For too long, multinational corporationsâand digital firms in particularâhave used existing rules to avoid paying taxes in countries where they do much of their business.
For some time now, multinational companies (MNCs) have been gaming the rules of the global economy to minimize their tax liabilityâor even eliminate it altogether. And for some time now, theÂ Independent Commission for the Reform of International Corporate TaxationÂ (ICRICT) has argued for the unitary taxation of MNCs. Fortunately, there have been some encouraging recent signs that the idea of a unitary tax is gaining traction.
Introducing a global minimum effective corporate-tax rate on MNCs of between 20 and 25 per cent, as the ICRICT (of which I am a member)Â advocates, would greatly weaken these firmsâ financial incentives to use so-called transfer pricing among their subsidiaries to shift recorded profits to low-tax countries. Moreover, a global minimum would end the race to the bottom in which countries lower their national tax rates to attract investment by MNCs.
These global tax revenues could then be allocated among governments according to factors such as the companyâs sales, employment and number of digital users in each countryârather than on where multinationals decide to locate their operations and intellectual property.
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Although tax experts and policy-makers initiallyÂ dismissedÂ the ICRICTâs proposal as impractical, even former naysayers now recognise the validity of this approach. Most importantly, it is now widely acknowledged that taxing multinational firms based on âwhere value is createdâ encourages massiveâand legalâtax avoidance through âbase erosion and profit shiftingâ, whereby companies take advantage of loopholes and differences in tax rules to move profits to low- or no-tax jurisdictions.
The resulting revenue losses for governments are mind-boggling. The International Monetary FundÂ has estimatedÂ that OECD countries may be losing $400 billion in tax revenue each year because of profit shifting, with non-OECD countries losing a further $200 billion. As the United Nationsâ 2019Â Financing for Sustainable Development ReportÂ points out, tax avoidance hits developing countries particularly hard, because their governments tend to rely more on corporate tax revenues, and because companiesâ declared profits are more sensitive to tax rates than in developed countries.
Multinationalsâ tax-avoidance strategies can also distort cross-border trade statistics. Global firmsÂ increasingly reportÂ intra-company trade and investment in intangible assets such as intellectual property, primarily for tax-arbitrage purposes. This creates âghost trade flowsâ that have little or no connection with real economic activity.
This completely legal tax avoidance is most evident in digital companies, mainly because digitalisation makes it very hard to establish where production takes place. As a consequence, a digital multinationalâs revenues typically bear no relation to its reported profits and resulting tax bill.
Amazon, for example,Â has paid no federal tax in the United StatesÂ for the past two years. In 2018, the company generated more than $232 billion in worldwide revenue, but reported profits of only $9.4 billion, on which it could then claim various deductions and offsetting credits. And in 2017, Google legallyÂ moved nearly $23 billion to BermudaÂ through a shell company based in the Netherlands, dramatically reducing its foreign tax bill.
Governments are finally trying to claw back this lost revenue. In January, the OECDÂ proposedÂ standardised rules for taxing digital companies across its member countries, building on measures already proposed in the European Union. The OECD proposals go beyond the âarmâs-length principleâ, which seeks to compel multinationals to bring transfer pricing into conformity with some market-value basis. They also go beyond current rules that limit taxation authority to countries where a multinational has a physical presence.
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This initiative is certainly welcome, and not only because it could help to reduce tax competition among developing countries. For too long, multinationalsâand digital firms in particularâhave used existing tax rules to avoid paying taxes in countries where their products are consumed. At the moment, the various proposals to address this (from the US, the UK and the G24 group of developing countries) all envisage expanding these âmarketâ countriesâ authority to tax global firms. The UK proposal is the narrowest in this regard, while the G24âs is the broadest.
But developing countries also want any global corporate-tax system to recognise their increasing importance asÂ producersÂ for traditional multinationals. Digital companies may be the largest and most prominent tax avoiders, but a tax reform that focused only on these firms would clearly not be in developing countriesâ interests. The US government is also against changing tax rules only for (mostly American) digital companies, because it would mean the US giving taxation authority to other countries and receiving nothing in return.
The geographic allocation of multinationalsâ global profits and tax payments therefore needs to reflect supply-and-demand factors. This would take into account both sales (revenues) and employees (as a proxy for production). Such a system would benefit developing and developed countries alike.
The arguments in favour of such an approach are overwhelming. But multinationals of both the digital and traditional sort remain politically powerful. Evenâor especiallyâin the digital economy, old-fashioned lobbying still counts.
Republication forbidden. Copyright: Project Syndicate 2019 How to tax a multinational