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| There’s a simple way to stop big corporations avoiding tax. Here’s how | There’s a simple way to stop big corporations avoiding tax. Here’s how |
| (about 1 month later) | |
| If multinationals had to pay their dues where they make their sales, the kind of activities revealed in the Paradise Papers would be a thing of the past | |
| Wed 13 Dec 2017 06.00 GMT | |
| Last modified on Wed 13 Dec 2017 11.54 GMT | |
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| The Paradise Papers revelations have again raised concerns over the way multinational corporations arrange their tax affairs. Why, with high turnovers in countries such as the UK, do they pay so little tax there? The answer is often quite simple: because legally, under international corporate tax rules, they are not required to. | The Paradise Papers revelations have again raised concerns over the way multinational corporations arrange their tax affairs. Why, with high turnovers in countries such as the UK, do they pay so little tax there? The answer is often quite simple: because legally, under international corporate tax rules, they are not required to. |
| In our globalised economy, where production chains are spread across the world and highly movable, it is difficult to determine under existing rules where and how the profits of big firms should be taxed. In effect, we can no longer properly identify the countries that have both the legitimacy and ability to tax those profits. | In our globalised economy, where production chains are spread across the world and highly movable, it is difficult to determine under existing rules where and how the profits of big firms should be taxed. In effect, we can no longer properly identify the countries that have both the legitimacy and ability to tax those profits. |
| Our response has been somewhat contradictory. On one hand there has been a multiplication of anti-avoidance rules and initiatives, at national and international levels, to prevent companies shifting profits between countries. On the other hand there has been an intensification of tax competition, with countries offering ever lower rates of corporate income tax in order to foster investment, thus incentivising that same corporate mobility. In the process we have given multinationals massive bargaining power: the power to pit countries against each other. | Our response has been somewhat contradictory. On one hand there has been a multiplication of anti-avoidance rules and initiatives, at national and international levels, to prevent companies shifting profits between countries. On the other hand there has been an intensification of tax competition, with countries offering ever lower rates of corporate income tax in order to foster investment, thus incentivising that same corporate mobility. In the process we have given multinationals massive bargaining power: the power to pit countries against each other. |
| There is therefore only one long-term means of effectively taxing corporations: we must remove the incentives to corporate mobility for tax reasons. How to achieve that is the key question. For years, people have advocated the introduction of a common method of taxing corporations – but political agreement, even within Europe, has proved exceptionally difficult. The likelihood of achieving that global agreement seems extremely low. | There is therefore only one long-term means of effectively taxing corporations: we must remove the incentives to corporate mobility for tax reasons. How to achieve that is the key question. For years, people have advocated the introduction of a common method of taxing corporations – but political agreement, even within Europe, has proved exceptionally difficult. The likelihood of achieving that global agreement seems extremely low. |
| In 2008 a paper by professors Michael Devereux at Oxford University, Alan Auerbach at the University of California, Berkeley, and Helen Simpson at Bristol University came up with a new solution: what if we taxed profits in the country where the customers are? Their idea was to tax corporations at the least movable point of the production chain, at a point that corporations could not shift or manipulate. | In 2008 a paper by professors Michael Devereux at Oxford University, Alan Auerbach at the University of California, Berkeley, and Helen Simpson at Bristol University came up with a new solution: what if we taxed profits in the country where the customers are? Their idea was to tax corporations at the least movable point of the production chain, at a point that corporations could not shift or manipulate. |
| The most common avoidance techniques rely on one crucial premise: that moving activities affects where profits are taxed | The most common avoidance techniques rely on one crucial premise: that moving activities affects where profits are taxed |
| The most common tax avoidance techniques rely on one crucial premise: that moving your headquarters or activities will affect where profits are taxed. If your patents are located in a country with lower corporate income tax rates, then the income they generate will be taxed at lower rates; if your management activities are located in that country, most of your profits may be taxed there. What these avoidance schemes have in common is their reliance on mobility: moving can result in a lower tax bill. | The most common tax avoidance techniques rely on one crucial premise: that moving your headquarters or activities will affect where profits are taxed. If your patents are located in a country with lower corporate income tax rates, then the income they generate will be taxed at lower rates; if your management activities are located in that country, most of your profits may be taxed there. What these avoidance schemes have in common is their reliance on mobility: moving can result in a lower tax bill. |
| If we taxed at the destination, or sales endpoint, there would be no benefit in moving headquarters or patent registrations to a lower-tax country. Because customers are relatively immobile, a destination-based tax would remove mobility from the equation. At a single stroke, we could almost completely eliminate tax competition and avoidance. Crucially, although international cooperation would make that more effective, it could still work if only one country unilaterally moved towards a destination-based corporate income tax. | If we taxed at the destination, or sales endpoint, there would be no benefit in moving headquarters or patent registrations to a lower-tax country. Because customers are relatively immobile, a destination-based tax would remove mobility from the equation. At a single stroke, we could almost completely eliminate tax competition and avoidance. Crucially, although international cooperation would make that more effective, it could still work if only one country unilaterally moved towards a destination-based corporate income tax. |
| But is it feasible to tax corporate profits in the country of destination? And is it legitimate? In 2014 Michael Devereux and I set out the reasons why we think it is both. We already have another tax based on destination – VAT. Many of the administrative features developed for VAT could be applied, with some adaptation, to a destination-based corporate income tax, even though one is based on consumption and the other on profits. | But is it feasible to tax corporate profits in the country of destination? And is it legitimate? In 2014 Michael Devereux and I set out the reasons why we think it is both. We already have another tax based on destination – VAT. Many of the administrative features developed for VAT could be applied, with some adaptation, to a destination-based corporate income tax, even though one is based on consumption and the other on profits. |
| How would such a system work in practice? The first step would be to identify the country of destination. This would usually be where the customer lives. In the case of digital transactions, it could be decided on the basis of the bank card used for payment. The scope for fraud would be smaller than if the destination country were determined, for instance, by the customer’s computer IP address, which can be easily manipulated. | How would such a system work in practice? The first step would be to identify the country of destination. This would usually be where the customer lives. In the case of digital transactions, it could be decided on the basis of the bank card used for payment. The scope for fraud would be smaller than if the destination country were determined, for instance, by the customer’s computer IP address, which can be easily manipulated. |
| An exception to using the customer’s country of residence would have to be made for cases such as restaurants, concert venues or shops, where customers cross borders to make purchases. In these circumstances, the sale could be taxed where the business is located. | An exception to using the customer’s country of residence would have to be made for cases such as restaurants, concert venues or shops, where customers cross borders to make purchases. In these circumstances, the sale could be taxed where the business is located. |
| Once the country of destination was identified, corporate income tax would be applied to sales made in that country. If international cooperation could be achieved, even within a small group of countries, they could delegate tax collection to each other. This would mean companies could concentrate all the compliance for tax regulation in their country of residence, a one-stop shop. | Once the country of destination was identified, corporate income tax would be applied to sales made in that country. If international cooperation could be achieved, even within a small group of countries, they could delegate tax collection to each other. This would mean companies could concentrate all the compliance for tax regulation in their country of residence, a one-stop shop. |
| There is natural anxiety about how developing countries would fare in a system that taxed profits in the country where sales take place: with smaller consumer markets, if corporate income tax is based on sales, would their revenues decrease? But this anxiety may not be warranted: many developing countries, such as most of Latin America and India, for instance, already use destination-based taxation in relation to services. They tend to import significant amounts of products, which would be a good indicator for estimating sales; and those with natural resources could easily apply a natural resources tax. | There is natural anxiety about how developing countries would fare in a system that taxed profits in the country where sales take place: with smaller consumer markets, if corporate income tax is based on sales, would their revenues decrease? But this anxiety may not be warranted: many developing countries, such as most of Latin America and India, for instance, already use destination-based taxation in relation to services. They tend to import significant amounts of products, which would be a good indicator for estimating sales; and those with natural resources could easily apply a natural resources tax. |
| More importantly, the end of tax competition would end the pressure of the race to the bottom felt by developing countries. They could freely establish their tax rates. The alternative to a destination-based corporate income tax is not a perfectly functioning international tax system for developing countries: it is a system that at present is fundamentally rigged against them. | More importantly, the end of tax competition would end the pressure of the race to the bottom felt by developing countries. They could freely establish their tax rates. The alternative to a destination-based corporate income tax is not a perfectly functioning international tax system for developing countries: it is a system that at present is fundamentally rigged against them. |
| The proposal has been progressively gaining traction. In 2013 the House of Lords economic affairs select committee recommended a detailed study on the possible adoption of a destination-based tax, both internationally and unilaterally. | The proposal has been progressively gaining traction. In 2013 the House of Lords economic affairs select committee recommended a detailed study on the possible adoption of a destination-based tax, both internationally and unilaterally. |
| A 2014 report from the European commission on how to tax the digital economy pointed in the same direction. Then in early 2017 the proposal became a hot topic in the US. Although the destination element has now been removed from the US tax reform debate, the issue was picked up again in recent OECD proposals on the digital economy. | A 2014 report from the European commission on how to tax the digital economy pointed in the same direction. Then in early 2017 the proposal became a hot topic in the US. Although the destination element has now been removed from the US tax reform debate, the issue was picked up again in recent OECD proposals on the digital economy. |
| Changing the fundamentals of our tax system would present short-term challenges. As in every tax reform, there would be winners and losers. But the mid- to long-term rewards of such a move could be extremely significant. | Changing the fundamentals of our tax system would present short-term challenges. As in every tax reform, there would be winners and losers. But the mid- to long-term rewards of such a move could be extremely significant. |
| Imagine a world where we do not need to constantly close loopholes with anti-avoidance measures; where countries do not have to erode their tax bases to attract investment; where developing countries can take back control of their tax systems; where digital businesses are fully integrated and taxed like any other business. | Imagine a world where we do not need to constantly close loopholes with anti-avoidance measures; where countries do not have to erode their tax bases to attract investment; where developing countries can take back control of their tax systems; where digital businesses are fully integrated and taxed like any other business. |
| No tax is perfect, but this vision of the world may just be worth fighting for. | No tax is perfect, but this vision of the world may just be worth fighting for. |
| • Rita de la Feria is the chair in tax law at the school of law at Leeds University, and international research fellow at the Oxford University Centre for Business Taxation | • Rita de la Feria is the chair in tax law at the school of law at Leeds University, and international research fellow at the Oxford University Centre for Business Taxation |
| Tax avoidance | |
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