Recent events suggest a sea-change on corporate abuse of tax havens. IBA Global Insight assesses whether they will pave the way for meaningful and lasting change.
Addressing the annual meeting of the World Economic Forum in Davos in January, UK Prime Minister David Cameron called for a clampdown on tax avoiders. ‘Individuals and businesses must pay their fair share,’ he said, adding that companies who fail to do this need to ‘wake up and smell the coffee, because the public who buy from them have had enough’.
Coffee? Why would a British Prime Minister, especially someone educated at the terribly British institutions of Eton and Oxford, use such a quintessentially American expression? Aren’t the British supposed to prefer tea? Of course his comments were aimed at Starbucks, the coffee chain that has had so much bad publicity in the United Kingdom and elsewhere over its tax affairs. Analysis revealed that in the last three years, the coffee chain paid no corporation tax at all in the UK, despite making sales of £1.2bn. Over the last 14 years, Starbucks has only paid £8.6m in corporation tax.
In response to this, in December 2012, the campaign group UK Uncut staged over 40 protests across the UK at Starbucks shops. ‘There is genuine public outrage that multinational companies are being allowed to avoid tax while benefits and essential services are cut,’ one protester said. A leaflet distributed on the day called on the UK government to wake up and smell the coffee – a message that appears to have resonated with the Prime Minister’s advisers – and speech writers.
Prior to these protests, Starbucks CFO Troy Alstead had been subjected to aggressive public questioning in the UK by an influential cross-party group of MPs, the Public Accounts Committee (PAC). Representatives of Amazon and Google, who face similar criticism over their tax affairs, were also called in for questioning.
The Committee’s subsequent report branded global firms operating in the UK that pay little or no tax as an ‘insult’ to British businesses. Committee chair Margaret Hodge urged Her Majesty’s Revenue & Customs (HMRC), the UK tax authority, to be ‘more aggressive and assertive in confronting corporate tax avoidance’.
Starbucks subsequently attempted to defuse the situation – and limit the damage to its brand and reputation – by making the rather odd move of agreeing to hand over up to £20m ($31.48m) to the UK government over the next two years. Kris Engskov, managing director of Starbucks UK, announced that the company would pay ‘a significant amount of tax during 2013 and 2014, regardless of whether the company is profitable’.
A further PAC report, released earlier this year, complained that rich businessmen who designed tax avoidance schemes were ‘running rings’ around HMRC. The tax agency is failing to crack down on these schemes, the report said, claiming that they are deliberately marketed to wealthy individuals and cost the government £5bn a year in lost tax receipts.
HMRC should ‘name and shame’ those who are benefiting from tax avoidance schemes, says Hodge – something the authority did just a few days later by publishing a list of names and addresses of ‘deliberate tax defaulters’ on its website. However, this list, which included a hairdresser, a greengrocer and a knitwear manufacturer, was criticised for focusing on small businesses.
What’s a ‘fair share’ of tax?
There have been calls for big companies and wealthy individuals not to avoid tax in many countries. But some point out that there is nothing new here. Roger McCormick is visiting professor at the London School of Economics and a member of the IBA’s Task Force on the Financial Crisis. ‘Aggressive tax avoidance has been common knowledge for many, many decades,’ he suggests. ‘Politicians have grappled with possible changes in the law to try and address the question, but they have not yet really found a solution.’
If the politicians really are that concerned, they should put on their legislative hat and think about whether they should change the law, McCormick says. ‘Tax avoidance is legal. There is no clear borderline between what is regarded as aggressive tax avoidance and what is not aggressive. Where does tax planning – which presumably is legitimate – stop, and tax avoidance start?’
‘The system that operates internationally does allow companies, within limits, to set up companies in their group which are in low-tax jurisdictions and to trap revenue in those jurisdictions’
Visiting professor at the London School of Economics and a member of the
IBA's Task Force on the Financial Crisis
Judith Freedman, Professor of Taxation Law at the University of Oxford, has some of the answers and agrees that the current furore over tax is aimed at behaviour that has been around for a long time. ‘Over the years, tax avoidance has been the frequent subject of parliamentary and media attention, although this ebbs and flows,’ she says.
Freedman co-authored a paper for the Oxford University Centre for Business Taxation (OUCBT), which attempts to define what sort of behaviour can be considered ‘tax avoidance’ and highlights the many legal difficulties that arise from an inexact use of the term. Oversimplifying the debate and searching for individual and corporate villains will not help to solve the underlying problems, the paper says. ‘Even if public naming and shaming influences a few taxpayers in the public eye to impose their own voluntary constraints, it will not necessarily affect the worst avoiders, and may even encourage some non-compliance from those who feel “everyone is at it”.’
The ire directed at Starbucks exemplifies much of what is wrong with the current debate, says the paper. The company has been criticised for not paying tax where it is making sales, but sales are not the basis for the corporation tax, so this alone is no cause for criticism.
‘The system that operates internationally does allow companies within limits to set up companies in their group which are in low-tax jurisdictions and to trap revenue in those jurisdictions by the judicious use of things like royalty payments or payments for the use of a brand and so on,’ McCormick explains.
‘We could argue that the tax base should change, but unless and until that occurs, the fact that there is a high turnover but no taxable profit is not in itself an indicator that the taxpayer is behaving in an unreasonable way,’ say Freedman and her co-authors, Professor Michael Devereux and Dr John Vella.
According to Heather Self, a partner (non-lawyer) with Pinsent Masons, one passage in the OUCBT paper is particularly useful in understanding any debate about paying tax: ‘While concepts of fairness and morality play an important role in any political debate about taxation levels and distribution, in order to ascertain what tax is actually due in a way that is practical and enforceable by society it is necessary to have a legal definition of what is to be taxed (tax base) and at what rate. The answer to those questions must ultimately depend on the law. There is no other way of determining the tax due.’
Self recognises that a General Anti-Abuse Rule (GAAR), which is currently being considered in the UK, may be needed as a backstop measure to protect against agressive avoidance. ‘A lot of people have come round to the view that a focused, narrowly-targeted GAAR could work in practise,’ she says.
‘The Obama administration has made a number of proposals that it continues to support, but, so far, Congress has not seen fit to adopt them’
Cleary Gottlieb Steen & Hamilton
‘However, there’s a lot of concern about whether there will be political pressure for it to be expanded and become much more of a general anti-avoidance rule,’ she adds. ‘That could cause significant uncertainty. It wouldn’t necessarily result in much more tax being collected, but if it makes the UK seem like a capricious tax system where companies don’t know what their tax burden is going to be, that could frighten away genuine economic investment.’
Self mentions the Indian government’s treatment of Vodafone as a case in point. The mobile phone giant is still fighting a retrospective tax charge of approximately $2bn relating to its $11.2bn acquisition of a majority stake in the Indian operations of Hutchison Whampoa in 2007. Many observers claim the dispute has spooked foreign investors, who are nervous of facing large and arbitrary tax demands if they put their money into the country.
One hundred years behind the times
While tax lawyers argue that much of the public anger about tax might not be entirely justified, many also accept that fundamental reform of the international tax regime would be welcome. In this they echo the message of campaign groups like the Tax Justice Network (TJN), which produced a report last year arguing that it is now ‘beyond doubt’ that many of the governing principles underpinning international tax are fundamentally flawed.
The report argues that government proposals for dealing with corporate tax avoidance involve trying to patch up an outdated international system that is beyond repair. ‘We need to move towards a very different way of taxing companies that treats them first of all as a single company and then apportions the profits to the countries where genuine economic activity happens,’ says TJN Director John Christensen. ‘We need unitary taxation, which has been used for many years in the US at state level.’
‘We need to move towards a very different way of taxing companies that treats them first of all as a single company and then apportions the profits to the countries where genuine economic activity happens’
Director, Tax Justice Network
Under this system, multinational companies would be treated as a single entity for tax purposes. Their profits would be determined on a worldwide basis and then allocated to different jurisdictions in accordance with a pre-established formula based on factors such as assets, labour and sales. This should help prevent multinationals like Starbucks shifting profits around the world to reduce their tax bills.
While lawyers accept that this would be no bad thing, they are sceptical about the chances of finding international agreement on it. ‘Whilst clearly providing a number of benefits, it is equally clear that this system raises a number of problems, including difficulties surrounding the design of the all-important formula that will suit all the relevant jurisdictions and not be open to manipulation by taxpayers,’ the OUCBT paper says.
However, the signs this year are that reform is on the way. In February 2013, the OECD published a major report, ‘Addressing Base Erosion and Profit Shifting’, which represented a significant step in an attempt to address the issue. Commissioned by the G20 group of the world’s major economies, it was presented to the G20 meeting held in Moscow in February.
The report notes that the tax practices of some multinational companies ‘have become more aggressive over time, raising serious compliance and fairness issues’. Some, based in high-tax regimes, create numerous offshore subsidiaries or shell companies, each time taking advantage of the tax breaks allowed in that jurisdiction. They also claim expenses and losses in high-tax countries and declare profits in jurisdictions with a low or no tax rate.
‘These strategies, though technically legal, erode the tax base of many countries and threaten the stability of the international tax system,’ says OECD Secretary-General Angel Gurría. ‘As governments and their citizens are struggling to make ends meet, it is critical that all taxpayers – private and corporate – pay their fair amount of taxes and trust the international tax system is transparent.’
The report also says that current international tax standards, some of which are based on principles developed by the League of Nations in the 1920s, ‘may not have kept pace with changes in global business practices, in particular in the area of intangibles and the development of the digital economy’.
For example, it is quite easy now for companies to be involved in the economy of other countries by selling people goods via the Internet, without having a taxable presence in that country. And while companies become increasingly integrated across borders, tax rules have remained uncoordinated, meaning that a number of structures, technically legal, take advantage of the differences between domestic and international tax rules.
The report also takes aim at offshore tax havens, which it says have become global financial centres in their own right and benefited from massive inflows of funds that previously went in tax payments to OECD member countries. Figures suggest that in 2010, Barbados, Bermuda and the British Virgin Islands received more foreign direct investment than Germany or Japan.
Offshore havens don’t just act as a base for multinationals to deposit funds; the funds are recycled for further investment into developing nations. The British Virgin Islands (BVI) accounted for 14 per cent of all investments into China in 2010, second only to Hong Kong (45 per cent). The US trailed far behind with four per cent. Cyprus is the top investor into Russia, with 25 per cent of all foreign investment, while Mauritius accounts for a quarter of all foreign investment into India.
The OECD says it will draw up an action plan in the coming months, developed in co-operation with governments and the business community, which will further quantify the corporate taxes lost and provide concrete timelines and methodologies for solutions to reinforce the integrity of the global tax system. The plan will be put to the G20 in July.
Stuart Chessman, Director of International Tax at Vivendi and Co-Chair of the IBA’a Taxes Committee, believes the development of a global action plan may be significantly more difficult than the reports’ authors seem to think. ‘The implementation of such a plan is not something that can be achieved in the near term,’ he says. ‘It will require changing innumerable domestic tax laws and income tax treaties in most countries.’
In that regard, it’s striking that the report has a dramatically cooler attitude towards the physical presence requirement for nexus in income tax treaties, ‘viewed here as a contributor to the base erosion process,’ Chessman says. ‘After all, the OECD has been for many decades perhaps the main force behind the creation of the current framework for international treaties.’
‘These strategies, though technically legal, erode the tax base of many countries and threaten the stability of the international tax system’
Predictably enough, Taxand, a global organisation representing specialist tax advisors to multinationals, says a harmonised approach to international tax planning entails significant risks relating to ‘double taxation’ for businesses. The European Union’s Financial Transaction Tax (FTT), introduced by 11 EU Member States in February 2013, illustrates the problems chairman Frédéric Donnedieu de Vabres associates with a unitary system. He fears the FTT may disregard long-term inter-country agreements. ‘The complexity of an international system also needs careful consideration,’ he says. ‘The location of taxable profits, or “permanent establishment”, for example, is an extremely difficult area, and one made even more complicated for companies with intangible assets, whose profits are essentially global in nature.’
Difficulties will test political will
While the work may be difficult, the political will to undertake it seems to exist – for now, at least. After the OECD report was published, the finance ministers of France, Germany and the UK sent a joint letter to the Financial Times business newspaper, outlining their determination to deal with tax avoidance.
This determination may have little effect if it is not matched in the US. But according to Leslie Samuels, senior counsel at Cleary Gottlieb Steen & Hamilton in New York, ‘this topic is on the front burner, and the pot is boiling rapidly’.
Samuels became a partner at Cleary Gottlieb in 1975. Between 1993 and 1996, during the first term of the Clinton administration, he served as Assistant Secretary for Tax Policy in the US Treasury Department, and between 1994 and 1996, he was Vice Chair of the Committee of Fiscal Affairs in the OECD.
He notes that in the US, there are now legislative proposals that would involve changing how the country taxes foreign income, particularly the income of foreign subsidiaries. There is also a proposal to deal with intangibles, which have been the focus of a lot of recent discussions, including the recent OECD paper. Those proposals have not been enacted, although the Obama administration is expected to re-propose them when it puts out its next budget.
‘The Obama administration has made a number of proposals which it continues to support, but so far, Congress has not seen fit to adopt them,’ Samuels says.
In early 2012, the administration put out a 25-page ‘framework for business tax reform’ that called for a 28 per cent top corporate income tax rate. The framework proposed a tax rate of no more than 25 per cent for certain domestic manufacturers and a permanent research credit. The framework also called for a ‘minimum tax on overseas profits’. That was the Obama administration’s ‘effort to say that they were willing to discuss corporate tax reform,’ Samuels says.
Congressman Dave Camp, the chairman of the influential House Ways and Means Committee, has also proposed rewriting the US approach to international taxation by creating a territorial system of taxation, in which the US would only tax domestically generated income. The proposal sets up a tax system in which companies would not lobby again for a temporary tax holiday because their overseas earnings would be out of reach of US tax authorities.
Chessman says it’s likely that various proposals will all be considered this year in the US. ‘Whether international tax measures will be adopted that will increase taxes on international operations of US multinationals depends on the nature of the possible overall agreement on the content and economics of the tax reform,’ he says. ‘You also have to keep in mind that multinationals of other countries operating in the US – or potentially subject to tax there – will also monitor this process very closely.’
Although debates about tax avoidance may have generated more heat than light over the years, they may at last be leading to meaningful moves to reform an outdated international regime. It is this outdated regime, rather than the multinationals that benefit from it – sometimes understandably, sometimes questionably – that should be the real focus of campaigns against corporate tax avoidance.
Jonathan Watson is a journalist specialising in European business, legal and regulatory developments, he can be contacted by email at email@example.com