‘Digital companies’ will not be above the law, says OECD tax chief

An OECD task force has concluded that ‘designing special tax rules for internet companies would not be viable, given the growing digital presence in large parts of the economy’, the Financial Times reported this morning.

The paper quoted Pascal Saint-Amans, director of the OECD’s Centre for Tax Policy and Administration, as saying: ‘The findings are that there is no such thing as digital companies rather than digitalisation of the economy. There may not be therefore a solution for the digital economy but we will need to draw on features of digital economy when we revise the system. Most of the tax planning by these companies will be addressed by this.’

Joel Hills of Sky News put it to Saint-Amans this afternoon that people would read his remarks as suggesting that ‘internet companies operate above the tax system’. Saint-Amans replied: ‘That’s wrong. Actually, what I mean is that the problem of the digital economy is across the board.’

The whole economy had been ‘contaminated’ by digitalisation, he said. ‘We need to be very strong in fixing the system.’

The FT report said HM Treasury had voiced support for the OECD’s stance, calling for ‘common principles’ to apply whether companies operate online or from physical premises.

As I reported for Tax Journal last week, respondents to an OECD consultation pointed out that there was no separate ‘digital economy’. The CIOT said digital businesses were ‘not sufficiently different’ from non-digital businesses to merit a distinct set of rules.

But none of this suggests that the FT’s first sentence – “Proposals for a tax crackdown on digital companies such as Google and Amazon are to be dropped … ” – is a fair summary of what is about to happen.

BEPS debate needs more practitioner input, says former tax lawyer (Tax Journal)

The OECD will have ‘plenty of economic analysis to drawn upon’ during the course of the BEPS project but there is a need for more commentary on practical questions, according to a former City tax lawyer.

John Watson, former head of tax at Ashurst LLP, wrote ‘Multinationals and the great tax debate’, a paper published by LexisNexis and distributed with last week’s Tax Journal.

He noted that ‘rather less material is written from a practical point of view and, in putting together systems designed to limit tax avoidance, it is practical questions which will govern how robust those systems are’.

Read more at Tax Journal.

OECD publishes responses to digital economy paper (Tax Journal)

The OECD has published comments received on its discussion paper on the tax challenges presented by the digital economy. The respondents included Deloitte, the CIOT, the International Bar Association and the BEPS Monitoring Group, which includes representatives of Christian Aid and the Tax Justice Network.

An OECD task force on the digital economy will discuss the responses early next month. On 23 January a live webcast presentation by the OECD’s Centre for Tax Policy and Administration will include an overview of the BEPS project and an ‘update on 2014 deliverables’; the involvement of developing countries; and engagement with stakeholders.

Read more at Tax Journal.

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.)


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).

Taxing multinationals: The trouble with transfer pricing

MailOnline claims to be the world’s largest English-language newspaper website, with 168m monthly global unique visitors, so Christian Aid has reached a potentially very large audience with a comment piece by Joseph Stead on 6 January.

Stead is senior economic justice adviser at Christian Aid. His article focused on the need for greater tax transparency, particularly in the extractive (eg. oil and gas) industries. He acknowledged that there are several initiatives requiring country-by-country reporting by multinationals. He wrote:

“Christian Aid estimates that tax dodging by multinational companies currently robs poor countries of US$160bn a year – far more than rich countries give them in aid. Of course, extractive firms are not responsible for all of this but they account for a high proportion of poor countries’ exports, so they very likely bear a disproportionate share of blame.”

The $160bn estimate drew some criticism on Twitter, and Stead has accepted that “we could do with better estimates”. The figure has been cited several times over the last five years and has been challenged by a (very small) number of tax professionals.

However, it does not include the impact of much of what the OECD calls “base erosion and profit shifting” (BEPS). There will be some overlap. Broadly speaking, Christian Aid’s estimate deals with deliberate mispricing, while BEPS is about the impact of gaps in the international tax system.

In both cases, the current transfer pricing system is a key feature.

Christian Aid’s report “Death and taxes: The true toll of tax dodging”, published in 2008, said developing countries were losing corporate taxes of $160bn a year due to two forms of “corporate evasion”. It added:

“The first of these is known as ‘transfer mispricing’, where different parts of the companies [this is a reference to different companies forming part of a multinational group] sell goods or services to each other at manipulated prices. [The] potential scope of this practice can be seen from the staggering fact that some 60% of all world trade is now thought to take place between global corporations and their subsidiaries. The other, ‘false invoicing’, is where similar transactions take place between unrelated companies.”

Christian Aid said that “these two forms of evasion are estimated to account for about 7% of global trade transactions each year”, and it combined that figure with World Bank figures on the volume of trade, and corporate tax rates, to calculate the implied loss of tax revenues.

That 7% estimate (see table 1 on page 53) is “Ray Baker’s ‘conservative estimate’ that 7% of trade volumes is illicit capital movement, by false invoicing between unrelated parties and by abusive transfer pricing within multinational groups”.

Baker is president of Global Financial Integrity, a think tank based in Washington DC. Its latest study, published last month, found that “crime, corruption, and tax evasion drained $946.7bn from the developing world in 2011”.

Baker’s 7% estimate was published in 2005. It was based largely on 550 interviews with senior executives of trading companies in 11 countries – respondents were assured of anonymity – in order to examine “the amount of mispricing in international trade between unrelated parties”. He wrote in “Capitalism’s Achilles Heel”:

“Mispricing in order to generate kickbacks into foreign bank accounts was treated as a well-understood and normal part of transactions.” He concluded that “thousands of companies provide helpful mispricing services to tens of thousands of their overseas customers in hundreds of thousands of transactions moving billions of dollars into western accounts”.

Moving on to transfer pricing between affiliates (ie. companies in the same multinational group), Baker said he had not done a formal investigation:

“I have, however, observed enough transactions, seen enough exaggerated intracompany (sic) prices, asked enough questions in dozens of countries, and collected and reviewed more than enough trade data to have every reason to conclude that, on a global scale, abusive transfer pricing between affiliated entities greatly exceeds mispricing between unaffiliated entities.”

He took the percentage for abusive transfer pricing to be the same as that for mispricing between unrelated parties in order “to be conservative”.

There is a distinction between deliberate mispricing (ie. lying) and applying a price that is within the range of possible answers that the law provides. The latter is an essential part of the tax compliance process and it may be the subject of negotiation with the tax authorities. But the system is flawed.

The OECD’s action plan is designed to fix weaknesses in the current rules that “create opportunities” for BEPS, which “relates chiefly to instances where the interaction of different tax rules leads to double non-taxation or less than single taxation”. Four of the 15 “actions” deal with transfer pricing.

The first 10 actions address:

  • the tax challenges of the digital economy (and in particular, the allocation of taxing rights between countries);
  • the effects of hybrid mismatch arrangements;
  • controlled foreign company rules (“CFC rules of many countries do not always counter BEPS in a comprehensive manner”);
  • base erosion via interest deductions and other financial payments;
  • harmful tax practices (broadly, preferential tax regimes);
  • tax treaty abuse;
  • artificial avoidance of “permanent establishment” status; and
  • transfer pricing issues including BEPS by (a) movement of intangibles among members of a multinational group, (b) transferring risks among, or allocating excessive capital to, group members, and (c) engaging in transactions which would not, or would only very rarely, occur between third parties.

The OECD has not tried to estimate the cost of BEPS. Pascal Saint-Amans is director of the OECD Centre for Tax Policy and Administration and is leading the BEPS project. There is an issue, he said last summer, but it cannot be measured: “We are not naive and we don’t want to come up with figures.”

But critics of the current “separate entity” approach, which relies heavily on the arm’s length principle for transfer pricing, argue that the whole system is flawed. Some say that a form of unitary taxation – with global profits allocated to tax jurisdictions on the basis of a formula – would eliminate profit shifting.

Sol Picciotto, a senior adviser to the Tax Justice Network, argues that unitary taxation would provide “a more sound foundation for the international tax system, one that matches the economic reality of [transnational corporations] as integrated firms”.

This week Ajay Gupta, editor of Tax Notes International, was looking back to 2013 and declared that “in the light of … multiple demonstrations of dysfunction and decay, we have selected the persisting vegetative state of global transfer pricing enforcement as the international tax development of the year”.

Last October Lee Sheppard, a contributing editor at Tax Analysts, wrote of the “twilight of the international consensus”. This consensus was “intended to permit multinationals to do business in treaty countries while paying tax only on income earned locally through separate entities and permanent establishments”. Sheppard added:

“This limitation of tax jurisdiction is key to the OECD model treaty. Of course, multinationals are vertically integrated and don’t transact with their affiliates at market prices. So an economic philosophy – which appears nowhere in the OECD model treaty – that multinationals should transact with their affiliates at hypothetical arm’s-length market prices was grafted on later.

“It has been an open secret for some time that multinationals – led by the Americans and their huge tax departments – have abused these privileges. The affected countries are no longer limited to corrupt, badly governed, resource-exporting countries. They now include European states with sophisticated tax administrations and the home governments of multinationals. Every country is just another country to be exploited.”

The trouble with the transfer pricing system is that it is based on fiction, but the OECD has claimed that it would be impractical to replace it. The OECD itself said that multinationals “have been able to use and/or misapply [the current] rules to separate income from the economic activities that produce that income and to shift it into low-tax environments”.

Unitary taxation seems, at least, to be based on economic reality. There is a strong argument that the OECD project will not be enough, and that root and branch reform of the system is necessary. And that should involve a long, hard look at the arm’s length principle and whether a different approach – such as a gradual move to unitary taxation – would be better.

Tax transparency alone will not restore trust, warns ICAEW (Tax Journal)

ICAEW’s Tax Faculty has warned that a widespread belief that some businesses can pay less than their fair share of tax can undermine confidence in the tax system. An eight-page paper titled ‘Taxing corporate profits: hard choices’ had not been published on the ICAEW website as Tax Journal went to press, but its author Andrew Gambier posted a link on Twitter on 20 December.

‘Low tax morale damages public finances,’ the paper said, adding that there were ‘good practical reasons’ for taxing company profits. The OECD’s project on base erosion and profit shifting sought to ‘ensure that all business profits are taxed somewhere’. Read more on the Tax Journal website.

Taxing multinationals: Are MPs expecting too much of HMRC?

Today’s Commons public accounts committee report criticises HMRC’s record on taxation of multinationals, but a key element of the report is really addressing an important issue of tax policy that is being tackled at international level.

The PAC suggested in October that HMRC should estimate the tax that would be payable if the international system for taxing the profits of multinationals was reformed.

HMRC defines the UK tax gap (which it estimates each year) by reference to the tax that would be paid if everyone complied with the letter of the law and HMRC’s interpretation of Parliament’s intention in setting the law. Responding to today’s report, HMRC insisted that it can only measure non-compliance with existing law.

Jim Harra, giving evidence for HMRC at a PAC hearing in October, said:

“[HMRC’s estimate of the tax gap] does not include a measure of how much additional tax might be collected if you changed the policy.”

HMRC can and does advise ministers on tax policy, but policy objectives are set by ministers and MPs vote on new tax law and changes to existing law.

Today’s report appears to understate the importance of the current OECD-led initiative to close gaps in the international tax system.

The OECD said last February that such gaps give multinationals an unfair competitive advantage over smaller businesses and “hurt investment, growth and employment”.

Its action plan to tackle “base erosion and profit shifting”, approved by G20 ministers in the summer, listed 15 specific actions to “give governments the domestic and international instruments to prevent corporations from paying little or no taxes”.

One area being addressed is “excessive deductible payments such as interest” – and it is widely recognised that the UK’s tax relief for interest is relatively generous.

The PAC report claimed that HMRC’s tax gap estimate “represents only a fraction of the amount that the public might expect to be payable”.

But what does the public expect? If the OECD’s ambitious project works, some multinationals may well pay more UK corporation tax, but others may pay less.

Now, at least, the PAC seems to have recognised that HMRC can do little at this stage to assess the impact of what may be a major reform of international corporate tax:

“When there are firm plans to change international tax laws to tackle avoidance, HMRC should use this intelligence to assess how much additional tax revenue the changes would generate within the UK.”

These are important issues. But is the PAC the right forum? Its own statement describing its role says this:

“The committee does not consider the formulation or merits of policy (which fall within the scope of departmental select committees); rather it focuses on value-for-money criteria which are based on economy, effectiveness and efficiency.”

IR35: Peers hear evidence from business groups

I wonder where the House of Lords inquiry into IR35 is heading. Peers on the personal service companies committee have now heard from HMRC and representatives of business groups, professional bodies and the Office of Tax Simplification.

Yesterday Martin Hesketh of Brookson, an accountancy firm providing services to contractors and freelancers, suggested that the IR35 legislation should be left alone. Where there was uncertainty, case law was providing the answers.

But representatives of the Federation of Small Businesses and PCG told peers that IR35 was unnecessary. Chris Bryce, chief executive at PCG, said the legislation was now “redundant” and should be abolished.

It is difficult to see IR35 being abolished without a major change in the tax and NIC rules. The continued absence of an NIC charge on dividends provides a major financial incentive for “freelancers” to operate via a company. But in recent years many engagers or “end user clients” have insisted on the arrangement in order to save employer NICs and eliminate the risk of a PAYE enquiry.

My report for AccountingWEB on the committee’s first evidence session last month is here.

My short Storify account of key points from yesterday’s session is here.

The Lords committee’s call for evidence (written evidence is invited by 31 December) is here.

See also Finance Bill 2014: New focus on control to tackle false self-employment.