Three of the key solutions to global tax dodging are the ‘ABCs’; Automatic Exchange of Information, Beneficial Ownership & a Common Consolidated Corporate Tax Base.
Automatic Exchange of Information (AEI)
Automatic exchange of information (AEI) is a method of data-sharing that prevents both corporations & individuals from using bank accounts they hold abroad to hide the true value of their wealth. By obscuring the extent of their wealth, they pay less tax at home. With AEI, country A will take all of the information it has on person A & corporation A, & if they are normally resident, i.e. living or headquartered in country B, then country A will automatically exchange information on their financial holdings with country B.
The goal of AEI is to increase tax transparency. However many solutions attempt to do this, so AEI is not unique in that regard. The crucial element of AEI however is the automaticity of it; if in place, information is exchanged with the ‘home’ country automatically. This means revenue authorities are alerted immediately about their residents’ (individual or corporate) financial holdings in other countries, & don’t have to engage in lengthy & sometimes expensive negotiations with other countries regarding the release of the financial information.
Today, nearly 100 countries are automatically exchanging information with each other. The information shared covers over 84 million accounts containing a total of $11 trillion. Unfortunately this does not cover all countries. This state of affairs means that money is still flowing to secretive jurisdictions that continue to withhold information on the financial holdings in their country. ‘The Price of Offshore, Revisited’ report looked at 139 low & middle income countries to find details on their unreported capital flows. It found that roughly one third of offshore financial assets can be attributed to so-called ‘developing’ countries; countries in the Global South. Tax transparency is therefore only as strong as its weakest link.
Interestingly, countries that are seen as debtors are actually creditors when capital flight & tax flows are taken into account. Nigeria is classified as a ‘debtor’ country as on aggregate it owes the rest of the world more money than it is owed. However, when the capital outflows from Nigeria are scrutinized, it is clear that it is actually a net-creditor!
What’s more, the lack of complete AEI increases capital flight. The ‘Capital Flight from Sub-Saharan African Countries, 1970 – 2010’ report found that the 33 Sub-Saharan countries covered by this report lost a total $814 billion dollars of taxable income from 1970 to 2010 because of capital flight, for an accumulated capital stock of $1.06 trillion in 2010. This far exceeds their external liabilities of $189 billion, making the region a ‘net creditor’ to the rest of the world. This shows how issues of debt are related to issues of tax.
Global Asset Register & Beneficial Owners
A Global Asset Register has been touted as a tool to create a registry of all international wealth & assets & their real ‘beneficial owners’. A beneficial owner is the human that ultimately benefits from the profit accrued due to the ownership of a company or legal body. The legal owner of a company could be another company (like a ‘shell’ company), or it could be an accountant, or somebody else altogether. This legal owner generally must be registered, however the beneficial owner usually does not have to be registered. Oftentimes, the legal owner may not even know who the beneficial owner is! Financial globalization has made this process opaque, as one company can have another company as its legal owner, & that company can have even another company as its legal owner, & so on, obscuring the beneficial owner(s) via a long & complex chain of legal ownership. This makes it very difficult to track & tax profit, & ensure that no laws are broken throughout the chain.
The crux of beneficial ownership is that the beneficial owner must be a human. By requiring beneficial owners to be registered just like legal owners, beneficial ownership registration laws make sure the wealthiest are held to the same level of transparency & accountability as everybody else. However, because of the nature of global capitalism & the ability of capital to move freely across borders, this won’t work for everyone unless all countries register beneficial owners. Until that happens, profits will continue to be able to be relocated to the place most amenable to paying low or no tax by those who wish to hide their identities from the rule of law globally. In order for this to work effectively, governments must drop the threshold from owning 25 percent of shares to owning at least one share in a company, so that true beneficial owners cannot escape being categorised as beneficial owners.
Most countries already have national registries, however these alone cannot account for the assets held abroad. By providing a public & centralised global resource showing who owns what & where, the register would provide a way to record, measure, & understand the distribution of global wealth. This would increase transparency, & give regulatory authorities the power to develop effective tax policies to reduce the exploitation of secrecy jurisdictions.
Common Consolidated Corporate Tax Base (CCCTB)
There are two ways to approach the taxing of a company that operates across multiple borders with subsidiaries nested under a parent company. The first method is via the ‘Arm’s Length Pricing Principle’.
The second is to have a ‘Common Consolidated Corporate Tax Base’; a single set of rules to calculate the taxable profits of companies. The EU is in the process of one within its parameters. With the EU CCCTB, cross-border companies would only have to comply with one, single system for computing their taxable income, rather than many different national rulebooks. The CCCTB seeks to apply a universal tax code for all MNCs operating inside the EU earning in excess of €750m. Companies earning above this threshold will file one tax return for all of their corporate EU activity. The EU claims that the CCCTB will contain robust anti-avoidance measures in order to prevent BEPS to non-EU countries. If so, this will eliminate mismatches between national systems that are exploited by those seeking to avoid paying tax.
Unitary Taxation
A similar method of allocating pre-tax profits is called ‘Unitary Taxation’, & it suggests that governments treat an MNC as one group made up of all its local subsidiaries. This is instead of treating each subsidiary as an individual entity separated from the global chain, which as seen in the transfer pricing example, allows a company to apportion some of its profits to an offshore subsidiary in a lower tax rate jurisdiction.
With unitary taxation, the countries in which sales take place are identified, not just the location of manufacture or company headquarters. The pre-tax profits that the multinational corporation declares as an entire group are then apportioned to each country where it operates, based on how much of its real economic activity took place in that country. The apportionment formula looks at where the sales take place, where employees are, & where the physical assets are. The pre-tax profit is then split into thirds between these three categories. This profit is then taxed in the respective countries accordingly depending on the percentage of the overall sale which that country accounts for. This same process takes place for apportioning the pre-tax profit assigned to ‘employees’ & ‘assets’. With unitary taxation, countries have the ability to set the tax allowances or credits as well as the tax rate & have full transparency over the profits a company makes & in what countries that profit-making activity is supported. All of this greatly increases national agency over tax collection.
Multilateralism at the OECD
Capital mobility & the structure of modern-day corporations with their wide-ranging subsidiaries means that governments must work together to tackle BEPS. The primary goal of institutional reform is to protect fiscal self-determination, or ‘the effective fiscal sovereignty of countries over the design of their tax systems’. However, currently there is no international body governing the rules of tax, although moves have been made in this direction. In 2013, the G20 maintained in its Saint Petersburg Declaration that “profits should be taxed where economic activities deriving the profits are performed & where value is created”. The principle that taxes should track value creation has since been almost universally endorsed. The G20’s Saint Petersburg Declaration is at the very core of the OECDs BEPS initiative which is an effort to align the taxation of corporate profits with value creation & economic activity. The following are two developments to the OCED’s initiative to tackle BEPS, introduced in 2021.
Tax rates differ between countries, & this is called the ‘tax rate differential’. Generally, companies are not taxed on their profits made in a country different to where they’re headquartered, & so this has encouraged companies to keep their profits in low tax jurisdictions. The issue has been summarised by the OECD as follows; “Digitalisation & globalisation have undermined the basic rules that have governed the taxation of international business profits for the past century. Large MNCs are able to earn significant revenue in foreign markets without those markets seeing much, if any, tax revenue as a result”. The OECD reform agreed in July 2021 seeks to, at least partially, reform the global tax infrastructure in order to amend this state of affairs. It has two pillars & will be finalised in October 2021, with implementation from 2023.
Pillar 1: Nexus & Profit Allocation
Under Pillar 1 are included solutions for determining the allocation of taxing rights, & ensuring that they are given to countries even if an MNC does not have a physical presence there; for example with IP. The nexus rule means that for a company to be taxable in a country, it will no longer need to be physically present or a permanent establishment in the country. The threshold of sales to trigger the nexus rule (i.e. the new taxing rights) is €250,000 in countries with GDP lower than 40 billion euros, & 1 million euros in countries with larger revenues.
Under Pillar 1 is also a new formula for profit allocation in order to address issues of economic globalisation & digitalisation. With this rule, if a company sells in a country, it will be taxable in that country. However, there are certain inclusion criteria which determine if this pillar will apply to a company. Under Pillar 1, 20-30% of profits of the largest & most profitable MNCs (above a set profit margin) would be reallocated to the market jurisdictions where the MNC’s users & customers are located. This is similar to unitary taxation.
However the scope of this pillar only applies to MNCs with global turnover above 20 billion euros & pre-tax profitability above 10%. Approximately 100 of the most profitable companies globally will be subject to the rules Pillar 1. These companies collectively make over $500 billion of profit, & a significant percentage of that profit will be allocated between the countries in which they make their sales or the services are provided.
If both of these pillars are implemented, the largest & most profitable companies in the world will pay more taxes where the clients are, in other words where the company’s goods or services are consumed. It is estimated that taxing rights on more than USD 100 billion of profit are expected to be reallocated to market jurisdictions each year.
Pillar 2: Minimum level of tax
OECD negotiations have frequently included discussions on the introduction of a global minimum level of taxation & in June 2021, the G7 finance ministers finally committed to a global minimum tax rate. Under Pillar 2 exists a system to ensure that MNCs pay a minimum level of tax on profits: at least 15% on the profits they make abroad from the country in which their HQ is located. This pillar is an effort to put a floor under the race to the bottom. It does not eliminate tax competition, but it does set multilaterally agreed limitations on it. This move is estimated to generate around USD $150 billion in new tax revenues globally per year. The rate would apply to any company with over EUR 750 million annual revenue.
This will likely have impacts on tax havens. Many studies have analysed how MNCs shift their profits in response to changes in corporate tax rate differentials finding that, on average, if a country increases its corporate taxation by one percentage point with respect to other countries, MNCs will decrease profits reported in that country by around 1% & shift them to other countries with a lower level of taxation. This phenomenon changes depending on whether the tax change happens in a low or high-tax country. It was found that profit shifting is significantly more sensitive to tax rate changes in countries with tax rates lower than the world average, & is less sensitive in countries close to the average. Specifically, they found that MNCs have been found to be 8 times more sensitive to changes in tax rates occurring in countries with a tax rate much lower than the world average & 60% less sensitive to changes in tax rates among countries with similar tax rates.
Criticism
Many African civil society organisations have called for a rejection of the G7 global tax deal hosted by the OECD because firstly, the fact that only approx. 100 companies would be affected under Pillar 1 has been deemed inadequate, & not enough of the company’s profits would be reallocated. Secondly, the proposed allocation of tax revenue under Pillar 2 would be allocated to the countries in which these MNCs are headquartered, which tend to be rich, northern countries which have historically extracted profits from the south. Thirdly, the two-pillar proposal does not progress the establishment of a UN tax body. Finally, the 15% rate enshrined within Pillar 2 has been shown to, at least in three countries, reduce the tax revenues accruing to African countries & so would have impact on certain countries’ ability to service their debt. This is in contravention to the OECD’s claim that “The OECD estimates that on average, low-, middle- & high-income countries would all experience revenue gains, but these gains would be expected to be larger (as a share of current corporate income tax revenues) among low income jurisdictions”. Instead, the members of the network propose that the Minimum Effective Tax Rate (METR) is used instead of 15%, so that the existing debt profile of countries is taken into account.
An ‘inclusive’ framework?
Moreover, in the current system of tax regulation & reform, negotiations take place within a body called the Inclusive Framework which is hosted by the OECD. However, in order to be part of it, countries must have agreed to commit to following the outcome of the 2015 BEPS negotiations. The issue with this is that these negotiations followed an agenda informed by the interests of rich countries. In fact, over 100 developing countries were excluded when the 2015 package was negotiated. There are a number of reasons for this, ranging from a concern regarding BEPS’ ability to genuinely ameliorate the global situation of tax injustice, to the annual membership fee of approximately €20,000.
Additionally, the OECD is officially biased towards its members. According to its founding convention, its mandate is to ensure “the highest sustainable economic growth & employment & a rising standard of living in Member countries”. There are only 38 members, & they are all rich countries. Therefore developing countries would in effect be paying an organisation of which they are not a member. Additionally, although the Inclusive Framework boasts 139 members (including countries & jurisdictions), the picture comes into sharper focus as the nature & type of member is scrutinised. Out of the world’s 195 countries, approx. one third have chosen not to join the IF. What’s more, of the world’s 46 least developed countries (LDCs), 37 of them are not taking part in the IF, equating to four fifths or 80% of LDCs.
Civil society proposal: UN body for global tax regulation
The current global tax system which consists of a complicated web of bilateral trade treaties & differing regulations across regions & countries results in inconsistent policies across the world, leading to the emergence of policy mismatches which are amenable to exploitation by those seeking to dodge paying tax. In this world of globalisation & capital mobility, there remains no international body tasked with ensuring tax rules are applied fairly, making it deeply challenging to regulate this area. A global problem requires a global solution. That is why the Group of 77 (G77), representing more than 130 developing countries, has repeatedly proposed the establishment of an intergovernmental tax body under the auspices of the United Nations (UN) to plug the gaps & fix the loopholes in the global tax system.
Why the UN? The UN is the only global institution where all governments participate as equals, & so it is a good forum to seek to achieve a global commitment to action. Because of this, it is the only body that can legitimately claim to be in a position to create a level playing field. In order for this to happen, all countries must feel that if they change their tax policies, they will not be negatively impacted to the advantage of another country. Otherwise, it will contribute to hesitancy due to the perceived ‘first mover’ disadvantage, whereby more stringent tax policies may simply result in businesses & wealthy individuals registering themselves in other jurisdictions.
A UN tax body would also allow for stronger cooperation between tax administrations, facilitating an increase in transparency via AEI. It would also likely result in governments needing to rely less on unilateral (one-sided) action. It would also contribute to the creation of a better global environment for business due to the increase in certainty regarding policies around the globe, reducing perceived risk & increasing investment. Crucially, it would also likely speed up an end to the race to the bottom, as governments would no longer have reason to fear capital flight due to the existence of lower-tax jurisdictions or more favourable tax policies elsewhere. Additionally, a globally coordinated system of tax regulation is likely to see increased buy-in from governments because, as aforementioned, all governments are equals in the UN so it is unlikely that a government will be hesitant to adopt policies because they are seen to have been created without the participation of said government. What’s more, if the world’s poorest countries were able to participate effectively in the development of global tax rules & standards, they would be able to ensure that the global system also works for their countries.
Negotiations regarding global tax rules impact citizens all over the world, & disproportionately those in developing countries. That is why many suggest that negotiations should take place in a neutral forum where all countries are on an equal footing; as opposed to in the OECD where some countries are members & others are not. What’s more, it is suggested by CSOs that all countries should be allowed to participate in setting the agenda; not just the OECD members & G7 countries.
