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Taxing multinationals across the world
Read more on - Polity | Economy | Schemes | S&T | Environment
- The story: It has been many years that governments have complained as multinational companies shifted profits out of tax collectors’ grasp and into low-tax havens like Ireland. The OECD, a club of rich countries, estimated in 2015 that avoidance robs public coffers of $100bn-240bn, or 4-10% of global corporation-tax revenues a year.
- Covid arrives: The fiscal fallout from Covid-19 is adding urgency to governments’ efforts to get some of this lost money back, most notably in America, where President Joe Biden plans to raise taxes on corporate profits, including foreign income.
- President in top gear: Mr Biden’s proposals will grind their way through Congress. Finance ministers from the G7 group of countries were set to discuss global tax reform in London on June 4th-5th. Later in the summer 139 countries were to discuss changing the system for taxing multinational companies. The confluence of a political shift in America and a global push to raise more tax revenue to pay for the pandemic means a degree of optimism is in the air.
- Where it all began: The foundations of the global corporate-tax system were laid a century ago.
- It recognises that overlapping taxes on the same slice of profits can curb trade and growth. As a result, taxing rights are allocated first to wherever profits are produced (the “source”) and then to wherever the parent company is headquartered (or “resident”).
- A multinational based in America but with an affiliate in Ireland, for example, typically pays taxes in both places. Where the company makes its sales is irrelevant. Payments between an individual firm’s various legal affiliates are recorded using the “arm’s-length” principle, supposedly on terms equivalent to those found on the open market.
- These principles are part of thousands of bilateral tax treaties, but they have had two unintended consequences. First, they have encouraged governments to compete for investment and revenue by offering tantalisingly low tax rates. In 1985 the global average statutory corporation-tax rate was 49%; in 2018 it was 24%. Ireland boasts a statutory rate of just 12.5%; Bermuda, 0%. And second, tax competition has encouraged companies to shuffle their reported profits to low-tax places. In 2016 around $ 1 trn of global profits were booked in so-called “investment hubs”. These include the Cayman Islands, Ireland and Singapore, which apply an average effective tax rate of 5% on the profits of non-resident companies.
- Activity were taxation: So now there is a huge mismatch between where tax is paid and where real activity takes place. OECD suggests that multinationals report 25% of their profits in investment hubs, although only 11% of their tangible assets and less than 5% of their workers are based there.
- Parents can allocate paper profits to affiliates in tax havens by having them hold intellectual property that is then licensed to other affiliates in high-tax places.
- The problem seems to have worsened over time, perhaps because more firms make money from intangible services, from software to streaming videos.
- The share of American multinationals’ foreign profits booked in tax havens has risen from 30% two decades ago to about 60% today. Most investors and bosses view firms’ tax bills as a black box that only a few lawyers and tax experts truly understand.
- Just one common tax rate: Imagine that there were a single common tax rate. A huge $ 670 bn in paper profits, unconnected to things like factories, would have moved in 2016, almost 40% of multinationals’ foreign earnings. Big Western countries are losers from the current system: profits in America and France, for instance, are depressed by around a fifth. By comparison, havens collect more revenue, as a share of GDP, despite their rock-bottom effective rates. Hong Kong collects a third of its corporate-tax receipts by attracting profits from high-tax countries; Ireland, over half.
- Silicon valley's push: The rise of Silicon Valley has added fuel to the fire. Some governments gripe at giant firms serving customers without any physical presence in their country and while paying no tax. The problems posed by the tech firms are not in fact new: pharmaceutical companies have long held mobile and hard-to-value intellectual property; exporters do not incur tax liabilities where they sell. Still, digital services have become a target. More than 40 governments, from France to India, are either levying or planning to levy digital-services taxes on the revenue of firms such as Amazon, Google and Facebook. The growing sense of anarchy over how to tax Silicon Valley, the global desire to raise more tax revenues and a more conciliatory White House all mean the scene is set for a global deal.
- What lies ahead: An idea is to reallocate taxing rights so that a slice of profits could be levied according to, say, the location of a company’s sales. That right could be incurred even if the company had no physical presence in the country. Mr Biden’s negotiators have proposed a reallocation that would apply to the 100 biggest and most profitable companies worldwide; in return, the Biden administration wants all the digital-services taxes to be dropped. So India would suffer. The second element would apply a minimum rate of corporation tax, putting a floor on the race to the bottom. The Biden administration wants a global minimum tax rate on foreign earnings of 21%, applied to profits within each jurisdiction separately.
- Summary: Problem lies with assessing the location of sales made by one business to another, if it then goes on to make sales in a different country. The European Union wants to go ahead with a digital levy regardless of the outcome at the OECD. Many tax havens may resist higher minimum tax rates that eliminate the advantage for companies of booking profits there. Any deal will involve compromises. What if countries cannot agree? America will forge ahead with reforms to its domestic taxes, including provisions that could unilaterally increase the tax load of American subsidiaries of foreign companies that pay low tax bills globally. Digital-services taxes could spread like wildfire, incurring American tariffs in retaliation. But taxes are bound to rise.
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