Sheilla Killian:Following yesterday’s primer on the landscape of multinational taxes, this post reviews today’s brand-new OECD report on their plans to address multinational tax avoidance.
What’s in the report?
This report, Addressing Base Erosion and Profit Shifting, is a good contribution to the area in three ways. First, it reviews the existing studies well, pointing to a number of indirect indicators of multinational tax avoidance. As one example, it notes that the top locations for affiliate employment (the UK, Canada, Mexico, China, Germany) barely match the top locations for gross profits (the Netherlands, Luxembourg, Ireland, Canada, Bermuda). Another indirect measure cited is the ratio of profits of US-controlled firms to the GDP of the countries in which those profits are booked. For G-7 countries the ratio ranges from 0.2% to 2.6%. It rises to 4.6% for the Netherlands, 7.6% for Ireland, 18.2% for Luxembourg and up to 35.3% for Jersey. FDI flows are perhaps the clearest sign that something is amiss: In 2010 the British Virgin Islands (with a population of 23,500) were the second largest investor into China (14%) after Hong Kong (45%) and a long way ahead of the United States (4%).
The report is also useful in that it details a number of aggressive tax planning structures involving the use of royalties, debt, hybrid instruments such as convertible bonds and cost-contribution agreements. A simplified example is the use of convertible bonds by, for instance, a French company0. This hybrid instrument is a bond which at the end of its term converts into a share. If a French company invests in a foreign subsidiary using convertible bonds, the return on that investment will generally be regarded as tax-deductible interest in the host country of the subsidiary. However in France, the income will come in as tax-free dividends, creating an obvious motivation to ramp up the interest rate as a way of shifting foreign profits home, tax free.
Most significantly, though, this report is a declaration of intent. It flags a marked change in the way in which the OECD will approach the question of multinational tax avoidance. While it has focused in the past on harmful tax competition, tax havens and transfer pricing, it now intends to look more holistically at aggressive tax planning, taking in a far wider range of practices, and setting about removing the tax advantages associated with them.
So what are the plans?
The aim is essentially to neutralise the aggressive tax schemes by removing their tax advantages. So how might the OECD achieve this? The focus is shifting to corporate practices rather individual countries, reflecting the international nature of the problem. One possibility on the table is to replace the 3,000+ double tax treaties in existence worldwide with a single multi-lateral tax treaty, applying the same rules and the same treatment of income in all countries. This would be effective, for example, against the convertible bond structure highlighted above. It would be a political challenge, however, particularly in a world where not all countries follow the OECD model treaty.
They plan to improve and clarify transfer pricing rules, with a particular focus on the intangibles at the heart of the Double Irish, the Dutch Sandwich and a host of other well-known and well-sold structures being peddled to multinational firms. Rules on financial transactions between related companies and on the location of digital services are being considered. The OECD plans work faster than usual on this, and to report with detailed recommendations within two years.
The new focus is far less on tax havens; they are adamant that they are not targeting particular countries. They do acknowledge that what they diplomatically describe as “conduit countries” - countries through which royalties, interest and other payments are channelled away from the tax net - might not be immediately advantaged by the process. They insist, though that since the ultimate aim is to ensure that large companies will pay more tax overall, there will be more tax to go around. So even if Ireland, for instance, were to get a smaller slice of the tax pie, the pie itself will be larger.
Will this work out in practice? Well it depends on why companies are locating here. If their motivation is commercial, or even primarily to avail of the low corporate tax rate in generating profits here, they (and we) should be fine. Those few companies or divisions of companies which are here to abuse the tax system may find that choice less rewarding in the future, and so may move on. In a way, this will be an acid test of who we are hosting, and should result in more stable FDI for the country in the long term.
The report stops short of overt consideration of unitary tax, country by country reporting, and a host of other recommendations of such NGOs as the Tax Justice Network. However, it is a significant report, and marks a departure from the long-held OECD brief of working to avoid double taxation. They now seem more serious about tackling double non-taxation, the backbone of international tax arbitrage.
That really matters. It's important to remember in all of this that tax "saved" by aggressive corporate tax avoidance comes at a cost to the revenue stream of countries, often in the Global South where such revenue is very badly needed. If these structures were broken, not only might the pie become bigger, but also more equitably distributed, which would be a good thing for millions living in developing countries.
The full OECD report is available here. The next interim report comes in June – well worth keeping an eye on.
Dr Sheila Killian is Assistant Dean, Research and Director, Principles for Responsible Management Education at the Kemmy Business School, University of Limerick. Her research addresses sustainability, accountability and the common good, with a focus on professional expertise, tax policy and business school education. She holds a PhD in taxation from UCD.
Prior to joining UL, Dr Killian worked as a tax advisor with Arthur Andersen, KPMG and Ernst & Young, and in air-finance and educational software development. A Fellow of the Institute of Chartered Accountants of Ireland, she is the author of Corporate Social Responsibility: a Guide with Irish Experiences (2012).