Taxing times lie ahead
Continued concerns over inequality coupled with a need for a post-pandemic economic recovery are putting the discussion about international corporate tax reform to the top of the agenda
If 2020 was the year of postponed enjoyment, it was only natural that Black Friday would come a little bit later than usual. In France, where this most un-Gallic institution has recently taken root, the government decided to postpone it by one week, yielding to pressure from small shop owners. As French officials acknowledged, holding Black Friday during the country’s second lockdown would benefit e-commerce powerhouses such as Amazon. Just a few days before the announcement, the US firm had disclosed that its sales had received a significant boost during the lockdown.
Although a one-off measure linked to the pandemic, the French government’s decision reflects a deeper disenchantment with large corporations and their tax practices. Despite its record revenues of €32bn across Europe, the US company received €294m in tax credits in 2019 due to a pre-tax loss of €983m. Another US tech giant, Google, has been forced to pay over $1bn in fines and back taxes to the French state for underpaid tax from 2005 to 2018, lending credence to the belief that large multi-nationals (MNEs) have been playing the system.
A broken system
International corporate taxation has traditionally been considered a topic dull enough to preoccupy accountants and academics. The Great Recession and the rise of populism turned it into a politicised subject, with pressure groups highlighting the links between inequality and the tax policies of large corporations. In the previous decade, the media shed light on the role of tax havens through a series of documents leaks, such as the Panama and Paradise Papers. Tommaso Faccio, an academic who heads the secretariat of the Independent Commission for the Reform of International Corporate Taxation (ICRICT), an advocacy group that includes in its ranks prominent economists such as Thomas Piketty, said: “Tax-related leaks showed that there are different rules for the one percent and the rest of us. Austerity imposed in several European countries exacerbated the feeling of the public that although public services and government revenues were hit, some corporations were getting away with it. That created the political momentum for change.”
The scale of global tax avoidance through obscure accounting methods such as transfer pricing is breathtaking
The scale of global tax avoidance through obscure accounting methods such as transfer pricing is breathtaking. ICRICT estimates that a staggering 40 percent of foreign corporate profits are shifted to tax havens. Losses from profit shifting surpass $500bn annually according to IMF data, with $200bn missing from the coffers of developing countries. The rise of the digital economy has exacerbated the problem. For tax authorities, online companies with little physical presence are elusive foes. The European Commission estimates that the gap between the tax rate facing digital businesses and other sectors stands at 12 percent.
The pandemic is expected to make things worse. Some fear that many corporations may attempt to boost dwindling profits through creative accounting. ICRICT estimates that global tax revenues may fall more steeply than the 11.5 percent drop from 2007 to 2009. The crisis has also revealed the privileges of tech powerhouses, Faccio said: “The pandemic highlighted the fact that there are two economies: the online one, which did very well, and the rest, which suffered the consequences.”
And justice for all
If there is hope for change, it comes from a leafy suburb of Paris. In October 2020 the OECD, a think tank based in the French capital, published the blueprint of its proposals for corporate tax reform, the product of a long negotiation involving 137 countries. The draft has been hailed as a major step towards an overhaul of the system that could increase global tax revenues by more than four percent.
The proposal, which includes two ‘pillars,’ seeks to modernise international corporate taxation. The first pillar recommends an apportionment of global profits, including online sales, to the countries where customers are located. To find a middle ground between the current system, which bases taxation on corporate physical location, and more radical ideas, the OECD proposes a formula that differentiates between routine and residual revenues, with a percentage of the latter being allocated to jurisdictions where revenues are generated. The measure targets consumer facing and digital companies with an annual turnover over €750m, which has prompted fierce resistance from the US.
For its part, the OECD hopes it will end the global race to the bottom, with governments scrambling to lure footloose MNEs with low tax rates. Professor Reuven Avi-Yonah, an expert on tax law teaching at the University of Michigan and one of the originators of the idea, told World Finance: “The customer base is relatively immobile, so this is the best way to address tax competition.” However, many critics believe that such optimism is overblown, pointing to the failures of a similar initiative in the US to end tax competition between states. Farid Toubal, an expert on MNE taxation who teaches at École Normale Supérieure Paris-Saclay and who is a member of an economic advisory body reporting to the French Prime Minister, said: “There is no clear effect on fiscal competition. The US experience is instructive, as apportionment of sales at the state level did not prevent competition among US states to attract investment.”
The root of the issue
Many experts claim that the plan only tinkers with the system, keeping intact controversial tax practices that allow MNEs to combine income from different countries to benefit from low tax rates. “The OECD’s proposal maintains the existing ‘arm’s length principle’ and transfer pricing system for a large share of corporate profits. The problems would also be maintained – including large-scale corporate tax avoidance and international tax competition,” said Tove Ryding, Policy and Advocacy Manager at Eurodad, a network of 50 European NGOs.
The OECD plan suggests that companies will have to comply with minimum tax rates on a country-by-country basis, rather than globally
Many believe that MNEs should be treated as unitary organisations, rejecting the idea that subsidiaries are separate from the main company. Others point to a simpler system that would mandate universal apportionment, instead of focusing on a slice of the revenue of specific MNEs. “You cannot find a meaningful way to determine what is residual and routine revenue. They have opted for this formula because they want to limit the impact of tax reallocation,” Faccio said. Complexity is a major concern. Determining residual and routine revenue involves high administrative costs, including the collection of data by tax authorities and international co-operation to avoid double taxation. “The complexity associated with more sophisticated allocation rules, paired with the need for tax authorities to collect new information, is likely to give more room to multi-nationals to circumvent corporate taxation, especially in low-income countries,” said Toubal, who added: “Simplicity should be the rule. It would help establish a fairer system, since not all administrations have the means to navigate complex rules.”
Another contentious issue is the tax base that will be targeted. Developed countries favour sales-based schemes focusing on consumption, whereas developing countries prefer formulas that highlight labour-intensive activities. A group of 24 developing countries has advocated for apportionment taking payroll into account. No solution is ideal, but a compromise is necessary, according to ICRICT’s Faccio: “The balance you choose between production and sales reflects the values of the negotiator.”
The second pillar of the blueprint includes a radical proposal: establishing a minimum corporate tax rate for all MNEs, regardless of their location. This would reduce incentives to shift profits to low-tax jurisdictions. Politically, it has also been less problematic, since it targets less powerful, low-tax countries. Although the number of the minimum rate is under negotiation, OECD officials have informally floated a figure close to 12.5 percent as a clincher.
Many worry that this measure will also add complexity to the system, given that the OECD plan suggests that companies will have to comply with minimum tax rates on a country-by-country basis, rather than globally. Conservative pressure groups like the US National Taxpayers Union have highlighted potential clashes between the two pillars that could lead to double taxation, particularly in jurisdictions where worldwide income is taxed, such as the US. “Minimum taxation would reduce certain forms of tax competition, but may give rise to new forms, like competition for headquarters,” said Professor Clemens Fuest, head of the German think tank Ifo Institute for Economic Research.
All eyes on the OECD
The role of the OECD, essentially a rich country club, has also come under scrutiny. Following the financial crisis, G20 countries tasked the organisation with the development of a roadmap to corporate tax reform, a process that led to the proposals published in October 2020. Many argue, however, that the right body to deal with the issue is the United Nations. “There is a question of legitimacy. This is a universal issue and the only forum with universal membership is the UN,” Faccio said.
Corporate tax income represents 15 percent of total tax revenues in Africa and Latin America, compared to nine percent in OECD countries. The Group of 77, a coalition of developing countries, has called for the establishment of an intergovernmental tax body within the UN, but this has been blocked by developed countries. “At the United Nations, the dynamic is different, and we often see broad coalitions of progressive countries become agenda-setters,” said Eurodad’s Ryding, adding that such a measure would increase “the level of ownership of the decisions” and thus reduce unilateral action.
Critics believe that implementation of the proposals could reduce corporate investment, halting post-pandemic economic recovery
Critics also point to the lack of transparency, with non-OECD governments having limited access to the details of the negotiation. Although 137 countries participate in the negotiation, many African countries are not represented. “The OECD says that all countries participate on equal terms, but this is not really the case,” Faccio argued, pointing to numerous African tax authorities that don’t have the resources and negotiating experience of developed countries. For the EU, corporate tax reform poses a difficult conundrum.
While member states are keen to increase tax revenue, any attempt to deal with the issue has run into a problem that lies at the heart of the union’s woes: different tax policies across the EU. The pandemic has complicated things further. Last summer, the European Commission prompted member states to avoid supporting companies linked to overseas tax havens.
However, many believe that the EU needs to deal with its own tax havens first. Countries like the Netherlands, Ireland, Cyprus, Luxembourg and Malta have come under fire for their lax attitude towards MNEs; tax schemes with imaginative titles such as ‘Double Irish’ and ‘Dutch Sandwich’ have become a quintessential part of Brussels lore. The issue came again to the fore during the heated negotiations over the establishment of a recovery fund to support COVID-hit countries. The slow progress of the OECD negotiation casts its shadow over the EU, Eurodad’s Ryding argued: “At one point there was hope that the OECD negotiations could pave the way for an agreement among EU member states, but now that the level of ambition in the negotiations is so low and the negotiations have stalled, that hope is clearly fading.”
Searching for a global agreement
The tax regime of technology companies, which operate across EU member states but pay most taxes in a single jurisdiction, is at the centre of the debate. In 2018, the European Commission proposed a digital services tax of three percent as a temporary solution until a global agreement is reached, only to be blocked by a coalition of countries. A similar plan to force large corporations to disclose paid tax and profits has also been blocked, sparking a debate over the unanimity rule that requires all members to agree for legislation to pass. The head of the Commission, Ursula von der Leyen, has threatened to use a treaty article that allows majority rule under exceptional circumstances. “Unanimity rule has prevented reform in the past. This is why the EU gave a chance to the OECD where countries like Ireland, Luxembourg and Cyprus are less influential,” Faccio said.
Reflecting the will of EU powerhouses like Germany, Italy, Spain and France to see a meaningful reform, the Commission has said that it will wait for the OECD negotiations to conclude in 2021. However, some accuse the Commission of being biased towards heavy taxation. “The agenda of the European Commission’s taxation and customs union directorate shows a great overlap with the agenda of tax activist groups, which are very vocal in the Commission’s recently established platform on tax good governance,” said Matthias Bauer, Senior Economist at the European Centre for International Political Economy (ECIPE), a Brussels-based think tank. The debate is further complicated by the departure of the UK. Many UK overseas territories have been added to an EU tax haven list. European officials fear that after Brexit the UK may opt for a low-tax regime, dubbed ‘Singapore-on-Thames,’ that would undermine the EU.
Blurred lines of the digital economy
The biggest worry, however, is that many countries will act unilaterally. The UK plans to impose a digital services tax in 2021. France also aims to impose a three percent tax on the turnover of technology corporations with earnings over €25m; the country’s tax authorities started approaching US technology companies in December, sparking a call for tariffs on French products on the other side of the Atlantic. Negotiations with the US came to an abrupt halt last summer. In a dramatic letter sent to several EU capitals, the US treasury secretary Steven Mnuchin declared that the US was at an “impasse” and had to focus on dealing with the pandemic.
Critics claim that unilateral digital taxes are counter-productive. “It is difficult to draw a line between the ‘digital economy’ and the rest, because the digital transformation affects almost all sectors,” said Toubal, who noted that tax planning is not limited to digital companies. Others believe that the side effects will be substantial, with consumers and small businesses suffering the most. “They [technology companies] will effectively pay these taxes, but at the same time pass them on to consumers. It is the users of digital services, mainly SMEs and small businesses, which suffer from such taxes, including restaurants, hairdressers and winemakers who pay more for advertising space on Google and Facebook,” Bauer said.
Waiting for Biden
The debate on corporate taxation has strained Europe’s already difficult relationship with the US, although US multi-nationals are estimated to cost the EU nearly €25bn per year in lost tax revenue. Under Trump, the US took a unilateral approach, with every measure against US companies deemed an act of war. When France announced its digital tax, the Trump administration responded in kind, threatening to impose tariffs on French wine.
Will the election of Joe Biden change the US position? Many analysts caution against optimism. “Even under Obama, the US government was only interested in protecting US multi-nationals. That is unlikely to change,” Faccio said. However, the Biden administration is expected to ditch the Trumpian America-First dogma. “Biden will take a multilateral approach, rather than the conflictual approach of Trump who was blowing hot and cold every other week. His administration will make an effort to reach an agreement,” Faccio said.
In the run-up to the election, Biden took a hard stance against big business. His platform included radical proposals such as closing tax loopholes and ending cross crediting. Crucially, he pledged to raise the corporate tax rate to 28 percent and double the minimum tax rates for foreign subsidiaries of US firms to 21 percent. Although tech powerhouses are traditional Democratic donors, Biden will not succumb to any pressure, Avi-Yonah said: “Tech companies do not have much clout in the Biden administration, which is likely to continue the antitrust cases against Google and Facebook.” A different US tax policy will drastically change the international agenda too, according to Faccio: “If the US implements a minimum corporate tax rate of 21 percent, the global negotiation will be different. The US rate is the benchmark, so the OECD will possibly figure out a global minimum tax rate around that number, rather than a low 12.5 percent that would kickstart a race to the bottom.”
A new era
As expected, the pandemic has cast its shadow over the negotiations. Many countries have already approved the OECD blueprint, hoping to reach an agreement by mid-2021 when the worst of the pandemic will hopefully be over. Critics believe that implementation of the proposals could reduce corporate investment, halting post-pandemic economic recovery. A Deloitte survey found that more than half of MNEs expect to be hit by the new tax regime. Although acknowledging the danger, Pascal Saint-Amans, Director of the OECD Centre for Tax Policy and Administration, said that this is a price worth paying: “The two-pillar proposals would lead to a relatively small increase in the investment costs of MNEs.
The negative effect on global investment would be small, as the proposals would mostly affect highly profitable MNEs whose investment is less sensitive to taxes.” Many believe that the prospect of a radically different post-COVID-19 economy has already shifted the debate. In a recent paper, Toubal and other academics argue that the pandemic has stressed the need for a more robust corporate tax system. “The crisis has revealed that some essential public goods, such as infrastructure and healthcare provision, have been underfunded in many countries, an issue that corporate tax avoidance has likely exacerbated. Some multi-nationals that have been avoiding corporate taxes for years are also receiving financial help from governments, which many find unacceptable,” Toubal said.
What everyone seems keen to avoid is a proliferation of unilateral action. “Under a worst-case scenario, resulting in a trade war, the failure to reach an agreement could reduce global GDP by more than one percent, at a time when we can least afford it,” said the OECD’s Saint-Amans. A compromise will be hard to reach, but the alternative should be more concerning, he added: “In contrast to what some may say, I believe the right question is: ‘What would be the costs if there is no agreement on a global solution?’”