fair single taxation is that he/she gets taxed in the country where he/she earned the money or where the economic activity actually occurred, and then this money shouldn’t be taxed again if it gets passed to another country at a later time.
But multinational enterprises (MNEs) that use tax avoidance schemes don’t quite want this set-up. They want to not get taxed where the real economic activity occurs but pass money to another country – specifically a state with low/no corporate taxes – for any profits to be taxed there instead. They want this version of single taxation – to be taxed in a country with low/no corporate taxation rather than where the actual sales and customer-interfacing economic/earning activities take place.
There is the tax rate (the percentage) and also the tax base (what things are liable for tax). It’s therefore misleading to just fixate on the tax rate (e.g. a 30% corporation tax) because multinational corporations are base eroding and profit shifting – which was first mentioned in Post No.: 0507 – so that they end up having nothing or very little to have to pay tax on (e.g. 30% of very little is extremely little!)
They’re tax base eroding by shifting profits from where they actually generate the sales and turnover to tax havens where they did not. Choosing to be taxed according to the more lax laws and rates of a country where a real economic activity did not actually occur is like choosing to be judged according to the more lax laws and sentences of a country where a murder was not actually committed, instead of those of the country where that murder did take place!
Subscribing to a source principle of taxation would mean that taxes should be paid to the country where the specific economic activity took place – and this would be a single, not double, taxation.
However, one key conundrum is whether to tax something according to where it is made or where it is sold? I personally think it should be taxed where the turnover and profit is realised i.e. where something is sold. But this still won’t make it easy to police – it’s relatively easy to shift profits because companies are only taxed on their profits, not on their sales and turnover; and so they can artificially make the operations in the countries where the revenues are actually being generated report greater losses than they otherwise would have.
They can achieve this via an aggressive tax avoidance strategy of using various arrangements such as loan interest payments, intellectual property royalties and shareholder dividends between the parent company (located in a tax haven) and a national subsidiary. A national subsidiary is doing great business and has earned a lot of revenue. But alas, it owes it’s own related or parent company much more in loan interests and royalties thus it reports a very low profit or even an overall loss in that particular country of actual operation, hence relatively little or no tax will be due there.
For example, ‘Company USA’ (a national subsidiary located in the USA) has turned over $100M in the USA, with $75M in costs, during an accounting period, but has to also pay enormous royalties to the tune of $25M to ‘Company Global’ (its own parent company located in a tax haven) to use the latter’s ‘Company’ trademarks in the territory of the USA. This makes the total costs for this national subsidiary during that period, coincidentally, $100M, which therefore totally wipes out its profits in the USA. Meanwhile, the parent company turns over that $25M from receiving those royalties, and because the internal paperwork to arrange this set-up costs relatively nothing (no lengthy negotiations are even required because it’s essentially a deal made with themselves) – this has in effect shifted that $25M of profits to a company located in a low-tax jurisdiction.
The MNE is able to carry out this sort of tax avoidance because it is not operating at ‘arm’s length’ with itself. It doesn’t have to charge itself the market rate – it can charge its loan interests, royalties and what have you at whatever rate suits them overall. It can offer much poorer or greater deals to companies or subsidiaries within it’s own corporate umbrella or common ownership/control than it could or world if it had traded at arm’s length with unrelated companies outside of its own corporate umbrella. Akin to insider trading, this is against free market principles. Transfer pricing rules have therefore been introduced to try to tackle these fuzzy market distortions.
It is claimed that ~60% of all international transactions are actually made within MNEs! ‘Mobile’ activities include licences, loans and share capital – activities that can easily happen from and to anywhere in the world, unlike e.g. physical stores and physical sales. (Digital online activities are a major area that the OECD has been looking at too. Some countries have implemented stopgap solutions in the meantime, such as the UK’s Digital Services Tax.) These ‘mobile’ activities and their resultant passive incomes (royalties, interest, dividends) are what are shifted around the world to base erode and profit shift. MNEs basically exploit differences in the treatments of multinational entities and their activities in different countries. For instance, entities can be transparent (not liable for tax purposes) in one place and non-transparent in another place, such as a tax haven.
‘Treaty shopping’ is again about exploiting the different rules and treaties of different tax jurisdictions or member states, to an MNE’s advantage. These differences in international taxation in different countries occur because of individual state sovereignty, historical reasons and state economy planning. (It’s not always because of independence e.g. the Cayman Islands is actually under British sovereignty and control.) It might sound simple in principle to solve this international problem – by unifying all international tax laws – but in practice it’s really difficult. So tackling tax avoidance is a bit more complicated than what many of us may think. But – like tackling other international problems such as global warming – international cooperation would no doubt help. Woof!
Aggressive tax planning is the problem; albeit this is hard to define, but work is being done to define the term clearly. Amazon, Facebook, Google, Apple and Microsoft are just a few examples of MNEs that have definitely been doing it for years though. ‘Corporate social responsibility’ should matter to companies and not just be lip service for publicity. And the image or reputation of a company employing aggressive tax avoidance strategies or being a ‘tax dodger’ should matter to consumers.
There is still a lot of categorically illegal tax evasion happening around the world too, facilitated by taking advantage of the banking secrecy afforded by tax havens. Companies and individuals evidently don’t always behave legally. But when it comes to behaving immorally and unfairly yet legally, we must update the laws and enforcement – create robust and compelling laws rather than rely on people self-regulating and following ‘the spirit’ of the law.
Stated without detail just to show that ideas have been generated – countries can increase withholding taxes at source, increase VAT (which don’t depend on profits), police non-arm’s-length transactions and transfer pricing more vigilantly, and monitor aggressive tax planning, state trade treaty abuses (e.g. EU fiscal state aid, patent boxes), harmful tax competition and hybrid mismatching, and more. ‘Hybrid mismatches’ can result in double-deductions (double-dipping) or deduction/non-inclusion tax avoidance tactics. Hybrid mismatching is when e.g. a cost declared as tax-deductible interest in Country C is declared as a tax-exempt dividend in receiving Country D, which results in a double non-taxation. ‘Controlled foreign corporation’ (CFC) regimes are supposed to discourage tax avoidance regarding foreign-controlled businesses (although the USA’s ‘check-the-box’ scheme has been criticised as ineffective).
As a side note here – having one’s income taxed (when over a threshold allowance) and then effectively having it taxed again if one wants to spend it on products that charge VAT (as an end-user) has been argued by some to be a form of double taxation. But one counterargument would be that this arrangement is more appropriate than a very large tax on income or alternatively a very large tax on spending. It also allows different products to be taxed at different VAT rates rather than assuming that everyone will just completely spend their wages on higher-tax-rated non-essentials.
We could therefore argue that it’s countries and governments too, not just corporations and wealthy individuals, who are complicit in all of this tax avoidance, in the form of harmful tax competition and international free-riding. Politicians might, on the one paw, tell us that they want to tackle and close tax loopholes for the sake of the nation’s people, who are losing out regarding what that lost tax income would’ve done for them as a nation e.g. better healthcare, better schools, better infrastructure, or even ultimately lower taxes for regular lower and middle-income earners – well if the super-rich paid more in taxes, or at least their fair percentage share relative to their incomes, it could potentially mean that the rest of the population could pay less. So, chances are, you are losing out because you are statistically likely to be in the set of lower and middle-income workers. Yet meanwhile at the same time, politicians are offering tax benefits to attract large foreign corporations, which ultimately gives those already-powerful international enterprises an advantage over smaller, perhaps local, businesses.
These companies may bring with them investment, jobs and increase GDP, but it’s like extortion (or sometimes there may be secret kickbacks going between the executives and politicians? Some companies are even net receivers of tax credits from the government(!)) Plus wouldn’t it be better in the long run to encourage more home-grown and home-based businesses that both create jobs and pay their fair percentage of taxes here? But alas, quick results are what politicians mostly want because democratic elections occur every few years, and in a country like the US, a President only has to show a good scorecard for up to the one decade when they’re in power.
We also need to constantly evolve tax rules according to the constantly evolving technology and business world (e.g. the rise of globalised e-commerce) – we cannot rely and stay rigidly fixed to old and outmoded ways when the world is moving forwards.
We consumers are indeed part of the problem too. We’re buying lots of stuff from companies that employ aggressive tax avoidance plans when we should be voting with our wallets. I will admit myself though that avoiding companies that employ aggressive tax avoidance methods is incredibly difficult because they’re typically dominant, and their dominance will likely continue to expand because avoiding paying their fair share of taxes is another way that the rich find it easier to get even richer compared to the rest. They can offer us cheaper products than the competition (paying lower taxes per unit sold compared to their competition plays its part again) but in the process unfairly strangle wider competition, which will reduce overall consumer choice in the long-term.
Sometimes there isn’t enough competition in the market to effectively compete against or ignore their dominance for us to satisfy what we, as consumers or other businesses, really want (just like if Google says jump then all web developers who want to be successful must jump).
Basically, these corporations are tremendously globally powerful, and in innumerable ways, not just when it comes to tax avoidance.