Tax Justice Network-Africa

International tax academy

Tax Justice: Financing Development in Africa
Nov 30-Dec 6 2014
Nairobi, KENYA

The International Tax System & Problems of

Taxation of Multinational Corporations
Especially for Developing Countries
Sol Picciotto
Emeritus Professor, Lancaster University
Senior Adviser, Tax Justice Network

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Why do we need an international tax system?

Tax & National Sovereignty

modern fiscal state 1875- (developed capitalist states)
shift to taxes on income
20C warfare-welfare state
deduction at source reduces evasion/avoidance

Colonial/dependent countries: `tribute states

levies on natural resource extraction
land/hut/head taxes: create money-economy
regulate boundaries of licit wealth & its appropriation (Roitman)
blurring of state & elite revenues > weak/failing states (Moore)

Governance & Fiscal Crisis

fiscal states legitimacy rests on broad general taxes

equally applicable to natural & legal persons/citizens
fair contribution to costs of collective services
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International Interdependence

Scope of Income/Profit Taxes 1875-

income taxes on residents/citizens worldwide income

how 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 Coordination
unilateral: foreign tax deduction; credit (USA, Netherlands)
UK: only for Empire, or by international agreement
League of Nations >> first model treaties 1928
growth of treaty network 1945 (US-UK) >>> OECD
main aim to facilitate FDI, so prevention of double taxation
1980s 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 Framework

Treaty Skeleton
League of Nations Fiscal Committee: 1928-1946
UN Financial & Fiscal Commission: 1948-54
OECD Committee on Fiscal Affairs (OECD-CFA): 1956UN Ad Hoc Group of Tax Experts: 1967-2004 > Committee 2004upgrading?
OECD Global Forum on Taxation /Transparency 2003
International Tax Dialogue (IDB, IMF, OECD, UN, WB) : 2002-

Flesh on the Bones

Commentaries on Model Treaties
Reports & Guidelines
(enactment in national laws)

Sinews
expert community: public-private
elaboration & application of rules

Limitations & Problems

technicism & 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
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result: upgrade of UNTC, creation of ITD
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Tax Rules for International Business

1928 model: main concern portfolio investment

Home State (residence of investor) should tax
investment 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/affiliate
also 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 apportionment
tax authorities can adjust accounts to ensure fair profit split
Separate Enterprise Arms 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 Avoidance

Treaty Models
1928+ few treaties negotiated
League: Mexico model 1943, London model 1946
US-UK treaty 1945 > US & UK networks
OECD 1963 model:
strengthens London model: income attributable to PE
OECD members negotiate 200 treaties by 1985

UN: Guidelines 1974, UN Model 1980

modification of OECD model: broader definition of PE

Tax Havens & Avoidance

1920s: 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 financing
US: `foreign personal holding company rules 1934, 1937
US foreign affiliates only taxed on remittances, with foreign tax credit

1960s: emergence of `offshore finance: systematisation

1979- currency liberalisation: free-for-all

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Basic Avoidance Strategies

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Googles Double-Irish Dutch-Sandwich

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Anti-Avoidance Measures

Controlled Foreign Corporations (CFCs)

US: Subpart F 1962
Germany: Steueroasenbericht 1964, decree 1965, AusStG 1972
`passive income of CFC in low-tax country attributed to owners
Swiss 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 available
Cost +, Retail, `Other
OECD Transfer Pricing Report 1979
US: 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 arms length principle

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CFC Rules and their Problems

Control test: owners resident in taxing country

how many multiple owners?
TNC globalisation/regionalisation
Passive income test
`mobile activities: financial services, IP management
Low-tax country test (lists)
proliferation of preferential regimes
Responses
increased complexity
shift to `territorial basis, e.g. UK 2012 reforms
Fundamental Flaws
(re)assertion of Home country tax on multinational income
do not deal with avoidance of Host country taxes
e.g. thin capitalisation, charges, royalties
`stateless income (Double Irish - Dutch Sandwich)
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e.g. Amazon, Google etc
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Transfer Pricing Rules and their Problems

OECD `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 Resolution
mutual agreement procedure
discretionary , secret (confidential to parties & advisers)
Glaxo-SmithKline: $5b assessment v. $1b refund, settled for $3.4b
Adoption by Developing Countries
no comparables
Brazil: fixed profit margins
China: profit-split with enhanced `locational factors
India: everything goes 3000 outstanding court cases
others: resource/capacity issues?
E.g. Dominican Republic hotel/tourism sector
Increasing activation will lead to more conflicts or avoidance
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TNCs 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 funding

Developing country >> aid dependency
Developed countries >> austerity, loss of public services

Distorts competition & TNC investment decisions

TNC advantages over domestic firms
TNC relocation benefits some countries but global net welfare losses

Facilitates `offshore finance

shadow banking, excessive leverage etc >> `financialisation bubble & crash

Supports the tax avoidance industry

costs for governments & firms
drain on economy & society

Legitimises Offshore Haven & Secrecy system

also used for crime & terrorism money-laundering
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International Tax Reform Initiatives

G7: 1996

Harmful Tax Competition 1998 OECD Report

derailed by Pres. Bush 2001 >> Exchange of Information
OECD standard: On Request, via bilateral TIEAs/DTTs
G8 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 1920s, 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
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worldwide allocation of profits and tax.
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Organisations Involved

OECD Committee on Fiscal Affairs + 8 G20 = 44

main responsibility for current system
BEPS Action Plan: reports Sept. 2014, Sept. 2015, Dec. 2015
consultations:
business (tax advisers) technical details
TUAC/civil society
developing countries >> enhanced engagement

UN Tax Committee
meagre resources
BEPS & beps subcommittee
work on services, extractives

IMF Fiscal Affairs Department

International Tax research programme approved June 2013
`Spillovers report May 2014
Hybrid methods
should not polarise arms 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 `advantagesof a multilateral and coordinated basis (## 44, 47)
simpler to apportion group financing costs
CFC Regimes
no proposals yet, but also better if coordinated
Problems: which is `home? what is `active business?
Joint CFC regime?
Limitation of Deductions
no proposals yet; linked to treaty abuse, & hybrids
interest cap: apportion total by EBITDA?
Harmful Tax Practices: Sept. 2014 (little progress)
OECD 1998 Report, EU Code shows problems
EU: `innovation preferences cleared >> spread of patent boxes
`economic substance test: complex, `track & trace
flip-side of CFC, linked? Unlikely
Transparency 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 articles
important to protect source taxation

Prevent `artificial 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 creation

intangibles: initial draft, complex & confused
shift to profit split?
risks & capital
other 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

Digital Economy
not separate sector: `digitalisation of the economy
closer/ symbiotic relations with users/customers
new 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 treaties
package deal, or a la carte?
Stronger MAP
to deal with increased conflicts
but lack of resources: delay now averages 28 months
compulsory arbitration? LDCs opposed.
Country-by-Country Report & TP Documentation
check if tax paid `where economic activities take place & value created
For detailed commentaries see BEPS Monitoring Group:
https://bepsmonitoringgroup.wordpress.com/

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Country-by-Country Reports & TP Documentation

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

Three Tiers:
CbCR
Master File
Local File

Access & Dissemination

still awaited

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CbCR Template: Table One: Overview of allocation of income,

taxes and business activities by tax jurisdiction
Tax
Jurisdn

Each
entity
included
in
consold
financial
report
(no excl.)
Incl. PEs

Reve
nues

Pre-tax
Profit/
Loss

Inc Tax
Paid
(cash)

Inc Tax
Accrued
(in year)

Stated
Capital

Accumlt
d
Earnings

Employ
ees

Tangible
Assets

Related
unreld
Total

Incl.
extraordinary
items

To all
jurisns
incl. WTs
on
receipts

Not incl
deferred
taxes or
provision

Incl.
capital of
PEs

Sum of
all
entities
in jurisn

FTEs
year-end/
average/
other;
may incl.
contractors

Net book
value
NOT
cash/
intangs/
financial

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Table Two: List of all the Constituent Entities of the MNE

group included in each aggregation per tax jurisdiction

Tax Jurisdiction

MNE Name &

Fiscal Year

Main business activity/ies

Entities Resident
(list each one)

Tax Jurisdiction R&D/IP Management/

of formation
Purchasing - Procurement
(if different)
Production-manufacturing
Sales-marketing-distribution
Admin./Services to 3rd parties
Internal Group Finance
Regulated Financial Services
Insurance
Holding (shares/equity)
Dormant
Other (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 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?

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 File

Organisational Structure
chart of ownership & geographical location

Description of business(es)
profit drivers
supply chains for main (>5%) products/services
internal services & transfer pricing for them
functional analysis + important restructuring in year

Intangibles
Description of strategy & location of R&D activities & management
List of intra-firm agreements/licences
description of TP policies on intangibles
important internal transfers during year incl. price paid

Intra-firm financial activities

description of financing
name financial affiliate(s) & place of formation / effective management
description of TP policies on finance

Financial & Tax positions

annual consolidated financial statement (if prepared for other purposes)
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List & description of APAs & tax rulings
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Transfer Pricing Local File

Local Entity
management structure, organisation chart, reporting lines abroad
description of business, strategy, restructurings, transfers
key competitors

Controlled transactions (i.e. related party)

description (e.g. goods, services, loans) & context
payments & receipts by jurisdiction
copies of all material agreements
comparability & functional analysis of parties
full details of TP methods & relevant data
copy of all APAs related to such transactions

Financial Information
annual accounts (audited if available)
information linking financial data with TP methods
schedules of financial data for comparables used in TP,
including sources
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Filing & Dissemination

Analysis of Options (by Jan. 2015), taking account of:

protecting the confidentiality of commercially sensitive information
ensuring timely availability to all relevant countries
ensuring appropriate use of information for TP enforcement
effective phasing in for successful transition to new regime
possible contributions of:
treaty information exchange mechanisms
coordinated technological platforms
development 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 question
many, including companies, regard it as inevitable

Review
before end of 2020
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Implementation

OECD Transfer Pricing Guidelines

New Chapter V
= international soft law
often incorporated into national law

Proposed Multilateral Convention on BEPS

may be included?
to be open to all states
package deal?

Existing MC on Mutual Assistance in Taxation

open to all states (approval?)
to obtain information from other states
conditional 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; `waters 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 states
usual anti-avoidance rules (TP, CFC) with 3rd 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.

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Components of UT System

Combined Report for TNC Group

overview of the firm as a whole
listing of all affiliates (where formed & resident)
consolidated accounts
employees, assets & sales by country
Apportionment Formula(s)
general formula
special sectors:
transport
extractive industries
banking & finance?
Conflict Resolution System
extension of existing MAP
Tax rates a matter for each country
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Combined Report

Unitary Enterprise
based on ownership/control test
presumption that engaged in unitary business
avoid problems of US
but exclude clearly unrelated business
wider PE concept: business presence
needed for Digital Economy
Tax Base Definition for Consolidated Accounts
financial & tax accounting standards diverge
harmonised tax accounting standard
cf CCCTB transaction based
capital & R&D allowances at national level?
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Apportionment Formula
Assets

physical excluding intangibles

owned or leased

Labour
US: payroll costs
international wage disparities suggest headcount better
EU: 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 customers
especially via website (e.g. Amazon)
wider than PE definition

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

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Transition to Unitary

Studies
OECD Base Erosion & Profit-Shifting project?
UN Committee: needs resources
needs 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 Immediately

UN Manual advises consolidated P&L and sales proportion data
use to guide profit split
apply to relevant sectors, e.g. global financial trading
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Pros & Cons

For TNCs
risk of inconsistent rules & conflicting formulae?
global offset of losses against profits
much lower compliance costs

For States
offset of foreign losses against local profits
much lower enforcement costs
reinforces fiscal sovereignty
higher revenues could allow lower marginal rates

Globally
resolve Transfer Pricing problem
remove respectability from tax havens
end temptation to offer tax incentives for FDI
redirect resources wasted on avoidance-enforcement
remove distortions on allocation of capital investment

Losers
tax avoidance industry
tax havens

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Thank You
Ke a leboga
Ngiyabonga
Enkosi
Dankie
Asante Sana
Grazie
Merci
Muchas Gracias
Obrigado
Vielen Dank
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