I was asked to do on interview on various aspects of the OECD's Base Erosion and Profits Shifting (BEPS) process on Good Friday and actually gave it yesterday. In the intervening three days I had ample time to consider issues over above and beyond the subject of hybrid entities that we were meant to be discussing. Since I have no doubt only a few selected quotes will be used from the interview let me offer some of the broader thoughts here.
First, let's be clear that BEPS is a G20 initiative, not just an OECD one. That means it involves a slightly bigger participating range of countries than usual but for all practical purposes the fact that this work is being done by the OECD in Paris makes this feel like an OECD project and it is not for nothing that the OECD is known as a club of rich nations.
Second, let's be aware that this is meant to provide a global tax solution even though only a subset of all nations that are developing it.
Third, let's be very aware that not all nations are equal when it comes to the OECD. Candidly, there is the USA, maybe the UK, and then there are the rest. Like it or not, if what the OECD comes up with is not Congress friendly, then nothing works. As a result, if the US stamps its foot then everyone jumps. That is massively destructive, not least because Congress is hostile, not least to the OECD. Many right wing Americans think it a profoundly socialist organisation because it produces regulations.
Fourth, let's also note that the OECD has very mixed form. It is completely wedded to the arm's length pricing method of allocating profits between companies within a multinational enterprise even though this makes two absolutely absurd assumptions, the first being that all companies within a group are independent of each other when they very obviously are not and the second of which is that there are comparable prices in the world's market places for any trade undertaken within a group when that is now very obviously untrue given that maybe 70% of world trade is intra-group.
Next, the OECD is opposed to anything looking like formula apportionment of profits between states because that is the alternative to arm's length pricing. The fact that very often this has to, in effect, happen because there is no data to achieve any other result is beside the point: the OECD has a closed mind on this issue.
It has much the same closed mind when it comes to country-by-country reporting although it has been told to address it. That closed mind is because it thinks it feels like formula apportionment.
And the OECD also lives in a time warp when not comes to accounting. That's because arm's length pricing was chosen as the bias for profit apportionment before most countries in the world required multinational companies to prepare consolidated group accounts and as such no one could apportion group profits between states because no one knew what group profits were. The OECD's accounting logic has never, as a result, moved into the post World War 2 era when group accounting became the norm, and the level of accounting illiteracy in the discussions I have witnessed at the OECD has been staggering.
Add all that to the fact that the OECD simply does not have a prevailing philosophy on tax competition and we have a problem. By that I mean that whilst the organisation is supposedly dedicated to making sure that tax is paid once and once only it was in practice for a long time obsessed only with eliminating double taxation and rarely if ever considered the possibility of double non-taxation. That means it is the architect of many of the problems for which it is now supposed to provide solutions.
And then also consider the fact that when tackling tax havens whilst it said these caused 'harmful tax competition' it has never been able to agree if there is a benign form and what that looks like. The consequence has been crippling confusion as states are allowed to undermine each other. The goal of ensuring fair international taxation is compromised as a result with the consequence that the process of base erosion and profit shifting from internationally mobile resources to nationally static tax bases like labour (in particular) has been tacitly encouraged by the OECD. No wonder big business has some liking for it.
Enough of the background to the current problems though: What of the present issues? It seems to me a number of recurring issues are emerging in the BEPS discussions as policy draft after policy draft is rushed out of the various OECD working parties tackling BEPS related issues.
Take the problems of the digital economy. These have been virtually sidelined by saying there is no distinct digital economy. That may be true, but it hardly helps.
And then there are the problems with transfer pricing. However big they are, the commitment is to keep the system, come what may. The US is adamant on this and its will must be done. The same may be true in the digital economy, of course.
Then there is country-by-country, one of the particular issues where the politicians spoke. This suffers the problem of being a tax solution not thought up in either the US Treasury or the OECD itself. It is, as a result, being steadily gutted of all meaningful content as discussion progresses through the OECD. The proposed 15 indicator template is now down to 7. Even then the US is seeking categoric assurances that no one will ever use the data to undertake formula apportionment calculations to see if the profit allocation of a multinational group reflects the likely location of the place where profit was actually earned - even though that is the whole purpose of the exercise.
Then turn to hybrid entities. Apart from the fact that I do not think anyone is happy with the intensely complex draft there is inherent in it the demand that all countries monitor each other's moves on issue. And that's where I begin to get alarm bells ringing which suggest that this whole project is just not going to work.
I have to say they've been present for a whole. The fact that OECD staff have already been saying for months that if only they had more time they might make BEPS work suggests to me they're already making their excuses in advance. And the profession is saying the problem is too complex to solve - as was said to me by someone who should know last week. That's their excuse for saying 'keep the status quo' which suits them too well. The result is that what we're seeing are some fig leaves. There will be a country-by-country template in some form. There will be some changes to arm's length pricing rules - but they happen periodically, anyway. And there will be more information exchange with tax havens, but I'm looking at substance not form when I say I have alarm bells ringing.
In my view an emerging theme is of the impossibility for many nations of achieving the outcomes the OECD is suggesting. So developing countries will not be able to monitor hybrid entity legislation in other states and deal with it, whatever the OECD wants. And nor will many developing countries be able to reciprocate on automatic information exchange as yet and so may be kept out of it. Likewise they can't create sophisticated arm's length pricing teams and have little inclination to do so when then know that however much they invest in them the system does not work and the odds are stacked against them.
Nor does it look as if developing countries will benefit from country-by-country reporting. Moves are being made to ensure that this data only goes to countries with double tax treaties with a group parent company's host nation. Those treaties are few and far between
I cold go on, but what is becoming clear is that, firstly, by refusing to make fundamental reform that is needed the OECD is piling complexity on complexity and in the process is making an already absurd system untenable in many ways.
Second, by heeding big business and the US too much the OECD is ensuring that demands are made of developing countries that they just cannot meet.
Third, and perhaps most tellingly, too much of any supposed benefit from this process is being denied to developing countries for them, in my opinion, to have any real confidence in this process, at all.
It is this last point that is the most worrying as far as I can see. The BEPS process was, at least in part, meant to tackle the enormous problem of tax being stripped out of developing countries leaving them in poverty and long term aid dependency, neither of which could possibly solve their long term economic problems. And now BEPS is beginning to look like it is going to bypass them, either deliberately on issues like CBC or by making demands of them they just cannot meet on information exchange, transfer pricing, hybrids and other issues.
How will they react? That to me is now the biggest and single most important BEPS question in very many ways. If developed countries fail to deliver a tax solution that meets their needs then I can see no reason why developing countries will then continue to play ball with the OECD. We already have Brazil operating its own transfer pricing rules. They are arbitrary in many ways, but they work for Brazil. China is clearly willing to move the same way. And I am sure many others will too. As for hybrid entities, where the corporate aim is to ensure no tax is paid I think the likely reaction is going to be to demand tax withholding at source on any income stream likely to be routed to such an undertaking.
In fact, this to me seems by far the most likely outcome of BEPS right now. The intransigence of the US position, in particular, promoted no doubt to assist the non-payment of tax by its own multinational companies is going to backfire very seriously unless some very rapid rethinking happens very soon.
The appearance of cooperation on tax across the Atlantic may well dissolve: France is gong to be the first to break ranks on that one.
Then a rapid move towards source taxation with deduction of tax in the country of origin appears to be likely in developing countries, I think.
An attitude of take the tax first and ask questions later will, I think, emerge. In some cases that may be exactly the right thing to do.
But what me will result in is a significant risk of double taxation. I am not a great fan of that, any more than I am a fan of double non-taxation which is what we have got. But the US inspired desire, backed by the OECD, to simply tinker with the existing system looks to me as if it will deliver the exact opposite of the desired outcome on international tax reform. We may be heading for international tax breakdown, and that's dangerous because protectionism and other such issues follow on very soon behind.
This will be the almost inevitable consequence of setting an agenda for change and then refusing to deliver it at cost to those who most need it.
I could be wrong, but I am worried. BEPS looks like it is failing vey badly to me. They're already now engaging in 'pasting over the cracks' exercises. The time to address the fundamentals is fast running out. We need to be worried.
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Perhaps some level of protectionism might not be so awful- globalisation seems to be delivering lower wages and destroying employment protection as we rush to the lowest common denominator for the work force and riches for the top 5%.
These multi national organisations appear to be just fig leaf’s for USA control. They have achieved a wonderful way of creating not just an empire but dominance of their hideous values across the world. Perhaps if other countries all left them there would be an opportunity to create something more positive.
There have been a considerable number of postings by Richard recently that I would characterise as laments verging on despair that all attempts to reform the accounting and taxation processes seem to end up chasing their own tails as the rich and powerful states, enterprises, professions and individuals divert them to their own ends. I believe that this posting is merely the most recent example.
I have said it before, and will no doubt say it again until Richard either ‘engages with’ my comments or ceases to accept them, that all attempts to reform accounting and tax processes are doomed by their own refusal to ‘engage with’ the fundamentals; their own refusal to ‘engage with’ the ’causes of the problems’ rather than the ‘effects of the current administrative processes’. More specifically, they are doomed by their own refusal to ‘engage with’ the fact that, irrespective of the administrative alignment of current tax processes, all taxes are already levied in economic terms out of a comprehensive definition of Gross Enterprise Profit; the profit gap between the consume value of the utility created/added/enclosed by enterprises (for which read gross prices), and the disutility of the labour input to enterprises (for which read net wages).
The Abstract to my own analysis of the nature and consequences of taxation processes (which I have offered before) is as follows.
We are all familiar with the seemingly inexorable increase in economic inequality. Keynes’s ‘wealth of nations’ increases, but the increases are ‘enclosed’ by an increasingly-wealthy elite. The wealthy elite have a lower marginal propensity to consume than those less fortunate. They have run out of ways in which to consume their wealth, and simply get richer. The ‘trickle-down’ effect simply fails to materialise. The less fortunate are excluded and marginalised.
Taxation is (or ought to be) the primary mechanism for equitable (re-)distribution of ‘the wealth and income of nations’. Democracy is (or ought to be) the primary mechanism for promoting measures to (re-)form taxation in order to deliver that equitable (re-)distribution. Unfortunately, the secrecy, obfuscation and (spurious) complexity built in to the current accounting and taxation processes pre-empts democratic ‘engagement’. The rich and powerful (and their agents in the accounting and taxation professions) have ‘enclosed’ the debates by default and by FUD (Fear, Uncertainty and Doubt).
This paper uses process re-engineering techniques in an attempt to define from first principles the nature and consequences of taxation, and to define a paradigm and blueprint for the end-game of the campaign for reform of the accounting and taxation processes. It argues that, irrespective of the administrative alignment of current tax processes, all taxes are already levied in economic terms out of a comprehensive definition of Gross Enterprise Profit; the profit gap between the consume value of the utility created/added/enclosed by enterprises (for which read gross prices), and the disutility of the labour input to enterprises (for which read net wages). However, taxes are levied out of that Gross Enterprise Profit in one of two different ways:
1. In the UK at the turn of the millennium, Payroll-Uplift Taxes (on Gross Enterprise Profit) included Income Tax on employee earned income, employee National Insurance Contributions, employer National Insurance Contributions, and Value-Added Tax on the value added through payroll costs. Payroll-Uplift Taxes are levied in proportion to payroll costs, irrespective of the profitability of those payroll costs. Indeed, for an enterprise to break even, that enterprise must be able to charge almost £2 as the gross price for the value added by each £1 of net wages. Thus, Payroll-Uplift Taxes pre empt propositions which cannot create/add/enclose almost £2 of utility for every £1 of net wages, and impose a (relatively) penal rate of tax, and risk of tax-induced loss, on high-employment enterprise.
2. In the UK at the turn of the millennium, Non-Payroll Taxes (on Gross Enterprise Profit Net of Payroll-Uplift Taxes) included Corporation Tax, and Value-Added Tax on the value added through Gross Enterprise Profit Net of Payroll-Uplift Taxes. For the purposes of this paper, the concept of Non-Payroll Taxes also extends to include Capital Gains Tax, Capital Transfer Tax, Inheritance Tax, Income Tax on un-earned income, and Income Tax on super-normal earned income. Non-Payroll Taxes do not distort economic activity. Profitable enterprise remains profitable.
Unfortunately, without global cooperation, productive nations have to compete with tax havens for the divertable tax base (i.e. Gross Enterprise Profit net of Payroll-Uplift Tax), in a downward beggar-thy-neighbour spiral to the point where Gross Enterprise Profit net of Payroll-Uplift Tax becomes virtually untaxable. In order to maintain tax revenue to fund social (re )distribution and communal spending, socially enlightened nations find themselves in a further downward spiral as they have to increase the punitive burden of Payroll-Uplift Taxes on the utility added by a working population shrinking as a proportion of the total population. Thus, contrary to all natural justice and economic efficiency, the effective rate of Payroll-Uplift Tax is almost invariably far higher than the effective rate of Non-Payroll Tax.
However, regardless of global cooperation, each tax regime could implement a revenue-neutral and distributionally-neutral ‘inversion’ of all taxes into the enterprises which create/add/enclose the gross profit from which those taxes are levied. Then, with global cooperation amongst the powerful nations on an increasing minimum effective rate of Non-Payroll Tax, and on measures to exclude tax avoidance and tax havens, each tax regime could implement a revenue-neutral ‘rotation’ of the tax base within each enterprise from Payroll-Uplift Tax to Non-Payroll Tax; to bear more directly and more fairly on the gross profit from which both such taxes are levied.
Thus, this paper goes on to argue that the campaign for reform must develop and maintain a strategic focus on the need to build a global critical-mass agreement to the following:
1. A rising global minimum effective rate of Non-Payroll Tax. By default, implementation in each tax regime should be combined with decreases in the effective rate of Payroll-Uplift Taxes; to be zero-sum in revenue and distributional terms. Eventually, the rising global minimum effective rate of Non-Payroll Tax should rise above the falling rate of Payroll-Uplift Taxes in all tax regimes. Indeed, in many tax regimes (particularly third world regimes), Payroll-Uplift Taxes could be set to zero.
2. Practical measures to allow complying regimes to exclude diversion of tax bases through non-complying regimes:
a. All cashflows (no questions asked) from a bank in a complying regime to a non-complying regime should be taxed as ‘profit’ by the sending bank (at the rising global minimum rate of Non-Payroll Tax).
b. All cashflows (no questions asked) from a non-complying regime to a bank in a complying regime should be taxed as ‘profit’ by the receiving bank (at the rising global minimum rate of Non-Payroll Tax).
Thus, cashflows diverted through non-complying regimes would in fact be double-taxed (at the rising global minimum rate of Non-Payroll Tax) in complying regimes, without challenging the ‘sovereignty’ of the non-complying regimes. If there was no potential to reduce taxes by diverting cashflows through non-complying regimes (and indeed, if there was a certain and substantial increase in taxes in such diversion), the incentive for such diversion would be stopped ‘at source’.
I stand by my previous observations Tim
This does not hang together to me