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The International Tax System & Problems of The International Tax System & Problems of Taxation of Multinational CorporationsTaxation of Multinational CorporationsEspecially for Developing CountriesEspecially for Developing Countries

Sol PicciottoEmeritus Professor, Lancaster University

Senior Adviser, Tax Justice Network

Tax Justice Network-AfricaInternational tax academyTax Justice: Financing Development in AfricaNov 30-Dec 6 2014Nairobi, KENYA

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Why do we need an international tax system?Why do we need an international tax system?

Tax & National Sovereigntymodern fiscal state 1875- (developed capitalist states)

shift to taxes on income20C warfare-welfare statededuction at source reduces evasion/avoidance

Colonial/dependent countries: `tribute’ stateslevies on natural resource extractionland/hut/head taxes: create money-economyregulate boundaries of licit wealth & its appropriation (Roitman)blurring of state & elite revenues > weak/failing states (Moore)

Governance & Fiscal Crisisfiscal state’s legitimacy rests on broad general taxesequally applicable to natural & legal persons/citizensfair contribution to costs of collective services

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International InterdependenceInternational Interdependence Scope of Income/Profit Taxes 1875-

income taxes on residents/citizens’ worldwide incomehow to apply to corporation?

UK: resident where board of directors (financiers) meets De Beers (1906) : even if operations in SA

foreign investors through London?involves `international law of the world’ (Cesena 1876)but if they choose to invest through London `must pay the cost’

International Coordinationunilateral: foreign tax deduction; credit (USA, Netherlands)UK: only for Empire, or by international agreementLeague of Nations >> first model treaties 1928growth of treaty network 1945 (US-UK) >>> OECDmain aim to facilitate FDI, so prevention of double taxation1980s liberalisation, 1990s >> competition for investment

Current Ferment: evasion/avoidance, havens, capital flight`courageous state’ (Murphy) vs minimalist state (Mitchell)fiscal crisis 2008> G8/G20 concern > OECD BEPS projectG20 St Petersburg Declaration 2013

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International Institutional FrameworkInternational Institutional Framework Treaty Skeleton

League of Nations Fiscal Committee: 1928-1946UN Financial & Fiscal Commission: 1948-54OECD Committee on Fiscal Affairs (OECD-CFA): 1956-UN Ad Hoc Group of Tax Experts: 1967-2004 > Committee 2004-

upgrading?OECD Global Forum on Taxation /Transparency 2003 International Tax Dialogue (IDB, IMF, OECD, UN, WB) : 2002-

Flesh on the BonesCommentaries on Model TreatiesReports & Guidelines(enactment in national laws)

Sinewsexpert community: public-privateelaboration & application of rules

Limitations & Problemstechnicism & politics: legitimation?G8- G20: refer implementation to OECD: eg `base erosion & profit-shifting’International Tax Organisation?

Vann (1991), Tanzi (1999 )Zedillo report 2001 >> Monterrey UN Finance for Development

result: upgrade of UNTC, creation of ITD

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Tax Rules for International BusinessTax Rules for International Business 1928 model: main concern portfolio investment

Home State (residence of investor) should taxinvestment returns (interest, dividends)

Host state (location of business enterprise) should taxbusiness profits

Adaptation to foreign direct investment FDI (TNCs)Home state (residence of parent company)

investment returns (interest, dividends)Host State should tax

business profits of subsidiary/affiliatealso local branch if Permanent Establishment (physical presence)

Adjustment of Intra-Firm Accounts (Transfer Pricing)Carroll Report 1932: Allocation of business profits of TNC(i) separate accounts (ii) empirical methods (iii) fractional apportionmenttax authorities can adjust accounts to ensure fair profit splitSeparate Enterprise – Arm’s Length Principle (ALP)` fact that the revenue authorities have the alternative of basing profits on a percentage of turnover prevents the taxpayer taking up an unreasonable attitude’ (UK)

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Growth of Treaty Network & International AvoidanceGrowth of Treaty Network & International Avoidance Treaty Models

1928+ few treaties negotiatedLeague: Mexico model 1943, London model 1946US-UK treaty 1945 > US & UK networksOECD 1963 model:

strengthens London model: income attributable to PEOECD members negotiate 200 treaties by 1985UN: Guidelines 1974, UN Model 1980

modification of OECD model: broader definition of PE

Tax Havens & Avoidance1920s: wealthy individuals/families >> business (e.g. Vesteys)1930s-: corporations: deferring tax on retained foreign earnings

(UK Crown dependencies; Bahamas, Panama, Newfoundland)UK: residence rules; negotiations for foreign currency financingUS: `foreign personal holding company’ rules 1934, 1937US foreign affiliates only taxed on remittances, with foreign tax credit

1960s: emergence of `offshore’ finance: systematisation1979- currency liberalisation: free-for-all

Basic Avoidance StrategiesBasic Avoidance Strategies

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Google’s Double-Irish Dutch-SandwichGoogle’s Double-Irish Dutch-Sandwich

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Anti-Avoidance MeasuresAnti-Avoidance Measures Controlled Foreign Corporations (CFCs)

US: Subpart F 1962Germany: Steueroasenbericht 1964, decree 1965, AusStG 1972`passive’ income of CFC in low-tax country attributed to ownersSwiss objection: conflict with treaty rules?

renegotiation of Swiss treaties with France (1966), Germany (1971)OECD 1987 Report:

counteracting measures must comply with consensus Transfer (mis)Pricing

US Regulations 1968 : Comparable Uncontrolled Price (CUP) where availableCost +, Retail, `Other’

OECD Transfer Pricing Report 1979US: GAO Report 1981, Tax Reform 1986, `comparable profit method’ 1988OECD Transfer Pricing Guidelines 1995 (now 2010)

CFC rules disregard separate personality – in limited circumstances Transfer Pricing rules based on separate-entity arm’s length principle

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CFC Rules and their ProblemsCFC Rules and their Problems

Control test: owners resident in taxing countryhow many multiple owners?TNC globalisation/regionalisation

Passive income test`mobile’ activities: financial services, IP management

Low-tax country test (lists)proliferation of preferential regimes

Responsesincreased complexityshift to `territorial’ basis, e.g. UK 2012 reforms

Fundamental Flaws(re)assertion of Home country tax on multinational

incomedo not deal with avoidance of Host country taxes

e.g. thin capitalisation, charges, royalties`stateless’ income (Double Irish - Dutch Sandwich)e.g. Amazon, Google etc

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Transfer Pricing Rules and their ProblemsTransfer Pricing Rules and their ProblemsOECD `consensus’

transactional pricing methods (CUP, Cost+, Retail-)`transactional profit’ methods (TNMM, profit-split)

(adopted after long debate 1988-94)Difficulties

lack of (true) comparables – how strict to be?Intangible `property’: owned & transferred, not sharedadministrability: bright lines, APAs

Conflicts & their Resolutionmutual agreement procedure discretionary , secret (confidential to parties & advisers)Glaxo-SmithKline: $5b assessment v. $1b refund, settled for $3.4b

Adoption by Developing Countriesno comparablesBrazil: fixed profit marginsChina: profit-split with enhanced `locational’ factorsIndia: everything goes – 3000 outstanding court casesothers: resource/capacity issues?E.g. Dominican Republic – hotel/tourism sector

Increasing activation will lead to more conflicts or avoidance

TNCs and Systemic Tax AvoidanceTNCs and Systemic Tax Avoidance Direct Revenue Losses

`double non-taxation’, `stateless income’ tax losses: >$1 trillion for US alone effective tax rate (ETR) e.g. Google 3%, Microsoft 4% (on non-US income)US TNC retained earnings `offshore’ > $1.7 trillion

Undermines legitimacy of tax & collective fundingDeveloping country >> aid dependencyDeveloped countries >> austerity, loss of public services

Distorts competition & TNC investment decisionsTNC advantages over domestic firms TNC relocation benefits some countries but global net welfare losses

Facilitates `offshore’ financeshadow banking, excessive leverage etc >> `financialisation’ bubble & crash

Supports the tax avoidance industrycosts for governments & firmsdrain on economy & society

Legitimises Offshore Haven & Secrecy system also used for crime & terrorism money-laundering

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International Tax Reform InitiativesInternational Tax Reform Initiatives G7: 1996

Harmful Tax Competition – 1998 OECD Reportderailed by Pres. Bush 2001 >> Exchange of InformationOECD standard: On Request, via bilateral TIEAs/DTTsG8 Lough Erne Declaration 2013 :

comprehensive, automatic & multilateralbeneficial ownership information

G8/G20: 2013St Petersburg Declaration, Tax Annex “International tax rules, which date back to the 1920’s, have not kept pace with the changing business environment, including the growing importance of intangibles and the digital economy.”

“existing international tax rules on tax treaties, permanent establishment, and transfer pricing will be examined to ensure that profits are taxed where economic activities occur and value is created.”

“more transparency will be established, including through a common template for companies to report to tax administrations on their worldwide allocation of profits and tax”.

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Organisations InvolvedOrganisations Involved OECD Committee on Fiscal Affairs + 8 G20 = 44

main responsibility for current systemBEPS Action Plan: reports Sept. 2014, Sept. 2015, Dec. 2015consultations:

business (tax advisers) – technical detailsTUAC/civil societydeveloping countries >> enhanced engagement

UN Tax Committeemeagre resourcesBEPS & beps subcommitteework on services, extractives

IMF Fiscal Affairs DepartmentInternational Tax research programme approved June 2013`Spillovers’ report May 2014

Hybrid methodsshould not polarise arm’s length vs unitary

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BEPS Action Plan: I BEPS Action Plan: I Establishing international coherence Establishing international coherence

Hybrid Mismatch Arrangements: Sept. 2014proposals for national rules: primary & secondarybut `advantages…of a multilateral and coordinated basis’ (## 44, 47)simpler to apportion group financing costs

CFC Regimesno proposals yet, but also better if coordinatedProblems: which is `home’? what is `active business’?Joint CFC regime?

Limitation of Deductionsno proposals yet; linked to treaty abuse, & hybridsinterest cap: apportion total by EBITDA?

Harmful Tax Practices: Sept. 2014 (little progress)OECD 1998 Report, EU Code shows problemsEU: `innovation’ preferences cleared >> spread of patent boxes `economic substance’ test: complex, `track & trace’flip-side of CFC, linked? UnlikelyTransparency of rulings:

`compulsory spontaneous’ notificationNeed for continuous monitoring: tax sovereignty?

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BEPS AP 2: Restoring International Standards BEPS AP 2: Restoring International Standards

Prevent Treaty Abuse: Sept. 2014LoB and/or Main Purpose articlesimportant to protect source taxation

Prevent `artificial abuse’ of PEbroader definition of involvement in contracts to end

`commissionaires’anti-fragmentation rule, but only for sales-related activities

Ensure Transfer Pricing outcomes in line with value creationintangibles: initial draft, complex & confused

shift to profit split? risks & capitalother high-risk arrangements

DD on Intra-Group Services: apportionment by `allocation keys’

other measures within `and beyond’ ALP`exceptional circumstances’?Value-chain analysis?

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`Horizontal’ Issues`Horizontal’ Issues Digital Economy

not separate sector: `digitalisation of the economy’closer/ symbiotic relations with users/customersnew test of taxable presence?limited to `fully dematerialised activities’? incompatible with analysis of DE & with Ottawa Principles

Data Collection Notification procedure for ATP practices Multilateral Convention

rapid revision of existing treatiespackage deal, or a la carte?

Stronger MAPto deal with increased conflictsbut lack of resources: delay now averages 28 monthscompulsory arbitration? LDCs opposed.

Country-by-Country Report & TP Documentationcheck if tax paid `where economic activities take place & value created

For detailed commentaries see BEPS Monitoring Group:https://bepsmonitoringgroup.wordpress.com/ 19/04/23

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Country-by-Country Reports & TP DocumentationCountry-by-Country Reports & TP Documentation

Purposesdivergent: overview vs. Details of intra-firm transactions

Three Tiers:CbCRMaster FileLocal File

Access & Disseminationstill awaited

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TaxJurisdn

Revenues

Pre-taxProfit/Loss

Inc TaxPaid(cash)

Inc TaxAccrued(in year)

StatedCapital

AccumltdEarnings

Employees

TangibleAssets

RelatedunreldTotal

Incl. extra-ordinaryitems

To alljurisnsincl. WTson receipts

Not incldeferredtaxes orprovision

Incl.capital ofPEs

Sum of allentitiesin jurisn

FTEsyear-end/average/other;may incl.contract-ors

Net book valueNOT cash/intangs/financial

Each entityincluded inconsoldfinancialreport(no excl.)Incl. PEs 19/04/23

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CbCR Template: Table One: Overview of allocation of income, taxes and business activities by tax jurisdiction

Table Two: List of all the Constituent Entities of the MNE Table Two: List of all the Constituent Entities of the MNE group included in each aggregation per tax jurisdictiongroup included in each aggregation per tax jurisdiction

MNE Name & Fiscal Year Main business activity/ies

Tax Jurisdiction Entities Resident(list each one)

Tax Jurisdictionof formation(if different)

R&D/IP Management/Purchasing - ProcurementProduction-manufacturingSales-marketing-distributionAdmin./Services to 3rd partiesInternal Group FinanceRegulated Financial ServicesInsuranceHolding (shares/equity)DormantOther (specify)

Tick box or specify

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Table Three: Additional InformationTable Three: Additional Information

Name of MNE Group & Fiscal Year

Please include any further brief information or explanation you consider necessary or that would facilitate the understanding of thecompulsory information provided in the country-by-country report.

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Additional Transactional Data?Additional Transactional Data?

Some countries want to include more in CbCRArgentina, Brazil, China, Colombia, India, Mexico, South Africa and Turkey:

related party interest payments, royalty payments & service fees

Why not in Master File?Access problems

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Transfer Pricing Master FileTransfer Pricing Master File Organisational Structure

chart of ownership & geographical location Description of business(es)

profit drivers supply chains for main (>5%) products/servicesinternal services & transfer pricing for themfunctional analysis + important restructuring in year

IntangiblesDescription of strategy & location of R&D activities & managementList of intra-firm agreements/licencesdescription of TP policies on intangiblesimportant internal transfers during year incl. price paid

Intra-firm financial activitiesdescription of financingname financial affiliate(s) & place of formation / effective managementdescription of TP policies on finance

Financial & Tax positionsannual consolidated financial statement (if prepared for other purposes)List & description of APAs & tax rulings

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Transfer Pricing Local FileTransfer Pricing Local File Local Entity

management structure, organisation chart, reporting lines abroaddescription of business, strategy, restructurings, transferskey competitors

Controlled transactions (i.e. related party)description (e.g. goods, services, loans) & contextpayments & receipts by jurisdictioncopies of all material agreementscomparability & functional analysis of partiesfull details of TP methods & relevant datacopy of all APAs related to such transactions

Financial Informationannual accounts (audited if available)information linking financial data with TP methodsschedules of financial data for comparables used in TP,

including sources

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Filing & DisseminationFiling & Dissemination Analysis of Options (by Jan. 2015), taking account of:

protecting the confidentiality of commercially sensitive informationensuring timely availability to all relevant countriesensuring appropriate use of information for TP enforcementeffective phasing in for successful transition to new regimepossible contributions of:

treaty information exchange mechanismscoordinated technological platformsdevelopment of model local law provisions

Confidentiality`Tax administrations should take all reasonable steps to ensure that there is no public disclosure of confidential information (trade secrets, scientific secrets, etc.) and other commercially sensitive information’

Publication of CbCR?Not mentioned, but said to be out of questionmany, including companies, regard it as inevitable

Reviewbefore end of 2020

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ImplementationImplementation OECD Transfer Pricing Guidelines

New Chapter V= international soft lawoften incorporated into national law

Proposed Multilateral Convention on BEPSmay be included?to be open to all statespackage deal?

Existing MC on Mutual Assistance in Taxationopen to all states (approval?)to obtain information from other statesconditional on `appropriate use’ of information?

National Lawsstates already demand transfer pricing documentationpower to compel production of documents held abroad?OECD to develop Model Laws

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An Alternative: Treating TNCs as Unitary An Alternative: Treating TNCs as Unitary

HistoryAlternative identified in Carroll report 1932 (Spain etc.)

political obstacles (League)permitted for PEs; profit-split = ad hoc apportionment

Used in federal states, e.g. USA, Canada, Switzerland Federal States

USA: e.g. California: film distribution via Nevada optional till 1942; TNC campaign 1970s; `water’s edge’ election 1986harmonised (partly) since 1957, some variations in formulae

Others: Argentina, Canada, Switzerland EU Single Market proposal 2011

Common Consolidated Corporate Tax Base (2011)limited to participating statesusual anti-avoidance rules (TP, CFC) with 3rd statesbut could deal with e.g. Luxembourg, Ireland (if they accept)better if integrated into global approach against international avoidance

Gradual Transition is PossibleResearch is needed.

Components of UT SystemComponents of UT System Combined Report for TNC Group

overview of the firm as a wholelisting of all affiliates (where formed & resident)consolidated accountsemployees, assets & sales by country

Apportionment Formula(s)general formulaspecial sectors:

transportextractive industriesbanking & finance?

Conflict Resolution Systemextension of existing MAP

Tax rates a matter for each country

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Combined ReportCombined Report Unitary Enterprise

based on ownership/control testpresumption that engaged in unitary business

avoid problems of USbut exclude clearly unrelated business

wider PE concept: business presenceneeded for Digital Economy

Tax Base Definition for Consolidated Accountsfinancial & tax accounting standards divergeharmonised tax accounting standard

cf CCCTB – transaction basedcapital & R&D allowances at national level?

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Apportionment FormulaApportionment FormulaAssets

physical – excluding intangiblesowned or leased

LabourUS: payroll costsinternational wage disparities suggest headcount betterEU: 50-50 weighting

Sales Revenueby destination (country of recipient/customer/client)if firm has business presence not just tradebut should include direct sales to retail customersespecially via website (e.g. Amazon)wider than PE definition

International Agreement?If possible, but could be compatible unilateral approachesaggressive approach would deter FDIscope for political trade-offs (sales vs. labour)Equal weighting of 3-factor Formula seems fair

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Transition to UnitaryTransition to Unitary

StudiesOECD Base Erosion & Profit-Shifting project?UN Committee: needs resourcesneeds serious research

Regional AdoptionUS States experienceEU CCCTB: enhanced cooperation, euro `fiscal pact’?Mercosur, Andean Pact, Asean, NAFTA, EAC, SADC

but should require worldwide Combined Report

Adopt Combined Reporting ImmediatelyUN Manual advises consolidated P&L and sales proportion datause to guide profit splitapply to relevant sectors, e.g. global financial trading

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Pros & ConsPros & Cons For TNCs

risk of inconsistent rules & conflicting formulae?global offset of losses against profitsmuch lower compliance costs

For Statesoffset of foreign losses against local profitsmuch lower enforcement costsreinforces fiscal sovereigntyhigher revenues could allow lower marginal rates

Globallyresolve Transfer Pricing problemremove respectability from tax havensend temptation to offer tax incentives for FDIredirect resources wasted on avoidance-enforcementremove distortions on allocation of capital investment

Loserstax avoidance industrytax havens

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