Taxing globalisation: pay where you earn

OECD look at ways of taxing globalisation as lacklustre intergovernmental attempts fall wide of the mark.

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By Jack Peat, Editor, The London Economic

Globalisation has eroded national sovereignty and the ability of tax authorities to effectively govern corporate revenue, but a recent OECD paper postulating that companies pay where they earn could offer a holistic remedy where intergovernmental attempts have failed.

Tax, like most legal aspects, relies on jurisdictions. But in a world without limits, borders have been eroded and business transactions now flow freely, placing a considerable conundrum in the hands of the tax authorities which have had to watch by as large corporates (legally) exploit the system by making money from making money. As tax is used as a political bargaining tool by governments around the world, market forces of the free economy have been allowed to rein, pushing corporates to stow the most amounts of money in the cheapest places possible.

Why is tax avoidance legal?

Tax avoidance (legal exploitation of the tax regimes) was legalised when countries started to use fiscal means to gain a competitive edge. The Middle East uses low personal tax schemes to plug its labour shortage and small island economies use low corporate levies to attract tertiary sector firms needing little more than a wireless hookup. But in doing so they are opened up to corruption, which is why people own empty houses in Dubai and employ a single accountant in the British Virgin Islands.

Let’s dispel some myths. Competition between companies in a market bears no economic resemblance whatsoever to ‘competition’ between countries on tax. They are utterly different economic beasts. Any other fanciful terms used to describe tax avoidance; ‘tax efficiency’ and the like, are also dressed up terms for illicit cash movements. The main problem is that with hundreds of bilateral tax treaties that have been laid down over almost 100 years, sneaking between the cracks is rather easy for those who have the means to exploit the system.

OECD proposals

Government attempts to solve the international tax dilemma single handedly has lead to a lot of chasing tails and piecemeal legislation that has merely exacerbated the problem. Ahead of the G20 meeting of finance ministers in Moscow,  the Organisation for Economic Co-operation and Development (OECD) released a white paper on tax reform proposals which it heralded a “once-in-a-century” opportunity, here’s why:

Under the proposals, online multinationals with extensive warehouse operations in an overseas country (Amazon) are required to pay local tax on any profits arising from sales in that country. Disclosure of other details will also be enforced in order to promote more transparency and tougher rules to block  transfers of high-value and mobile “intangible” assets – such as brands and intellectual property rights – to tax havens where there is little or no associated business activity will also be brought in.

Countries with tax regimes seen to encourage this sort of behaviour – The British Virgin Islands, Switzerland, Lichtenstein etc – will be required to meet a new benchmark for appropriate taxation of controlled foreign companies, and wider measures to combat predatory tax competition policies (UK’s ‘patent box’ tax) will also be examined. A raft of treaty updates to neutralise the tax advantages of complex financial instruments, schemes and structures, including hybrid capital, interest payment deductions and over-capitalisation should also ensure the clever tricks of rich corporates are no longer applicable.

The fact that countries around the world are trying to stamp out tax avoidance at the same time as lowering fiscal rates to attract new business (with the obvious exception of France) highlights that any solution tackling the roots of the problem will have to come from the top. Taxing globalisation will never be straightforward and there will invariably be leaks, but the OECD report shows we understand the nature of the beast, which will be crucial in stamping it out.

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