13, 2013 7:22 pm
Taxation: Unsafe offshore
Governments want to close tax loopholes but risk scaring off big foreign investors
©Alamy
Reading the barometer: governments are responding to a changing political climate and are looking to stop companies logging their profits in offshore tax havens
In April 1961, a newly elected President John F. Kennedy launched an offensive against a phenomenon that he feared could undermine America’s future: aggressive tax avoidance.
In a message to Congress, he railed against the “unjustifiable” use of tax havens by growing numbers of businesses to slash their tax liabilities at home and abroad.
More than 50 years on, the political rhetoric seems to be identical, echoing Kennedy’s broadside against “artificial arrangements”. Once again, businesses are under fire for using corporate structures that shift profits to low-tax jurisdictions. Political anger is mounting over the low taxes paid by multinationals such as Apple, Google and Amazon during an age of brutal cuts in public spending.
In the US, the powerful Senate investigations panel has attacked the “loopholes” and “gimmicks” used to move earnings offshore; in Australia, a Treasury minister slammed multinationals’ tax practices as “not fair game”. In Britain, David Cameron, the prime minister, sent a blunt message to business: “We’re playing fair by you; you’ve got to play fair by us.” Pascal Saint-Amans, the OECD’s top tax official, says this political pressure has now moved beyond rhetoric and represents a turning of the tide against avoidance by big business.
“The aggressive tax planning of the last 20 years was achieved with the complicity of governments themselves to cope with tax competition,” he says. “This mindset is seriously changing.”
Galvanising co-ordinated action, Britain, Germany and France have thrown their weight behind an urgent review of the international tax standards, which they say, faces “difficulty keeping up with changes in global business practices, such as the development of ecommerce in commercial activities”.
The potential reforms will start to take shape next month at a Group of 20 meeting in Russia, where the Paris-based OECD will release an interim report on tax. Governments are already locking horns with businesses over how far the measures will go.
In November, they met to discuss proposals to tighten the rules on the artificial shifting of profits to tax havens. While these meetings are normally dry, sedate affairs, the session in Paris was marked by a more palpable sense of tension.
James Phillips, a tax executive at CGGVeritas Group, a French oil services company – but speaking at the meeting in a personal capacity – stressed what he saw as the dangers of pushing business too far. “The current financial crisis will, eventually, pass – it is far from historically unique. If, however, its legacy is to retrench international trade via reducing opportunities for profitable gain by institutionalising double taxation its legacy will be much further reaching,” he said.
Despite the protestations from business, finance ministries must respond to an increasingly irate public that feels global tax rules have been rigged in favour of multinationals.
“All of this is taking place against the backdrop of anti-globalisation and protectionism. Politicians are starting to pick up the vibe,” says Jeffrey Owens, professor at the Vienna University of Economics and Business.
Multinationals, stung by the damage to their reputations, accuse governments of blaming companies for a system that the states themselves designed to attract investors. When Google, which shifted billions of dollars from Ireland to Bermuda to achieve an overseas tax rate of just 3.2 per cent in 2011, drew fire from politicians, Eric Schmidt, its executive chairman, insisted the tax structure was “based on the incentives that the governments offered us to operate”.
Ireland, where Google employs 3,000 people from 65 countries in Dublin’s former docklands, taxes a sliver of profit from the billions of the Google’s overseas sales which are booked in the country. This is achieved by Google’s use of a “double Irish” structure, that exploits different definitions of tax residence in the Irish and US tax codes. The Irish unit pays royalties to Google in the tax haven of Bermuda for using the company’s own intellectual property.
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But Google’s arrangements are, above all, a symptom of flaws in the US tax system. Scott Hodge, president of the Tax Foundation, a non-partisan research group in Washington, says these kinds of “tax planning gymnastics” are the “the response you would expect when businesses are subject to an arcane, outmoded tax system”.
As well as having the highest tax rate in the industrialised world, the US is increasingly unusual in taxing companies’ worldwide profits. To mitigate these disadvantages for its companies competing abroad, it allows them to defer US taxes on foreign earnings until they are repatriated.
Since 1997, Washington has tilted the tax system further in the companies’ favour by passing the “check-the-box” regulations that opened up new opportunities to put income in tax havens, without having to invest in real operations there. Companies had a new incentive to strip taxable profits out of high-tax countries through payments of interest or royalties, pushing down the average overseas tax rates of US businesses.
In Europe, the problems are exacerbated by the anti-discrimination rules enshrined in the 1957 Treaty of Rome which have hindered the policing of national tax boundaries. Existing single-market rules allow businesses to “structure arrangements with such jurisdictions via the member state with the weakest response ... this does not only erode member states’ tax bases but also endangers fair competitive conditions for business”, according to a new report on aggressive tax planning by the European Commission.
Emerging economies, particularly the powerhouses of Brazil, China and India, are also feeling the pinch. The existing rules on international taxation “only take care of the interest of developed countries”, the Indian government told the UN in March 2012, a sign of frustration over multinationals’ ability to siphon off profits through royalties and management fees and deposit them in tax-friendlier locales. “The Brics are saying: you are raiding our markets,” says one multinational executive.
Beijing is increasingly resisting efforts to cast its companies as low-margin “contract” manufacturers, arguing that its own technical expertise, infrastructure and huge population mean substantial value is created in China and should be taxable there. Brazil has rejected conventional approaches to determine multinationals’ tax bills in favour of a simpler, more rigid approach that assumes fixed industry-wide profit margins.
Facing competing demands, the fragile consensus over the international allocation of multinationals’ profits risks a breakdown. Highlighting the dangers of a failure by governments to collaborate on reforms, the OECD warns: “The consequences could be damaging in terms of increased possibilities for mismatches, additional disputes, increased uncertainty for business, a battle to be the first to grab taxable income through purported anti-avoidance measures, or a race to the bottom with respect to corporate income taxes.”
There is “no magic recipe” to address profit shifting, the OECD warns. But it is increasingly confident about the technical changes that would make the system more robust.
The new guidelines on “intangible” assets it is pushing through would stop companies shifting profits to shell companies in tax havens, although they would not stop the transfer of intellectual property and other intangibles to a low-tax country if companies had genuine business operations there.
It is also likely to propose a crackdown on arbitrage – the exploitation of differences between countries’ tax codes – by recommending governments refuse tax deductions on income that will be untaxed in another jurisdiction. Reforms of the rules affecting ecommerce companies are also under consideration.
Similar proposals are being pushed by the European Commission. Calling for a “strong and cohesive EU stance”, Algirdas Semeta, the tax commissioner, said: “In a single market, within a globalised economy, national mismatches and loopholes become the playthings of those that seek to escape taxation.”
Some factors are already working in governments’ favour: demands from the public and investors for greater transparency, a growing and renewed awareness of the risks of extreme tax planning to companies’ reputations and the recently acquired ability to prise open the details of companies held in tax havens.
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Attempts at reform will, however, face powerful headwinds. The forces of tax competition – including the temptation to grab the most mobile profits, such as those arising from intellectual property – remain significant. In spite of the soaring rhetoric, governments must proceed with some caution, fearing any cooling of investment because of a crackdown on tax avoidance.
“Member states are defensive,” says a Brussels-based official contemplating efforts to co-ordinate a tougher code.
“Countries are using their tax system to compete.” In the UK, for example, at the same time as spearheading international efforts to collaborate on reforms, George Osborne, the chancellor, is this year launching a “patent box” offering a cut-price tax rate for certain types of intellectual property and an offshore finance company regime to enhance the UK’s ability to attract headquarters.
Rooting out avoidance might, paradoxically, intensify competition on tax rates. James Hines of the University of Michigan says tax havens “play the important role of pressure valves”, allowing big countries to impose higher taxes on domestic businesses without deterring international investors or triggering “beggar thy neighbour” tax competition.
Rates in industrialised countries have already been driven down from almost 50 per cent to less than 30 per cent since the 1980s in a trend that shows no sign of ending. Pressure is likely to intensify if the US joins the fray. The International Monetary Fund reports: “Any sizeable US corporate income tax reform can therefore be expected to elicit a tax competition reaction by other countries.”
But as cash-strapped governments around the world attempt to repair their deficits, they will battle to defend corporate tax revenues that – while failing to keep up with the growth of companies’ profitability – have held broadly steady at 8-10 per cent of the total for the past 50 years.
One likely alternative would be a far greater reliance on consumption taxes, which would only add to increasingly unequal income distribution.
Given this need to preserve the integrity of the tax system, businesses would be well advised to brace for higher tax bills.
“Governments have made the business tax system more friendly since the mid 1980s,” says Mr Owens. “Now it is payback time”.
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Copyright The Financial Times Limited 2013.
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