Multinationals: Three useful contributions to ‘the great tax debate’

“Multinationals and ‘the great tax debate’” is the title of a 30-page paper that was tucked inside my copy of Tax Journal last week. It is a useful contribution to the debate on the taxation of multinationals – whether or not you agree with its conclusions. It was written by John Watson, who retired last year after 35 years as a tax lawyer in the City of London.

The paper was published by LexisNexis, a division of Reed Elsevier, and is available on the Tax Journal website.

Last week Maya Forstater flagged a discussion paper titled “Profit Shifting and ‘Aggressive’ Tax Planning by Multinational Firms: Issues and Options for Reform”, published by the Centre for European Economic Research (ZEW) based in Mannheim, Germany.

Both Watson and the ZEW provide background information that is accessible and useful for non-tax people who need to understand the problems that have given rise to the OECD’s project on base erosion and profit shifting, as well as the possible solutions. I mention just a few key points here.

(I would also recommend Andrew Jackson’s series of blog posts on unitary taxation. Yesterday he considered the use of sales as a factor in the proposed apportionment of global profit.)

Solutions

Watson concludes that “the existing transfer pricing system should be left as it is, with the current OECD guidelines being preferred to a general move to unitary tax”, although in a discussion on unitary taxation he does point out that basing the tax charge on a group’s consolidated accounts is “not quite as radical as it might sound”.

Tax authorities “should not hesitate to use a profit split [in arriving at a transfer pricing adjustment] where it is the most appropriate method”.

Watson also suggests that opportunities for tax avoidance could be reduced by unifying tax rates.

Last year the House of Lords economic affairs committee suggested that “a destination-based cash flow tax could dramatically reduce the scope for profit-shifting and tax rate competition between countries”.

Watson writes: “The reasons why a jurisdiction might wish to tax profits ultimately funded by sales to its residents, even where those profits are generated elsewhere, are not wholly quixotic.”

He suggests “practical reasons” for a destination based tax, including:

“The non-taxation of a company’s profits means that it needs a lower pre-tax return to justify its shareholders’ investment, giving a commercial edge over fully taxed competitors. Once one group selling to a jurisdiction sets up operations in tax havens, others may find it necessary to do the same in order to maintain a level playing field.”

He says it is “difficult to see how a destination based tax on profits can be substituted for source based taxation unless the new regime is universal”, but “the possibility of a destination based top up tax is well worth considering further”.

This top up tax proposal occupies six pages of the paper and looks very complex. Watson says compliance would be expensive, so the tax would be charged only where a group’s sales to consumers resident in a country exceeded a substantial threshold, eg. £100m.

The ZEW paper describes “arrangements for [intellectual property]-based profit shifting which are used by the companies currently accused of avoiding taxes” and suggests that “preventing this type of tax avoidance is, in principle, straightforward”.

The authors Clemens Fuest, Christoph Spengel et al argue that in the short term, policy makers should focus on extending withholding taxes. “Other measures which are currently being discussed, in particular unilateral measures, like limitations on interest and license deduction, fundamental reforms of the international tax system and country-by-country reporting, are either economically harmful or need to be elaborated much further before their introduction can be considered”.

For “the longer perspective” the authors recommend investigation of “more fundamental approaches” such as a destination-based cash flow tax or CCCTB (the common consolidated corporate tax base, a proposal for unitary taxation within the EU).