Base Erosion & Profit Shifting (BEPS)
Base erosion (diminishing the amount of government revenue accrued via tax by deducting payments such as interest or royalties from taxable profits) & profit shifting (shifting profits to low or no-tax jurisdictions or where there is no or little economic activity by that company) refers to the suite of tax strategies used to exploit mismatches & gaps in tax systems between countries. Developing countries’ higher reliance on corporate income tax means that they suffer disproportionately from BEPS. The first comprehensive view of the cost of profit shifting for governments worldwide found that governments of the EU & developing countries are the prime losers of this shift. Over $200 billion of the $500 billion lost globally due to BEPS is lost from the Global South; more than those countries receive in aid from the Global North.
Close to 40% of multinational profits are shifted to tax havens each year. Based on reports filed by the biggest multinationals to OECD members, the tax lost each year to international corporate tax abuse & private tax evasion costs countries altogether the equivalent of nearly 34 million nurses annual salaries every year – or one nurse’s annual salary every second. The OECD estimates conservatively that 4–10% of global corporate income tax revenue (100–240 billion USD annually) is lost to BEPS.
More recent figures from the Tax Justice Network analysing OECD data track US$467 billion worth of corporate profits shifted into tax havens, leading to a loss of US$117 billion around the world annually. However this is only a collation of data from just 15 countries. By using higher quality data from 2017, the Tax Justice network estimated that profit shifting for US data is likely in the region of $US840 billion, & by extrapolating to the global picture they arrive at US$1.3 trillion a year. Including indirect effects from the race to the bottom, the annual losses imposed by the use of tax havens by MNCs is likely in excess of US$500 billion.
Transfer (mis)pricing, or ‘Creative Accounting’
International regulation requires companies to price goods & services as if they were selling them in the open market & as if they are not selling between subsidiaries. This is supposed to ensure that they are taxed accordingly. This rule is called ‘arm’s length principle’ i.e. goods & services should be sold ‘at arm’s length’. There are valid reasons why transfer pricing exists, for example if a company has a subsidiary in France that makes vinegar & one in Ireland that bottles it, then there are reasons you want to be able to sell between different subsidiaries. However, when this doesn’t take place using the arm’s length principle & instead reduces the company’s declared profits & therefore taxable income, it is called transfer mispricing. Put simply, they sell a resource or item to a subsidiary company at a price different to the market price in order to report lower profits & therefore pay lower tax.
Let’s take an example. Imagine a company’s headquarters is in country A where the corporate tax rate is 35% (of pre-tax profits). They may set up a subsidiary in country B which has a lower tax rate, for example 5%. The company may then tell Country A that their pre-tax profit is lower than Country A thinks it is because in fact, they need to pay the subsidiary to use the intellectual property (IP). For example, on US$1 million pre-tax profits, the company may send $800,000 to the subsidiary in royalties & licensing, drastically reducing the amount of profit on which the higher (35%) corporation tax may be charged; US$200,000 instead of US$1 million. By moving pre-tax profit offshore to a lower tax rate jurisdiction via an IP subsidiary, the company pays significantly less tax overall than it would have done had it not had the option of creating offshore subsidiaries in lower tax rate jurisdictions.
For tangible goods (as opposed to IP) it is very possible to monitor & regulate transfer pricing. But what happens in a scenario where the item(s) traded between subsidiaries have no easy comparison on the market, & so the price can’t accurately be determined? For example, how can the worth of this logo be determined? It can be powerfully argued that much of Apple’s value comes from its reputation, so it does not make sense to compare the value of Apple’s IP to that of a brand new company that has no societal reputation. So then the question arises, at what price should Apple sell their IP to Apple subsidiary companies? This question is becoming increasingly relevant in today’s digitised world, however the rules for monitoring & regulation transfer pricing in the realm of IP have not kept pace with global technological developments. Since for many such transfers no comparable market transactions exist that would allow for an accurate price determination, MNCs will likely continue to be able to manipulate the system for tax purposes until a system for accurately determining market prices in IP exists.
The victims of trade mispricing are often poorer countries where the revenue authorities are often under-resourced & unable to monitor or prove what is happening. The Mbeki Report revealed that African countries lose over $50 billion/year in illicit financial flows (IFFs), transfer mispricing being a significant cause of this. According to research by Action Aid, 20 developing countries could be missing out on as much as $2.8bn in tax revenue from Facebook, Alphabet Inc. (Google’s parent company) & Microsoft due to global tax rules. This is unjust, especially considering how developing countries offer tech businesses new markets, increased global brand recognition & billions of new users’ data, which translate into continuing revenue growth.
Ironically, some of the methods that countries are taking to regain lost tax revenue are in fact affecting the use of apps such as Facebook. In 2018, the Ugandan, Zambian & Benin governments announced or imposed new taxes on mobile internet customers to use certain apps. These taxes, (which are also an effort to protect national telecom industries), are partly a result of the diminished tax base due to the activities of corporate actors.
Secrecy Jurisdictions
The impact of transfer mispricing is compounded by global secrecy & lack of transparency in financial reporting. Secrecy jurisdictions, more commonly known as tax havens, facilitate the opacity of financial holdings & transactions. They allow companies & wealthy individuals to hide assets & so avoid paying tax. Their refusal to share information on these holdings with other countries prevents other countries from knowing if their residents or companies which operate on their shores are holding more assets than declared. In 2015, close to 40% of MNC profits made outside of the country where their parent company is located were shifted to tax havens.
Aggressive Tax Planning
After 4 decades of economic globalization whereby companies have increasingly been facilitated to operate across borders, it is evident that many of these companies have adopted what are known as ‘aggressive tax policies’ in order to avoid paying tax. This has allowed them to lower their effective tax rate to jurisdictions with very low rates & sometimes 0%. These companies are allowed to move their operations, but the citizens of the countries which they deprive of tax are unable to move, & are burdened with consumption taxes to plug the ‘tax gap’.
