Tax is a hotly debated issue in the run-up to the G8 summit in June 2013, with western media featuring headline news on tax avoidance every day: Starbucks, Google, Apple. The G8 is already providing a stimulus for further international co-operation in the area of tax, but has a crucial opportunity to help reset the debate on tax and development.
Parliamentarians are outraged at the tax avoidance strategies of major businesses, whilst companies cite compliance with government rules or point to their significant investments benefitting countries. Increasing polarisation between business and ‘the public’ is not helpful. Business plays a crucial role in development, in part because of the direct and indirect taxes they bring, but raising corporate tax revenues depends on a positive relationship between state and business. Tax is a key component for developing countries to meet future development goals, so we need to channel the outrage into positive initiatives that can support development too.
Tax evasion, tax avoidance and transfer pricing are amongst a range of international tax issues affecting developed, developing and offshore countries. Large amounts of cash, deposits and foreign direct investment (FDI) are involved. The Cayman Islands (CI) had some US$ 2 trillion worth of portfolio liabilities in 2011; small islands such as the British Virgin Islands and the CI hold 2.5% of world FDI stock, equal to a major European country; several European countries are involved too, for example Luxemburg, the Netherlands, Hungary and Austria channel some 80% of their inward and outward stocks through special purpose entities whose main purpose is to avoid taxation. Moreover, a quarter of UK profits on UK FDI in 2011 was reported in Luxemburg and the Netherlands.
The debates on base erosion and profit shifting paint a rather bleak picture on the future of taxing mobile factors such as capital. So far corporation taxes as a % of GDP have remained relatively stable in OECD countries in the past few decades (although corporate profits have risen), and actually increased in developing countries due to improved tax collection efforts. Nonetheless, tax to GDP ratios are often too low in developing countries to provide for the public goods that are essential for sustained growth and development.
Recognising these challenges, the major international agencies issued a report for the G20 in 2011 on ‘Supporting the development of more effective tax systems’. More recently, the OECD has called for a global action plan on tax to address base erosion and profit shifting. Current tax rules developed in the 1920s need to be updatedto reflect a rapidly changing business environment brought about by globalisation involving transactions based on intellectual property rights and ICT. Corporations have argued for treaties to deal with double taxation, but the bigger risk now is of double no-taxation (e.g. through Double Irish and Dutch Sandwich arrangements). Current tax systems also include an implicit bias towards establishing international companies rather than domestic ones. The OECD’s proposed action plan aims to deal with the tax problems associated with hybrid structures, digital products and services, intra-group financial transactions, transfer pricing (including the shifting of risks and intangibles), and anti-avoidance measures (e.g. Controlled Foreign Company regimes, rules to prevent tax treaty abuse). This is potentially a big and substantial agenda in which developing countries need to have a voice because it affects them substantially – e.g. a move towards territorial taxation (irrespective of whether it will be based on corporation, sales or wealth taxes) from world-wide taxation will have an impact on poor developing countries with a small economic base. Can this be done through a United Nations forum on tax issues?
The G8 has generated a momentum of its own on tax issues which has led to increased co-operation. It now needs to recall the suggestions in the G20 report and provide further momentum to the OECD report to help developing countries. And it can do more.
Prime Minister David Cameron recently called for action in four key areas, on which I assessed the development dimensions during a recent roundtable discussion convened by ODI on the G8 and tax:
- A new global standard for multilateral information exchange –the US Foreign Account Tax Compliant Act, the EU savings directive and bilateral agreements with overseas territories are making a change, but there are significant capacity constraints that restrict benefits for developing countries from a central registry. Greater efforts are needed to ensure that a country such as Zambia can understand better what happens to copper profits when they are passed abroad. In many cases companies already collect country-by-country profits, but they are not compelled to report it in that way.
- Action plans to increase transparency in beneficial ownership (including for ‘trusts’ popular with individuals in Anglo-Saxon tax legislation) – this might help to address tax evasion and avoidance in developing countries if there are units dealing with high net-worth individuals and in the presence of appropriate governance, so again this requires more efforts in developing countries. Increased transparency might also lead to an alternative model in small states that depend on offshore services.
- Reform of global tax rules through the G20 and OECD, e.g. greater country-by-country company reporting on the tax paid in their countries of operation – there are risks and opportunities for developing countries associated with tax changes in the context of new business models with increasing importance and relocation of intangible assets, risk management and online sales functions, all of which affect where profits are recorded and taxed. As G8 countries (including capital exporters such as the US and UK) move towards a territorial rather than a world-wide system of taxation, this is likely to intensify the tax competition amongst developing countries that are capital importers. ‘Spillover’ studies of changes in tax systems are needed, as previously emphasised in the G20 study.
- Improving the ability of developing countries to collect tax – top of the list might be technical assistance to address transfer pricing (in the narrow sense used for commodities, but also in the broader sense valuing intangible assets), but this needs to be seen in the context of work on other issues such as VAT, which is just as important for tax revenues.
The G8 offers an excellent opportunity to reset the debate on tax and achieve a step-change in helping developing countries to raise tax revenues, but a range of measures are required to bring tangible benefits for developing countries.