TJN-A Academy - Sol Picciotto

8/10/2019 TJN-A Academy - Sol Picciotto

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05/12/20141

The International Tax System & Problems ofTaxation of Multinational Corporations

Especially for Developing Countries

Sol PicciottoEmeritus Professor, Lancaster UniversitySenior Adviser, Tax Justice Network

Tax Justice Network-Africa International tax academyTax Justice: F inancing Development i n Afr ica Nov 30-Dec 6 2014Nairobi, KENYA



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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’ states levies 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 taxes equally applicable to natural & legal persons/citizensfair contribution to costs of collective services



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International InterdependenceScope of Income/Profit Taxes 1875-income taxes on residents/citizens’ worldwide income how to apply to corporation?

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

foreign investors through London?involves ìnternational 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) >>> OECD

main 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 project

G20 St Petersburg Declaration 2013



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International Institutional FrameworkTreaty SkeletonLeague 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 2003International Tax Dialogue (IDB, IMF, OECD, UN, WB) : 2002-

Flesh on the BonesCommentaries on Model TreatiesReports & Guidelines(enactment in national laws)Sinewsexpert community: public-private

elaboration & application of rulesLimitations & 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 Developmentresult: upgrade of UNTC, creation of ITD



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Tax Rules for International Business1928 model: main concern portfolio investment

Home State (residence of investor) should taxinvestment returns (interest, dividends)Host state (location of business enterprise) should tax

business 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 percentageof turnover prevents the taxpayer taking up an unreasonable attitude’ (UK)



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Growth of Treaty Network & International AvoidanceTreaty Models1928+ 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, 1937 US foreign affiliates only taxed on remittances, with foreign tax credit

1960s: emergence of òffshore’ finance: systematisation 1979- currency liberalisation: free-for-all



Basic Avoidance Strategies

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Google’s Double -Irish Dutch-Sandwich

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Anti-Avoidance MeasuresControlled 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)PricingUS Regulations 1968 :

Comparable Uncontrolled Price (CUP) where availableCost +, Retail, Òther’

OECD Transfer Pricing Report 1979US: GAO Report 1981, Tax Reform 1986, `comparable profit method’ 1988 OECD 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 Problems

Control test: owners resident in taxing country

how many multiple owners?TNC globalisation/regionalisationPassive income test

`mobile’ activities: financial services, IP management Low-tax country test (lists)

proliferation of preferential regimesResponses

increased 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 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 shared administrability: bright lines, APAs

Conflicts & their Resolutionmutual agreement procedurediscretionary , secret (confidential to parties & advisers)

Glaxo-SmithKline: $5b assessment v. $1b refund, settled for $3.4bAdoption by Developing Countries

no comparables

Brazil: fixed profit marginsChina: profit- split with enhanced ̀ locational’ factors India: 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 AvoidanceDirect 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 òffshore’ > $1.7 trillion

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

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

Facilitates òffshore’ finance shadow banking, excessive leverage etc >> `financialisation’ bubble & crash

Supports the tax avoidance industry costs for governments & firmsdrain on economy & society

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

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International Tax Reform InitiativesG7: 1996Harmful 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 & multilateral beneficial ownership information

G8/G20: 2013 St 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 growingimportance of intangibles and the digital economy .”

“existing international tax rules on tax treaties, permanentestablishment, and transfer pricing will be examined to ensure thatprofits 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 theirworldwide allocation of profits and tax”. 05/12/201413



Organisations Involved

OECD Committee on Fiscal Affairs + 8 G20 = 44main responsibility for current systemBEPS Action Plan: reports Sept. 2014, Sept. 2015, Dec. 2015consultations:

business (tax advisers) – technical detailsTUAC/civil society

developing countries >> enhanced engagementUN Tax Committee meagre resourcesBEPS & beps subcommitteework on services, extractives

IMF Fiscal Affairs Department International 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 Establishing international coherence

Hybrid Mismatch Arrangements: Sept. 2014

proposals for national rules: primary & secondary but ` advantages…of a multilateral and coordinated basis’ (## 44, 47) simpler to apportion group financing costs

CFC Regimes no proposals yet, but also better if coordinatedProblems: which is `home’? what is àctive 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: ìnnovation’ preferences cleared >> spread of patent boxesèconomic substance’ test: complex, `track & trace’ flip-side of CFC, linked? UnlikelyTransparency of rulings:

`compulsory spontaneous’ notification Need for continuous monitoring: tax sovereignty?

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BEPS AP 2: Restoring International Standards

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

Prevent àrtificial abuse’ of PE broader 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 ànd beyond’ ALP èxceptional circumstances’? Value-chain analysis?

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`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 practicesMultilateral Convention

rapid revision of existing treaties package deal, or a la carte?

Stronger MAP

to deal with increased conflicts but 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 createdFor detailed commentaries see BEPS Monitoring Group:https://bepsmonitoringgroup.wordpress.com/ 05/12/2014

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https://bepsmonitoringgroup.wordpress.com/

https://bepsmonitoringgroup.wordpress.com/



Country-by-Country Reports & TP Documentation

Purposes divergent: overview vs. Details of intra-firm transactions

Three Tiers:CbCRMaster FileLocal FileAccess & Dissemination still 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 all jurisnsincl. WTsonreceipts

Not incldeferredtaxes or

provision

Incl.capital ofPEs

Sum ofallentitiesin jurisn

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

Net bookvalue

NOTcash/intangs/financial

Each

entityincludedinconsoldfinancialreport(no excl.)Incl. PEs 05/12/2014

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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 MNEgroup 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 3 rd partiesInternal Group FinanceRegulated Financial ServicesInsurance

Holding (shares/equity)DormantOther (specify)

Tick box or specify

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Table Three: Additional Information

Name of MNE Group & Fiscal Year

Please include any further brief information or explanation you considernecessary or that would facilitate the understanding of thecompulsory information

provided in the country-by-country report.

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Additional Transactional Data?

Some countries want to include more in CbCR Argentina, 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 FileOrganisational Structurechart of ownership & geographical location

Description of business(es) profit driverssupply chains for main (>5%) products/servicesinternal services & transfer pricing for themfunctional analysis + important restructuring in year

Intangibles Description 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 positions annual consolidated financial statement (if prepared for other purposes)List & description of APAs & tax rulings 05/12/201423



Transfer Pricing Local FileLocal 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) & context

payments & 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 Information annual 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 & DisseminationAnalysis 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 regime

possible 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 isno public disclosure of confidential information (trade secrets, scientificsecrets, etc.) and other commercially sensitive information’

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

Review before end of 2020

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ImplementationOECD 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 states package deal?

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

National Laws states already demand transfer pricing documentation

power to compel production of documents held abroad?OECD to develop Model Laws

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An Alternative: Treating TNCs as Unitary

History

Alternative 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 1986 harmonised (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 3 rd states but could deal with e.g. Luxembourg, Ireland (if they accept) better if integrated into global approach against international avoidance

Gradual Transition is Possible

Research is needed.



Components of UT SystemCombined 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 industries

banking & finance?Conflict Resolution System extension of existing MAPTax rates a matter for each country

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Apportionment FormulaAssets

physical – excluding intangiblesowned or leased

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

Sales Revenue by destination (country of recipient/customer/client)if firm has business presence not just trade

but should include direct sales to retail customersespecially via website (e.g. Amazon)

wider than PE definitionInternational 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 Unitary

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

Regional Adoption

US States experience EU 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 & ConsFor 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 05/12/201432



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Thank YouKe a lebogaNgiyabonga

EnkosiDankie

Asante SanaGrazieMerci

Muchas Gracias

ObrigadoVielen Dank

Documents

TJN-A Academy - Sol Picciotto