A thought on international tax avoidance

[andrewducker]

A lot of tax avoidance strategies* seem to depend on payments from one part of your company to another part of your company, where the second part just happens to be in a low-tax country. Where the company puts their hands up and says "We'd love to pay more tax, but it turns out that Nike (Australia) owes Nike (Denmark) a billion dollars, and so we have to pay that off each month before we see how much left we have as profit."** This is literally how Nike ends up with 2% profit in Australia and 14% in the USA - because it's moving all of the profit to somewhere it doesn't need to pay on it.

So, my thought was this - how about a tax rule which says "If your company owes (or is otherwise paying) money to a foreign company which it owns more than x%*** of then that money is not removed from the balance sheet for the purpose of tax". So it's fine for Google (UK) to pay Google (Ireland) £1,000,000 per month for use of the Google logo - but that comes off _after_ they've worked out how much tax they're paying.

This seemed so simple to me that I thought it must have some kind of negative affect, or it would already have been instituted.

But I've been thinking about it for about three years now, and I can't work out what it is.

So, anyone who understands tax better than me care to tell me what the thing I'm missing which would stop this working is?



*Legal methods of avoiding tax, by following the rules. Different from tax evasion where you ignore the rules. But varies from the generally acceptable (pensions, investing in R&D) to nitpicking through tiny loopholes looking for ways to combine them in a way that the people writing them didn't expect.

**I sometimes see an answer of "Tax them on revenue rather than profit" - but that means that, for instance, a company which buys in £1000 computers and £1000 printers and then sells them combined for £2050 would pay tax on £2050 rather than £50. Seeing as they are legitimately only making £50 on that (less, once you think about other costs they have, like people) that basically makes that company impossible. It also means that a vertically integrated company which makes both the computer and the printer has a massive tax advantage over one which buys in parts and then resells them.

***I'm not sure what X% would need to be to avoid situations like "Our pension fund is invested in the FTSE, and so we own shares of damn near everyone". I'm sure that arguments could go on for ages over that.

Comments

[danieldwilliam]

Re your asterix about the FTSE - there are already rules on what constitutes a group company or a controlled company.

[rhythmaning]

The "tax them on revenues" point is covered by reducing the rate of tax - so that the total value of tax taken is the same.

It doesn't get around the problem of taxing loss making firms, though.

[danieldwilliam]

It's not just a foreign company that it owns. There are parent and sibling companies too.

The main problem with the proposed scheme is that it is arbitrary and unfair.

There are dozens of entirely real and legimate reasons why one group entity might be paying another group entity.

Management fees for services rendered (head office legal and accounting, treasury management, senior management).

Cost of goods actually produced by the other entity and shipped internationally.

Use of intellectual property generated by the payee and used by the payor. Who should profit from the invention of the Dyson vaccuum, Dyson UK or Dyson Malaysia?

What do you do with embedded IP when shipping goods? £100 of metal when properly arranged is a £100,000 motor car. A bucks worth of grape juice when treated the correct way and with a label that promises that it has been treated the correct way is a $100 bottle of champagne.

The problem is more that (probably) logos and trademarks are over-valued for transfer pricing purposes and that tax authorities are reluctant to pursue with vigour people who are stretching the rules.

The logo and trade-mark and the brand that they support are probably worth something. They will have a measurable impact on the profitability of a coffee shop that can probably be easily quantified. The question is how much of that extra value is created in which country.

[andrewducker]

But it means that you're not taxing on value add, but on happening to deal with an expensive thing.

If you buy a computer, put a sticker on it, and sell it on, it makes no sense to tax you on the whole worth of the computer rather than the value you added. And it puts you at a huge disadvantage against the computer company buying the stickers itself, where it would only pay one set of tax and so could undercut you.

(Basically you end up with a tax on "moving things between entities" which means entities can't specialise, which makes the whole system less efficient)

[andrewducker]

Ahhh, so we're back to exactly the argument I'm making above, that we're taxing "moving things from place to place" I'm talking about above. That makes sense.

[danieldwilliam]

Yeah - I think so.

Which doesn't mean that large international companies aren't taking the piss but it's difficult to prove it or to set up transfer rules in a way that doesn't have undesirable side effects or aren't demonstrably on fair on legitimate transfers.

I'd certainly be happy with a rule that there was a withholding tax on royalty payments for trade dress, branding and get up fees. That seems to me to be a set of cases where the economic value of what is being transferred is more likely to be made up.

(And this all presupposes that taxing corporations is actually a useful way to think about tax.)

[jack]

We currently have a bunch of transitions between "small" companies and "large" companies, where lots of regulation only applies to sufficiently large companies, because they can more easily absorb the overhead of complying.

Maybe there needs to be a similar transition between large companies and truly ginormous international conglomerates. One I'm thinking of is that you reach a point where there's an international rate of tax, and countries tax you at that rate even if you claim to be based somewhere else.

[rhythmaning]

I completely agree!

[rhythmaning]

There is quite a bit of "taking the piss" - such as Starbucks transferring ownership of its trade mark and IP to low tax countries to minimise tax on profits arising from that IP.

[pseudomonas]

I think if you take this approach you might risk the opposite problem — where you're punishing companies for not doing all their business within one nationstate — when in practice it's entirely reasonable to do your R&D in one place, your components manufacturing in another, your assembly in a third, and your marketing split across several others. All the apparent revenue is going to be generated in the countries from which things are being sold, but the "value" is generated upstream of that.

It's possible that this is still the lesser of two evils, but it's not obvious to me that this is the case.

[pseudomonas]

That is clearly taking the piss, but if they were prevented, they'd presumably move to other less obvious piss-takes — they alreadly (IIRC) pull the same trick to some extent with coffee beans, buying them from their own outlets in the Netherlands at very high prices.

[danieldwilliam]

There certainly is a lot of it.

But probably much less of it than there is legimate transfers across borders of goods or services between related companies.

[doug]

Have I got your proposal right? Say Company A pays Company B for goods and/or services supplied. There's a substantial tax penalty if Company B is in a foreign country, but not if it is in the same country?

That looks awfully like a trade barrier, and would probably breach WTO rules, and would certainly annoy other countries greatly if they weren't doing the same. If it's not so much about goods and services but about cross-border ownership, that looks like restraints on the free international movement of capital, which are likewise incendiary internationally.

If you can get international coordination, you might be able get round this, but a lack of international coordination is why we have the international tax avoidance dance at all.

[skington]

So the next question is: how much can the EU do in its own? (Assuming that the political will is there to piss off Luxembourg, and the UK if it's still around.)

[drplokta]

The linked article says that Nike is moving its profits from Australia to the Netherlands, not to the USA. Which makes more sense, because the US corporation tax rate is higher than the Australian one.

[drplokta]

The way to make your proposal work is to have an international treaty specifying minimum rates of corporation tax, and restricting the permitted exemptions, and then only tax money transferred by a company to a country that hasn’t signed up to the treaty. That will avoid unfairly penalising companies who have legitimate international transfers of money. But of course it will take longer and be much more complicated to set up.

[pseudomonas]

And Ireland and the Netherlands.

[danieldwilliam]

There is already a minimum rate of corporation tax. It is zero.

The question is how do you tax the ultimate real beneficiaries of the profitable investment if they are located in a different country to the investment.

[doug]

There is already a minimum rate of corporation tax. It is zero.

Yes indeed, although it is also open to municipalities and governments to pay subsidy in cash or kind to companies that they very much want to attract. There are international treaties about this sort of thing (and, notably, a comprehensive set of rules for the European Union on State Aid), but not sufficient to stop it going on across the board.

[danieldwilliam]

To summarise a conversation elsewhere on corporation tax.

Just looking at corporation tax is to miss a larger and more complex picture. It's just one way for a state to tax the economic value that conglomorations of labour, capital, land and technology produce. Corporation tax is badged as a tax on capital. It may be more complicated than that.

States have lots of other taxes they can use to extract revenue as a contribution towards the commonweal or for "payment" towards the upkeep of the society in which that capital is deployed and in which the owner of the capital lives. The can levy payroll taxes, consumption taxes, land taxes, various forms of unearned income taxes, stamp duties, import and export duties, transaction taxes, tolls, fees, dues and so on and so on.

Tax incidence theory suggests that corporations don't pay any tax. They aren't real people. Their wealth or income isn't being diverted to the commonweal or to pay for the upkeep of the state. Corporations only hold wealth on behalf of their owners. The owners are paying the tax. If you dropped the corporation tax rate to zero those owners would pay more taxes on dividends and capital gains. Also, everyone else who traded with the corporation would try and put their prices up. Staff would ask for a pay rise, suppliers for a price increase, customers for a price decrease. All of the changes in the factor prices have tax implications through the other forms of tax listed above. There are clearly issues with where the tax gets paid.

An important thing to keep an eye on is who has power and how are they organising that power? Not just power between the tax authorities and the owners of capital but between the various factors of production when they come to divide the value they have all created.

Two thought experiments.

If you owned a company in the UK but were a tax resident in the British Virgin Isles and the British government increased corporation tax to 90% what would you do?

Who generates more profit, Starbucks or a similar number of independent coffee shops where each of the owners works behind the till and pays themselves a salary as well as a dividend?

[drplokta]

Yes, but a minumum rate of zero is what permits tax avoidance of this kind. My proposed treaty would involve the signatories setting a minimum rate substantially higher than zero.

[drplokta]

This only works within a single jurisdiction. If a company pays low corporation tax in one jurisdiction that has low corporation taxes and high taxes on dividend income, but then pays its dividends in a different jurisdiction where it’s the other way around, then it fails.

[armiphlage]

It's changed! Before 2018, US corporate tax was about 5% higher than Australian tax. Now, if your company makes its money on intangible assets (such as royalties on the Nike logo), AND is incorporated in Delaware, it's actually 4% cheaper than in the Netherlands. I expect this will result in a lot of numbers changing in bank accounts, with nothing actually physically changing in reality .

[armiphlage]

"So, anyone who understands tax better than me care to tell me what the thing I'm missing which would stop this working is?"

The people who would pay the money would just pay politicians to make sure it would never happen.

[armiphlage]

" If you dropped the corporation tax rate to zero those owners would pay more taxes on dividends and capital gains. "

Or they would have the corporation pay to support the owners' lifestyle as a business expense, rather than pay the owners salary or dividends. Business lunches, company cars, board meetings in exotic locales on the company jet, with executive housing naturally provided.

Of course, they're doing that already. Conrad Black went to jail for multiple issues, but the court ruled it was not incorrect for him to write off a birthday party in Tahiti (plus private jet transport for the guests) as a business expense.