It’s hard to pick up a newspaper these days (or, more likely for those reading this, do the digital equivalent) without reading about Apple, Amazon, Google, or a host of others managing, by some magic, to pay little corporate income tax – and the consequent outrage of duly shocked and horrified politicians. Entertaining though all this is, understanding the rules that make such tax avoidance possible is a dull task that many of us are happy to leave to the tax nerds – detail really matters (just ask an international tax lawyer). But the complexity of the underlying tax rules risks blinding us to their wider importance. A recent paper of ours with our colleagues at the IMF (IMF 2014) concludes that these seemingly impenetrable issues are not just fodder for good headlines, but also matter for macroeconomic performance (IMF 2014). And this is especially so for low-income countries – somewhat ironically, since these have been less to the fore in recent news headlines and policy actions. At one level, this further emphasises the importance of the current G20–OECD Action Plan on Base Erosion and Profit Shifting (OECD 2013). But the analysis also points to the need for a deeper rethinking of current tax policy designs – and for a deeper global debate about the international tax architecture itself.
Some macro perspectives
That international taxation matters at the macro level quickly becomes clear from looking at Table 1. Though tax is clearly not the only explanation, the FDI positions shown there are hard to understand without reference to tax arrangements that make several of these countries well known as advantageous conduits through which to route investments. FDI as a ratio of GDP in Luxembourg is, for instance, more than 150 times the world average; and, in terms of its share of global FDI, the Netherlands is the world’s biggest country.
Table 1. FDI stocks relative to GDP – the world’s top five (2012)
Source: Calculations from IMF Coordinated Direct Investment Survey (http://cdis.imf.org/).
Note: Figure shown is average of outward and inward positions. Singapore and Mongolia (for which outward data are unavailable) would enter the top ten if only inward positions were considered.
Looking deeper, the revenue at stake can be large, sometimes very large – especially for developing countries. At the broadest level, they actually have more to lose in that they are more reliant on corporate tax as a share of revenue than are more advanced economies (Figure 1). In the detailed advice that the IMF provides to its members, we have come across cases in which the sums involved are large, not just relative to corporate tax, but relative to all tax revenue – up to 10–15%. And new evidence in our paper (IMF 2014) shows that these patterns are systematic – developing countries are overall much more affected by spillovers from other countries’ tax choices than are advanced economies.
Figure 1. Revenue from the corporate income tax (% of total revenue)
Source: IMF staff estimates.
Notes: Resource-rich counties excluded. Figure shows medians with countries ranked by income per capita each year and divided into four equal-size groups.
Some top issues for developing countries
IMF experience in developing countries also points to some policy issues that are especially important for them. What to do about tax treaties – which generally involve clarifying and ceding some taxing rights in the hope of attracting FDI – is one of the most prominent. Over the past two decades, developing countries have signed a huge number of these (Figure 2). But the evidence on whether they actually affect FDI (plagued by endogeneity issues) is mixed at best. What we do see close up in our country work, however, are sometimes significant revenue losses, reinforced by the ability of multinationals to route and structure their intra-group payments to exploit treaty arrangements. This has for some while led IMF staff to (cautiously) urge caution in signing treaties – a view that is now much more widely accepted and included in the Action Plan of the Base Erosion and Profit Shifting project.
Figure 2. Numbers of bilateral tax treaties, 1975–2013
Source: International Bureau of Fiscal Documentation database.
One other issue, however, is not so prominent. This is the tax treatment of capital gains on the transfer of interest in assets, such as telecoms or mineral licenses – the point being that it may be possible to avoid tax in the country where these assets are inherently located by holding them through a chain of offshore companies, and then selling the claim to a low-tax jurisdiction. This is a supremely nerdy issue. But it is extremely important – over the last few years, this has emerged as a macro-relevant concern in several low-income countries (such as, for instance, Mauritania and Uganda) – particularly (as in these cases) those with large natural resource discoveries. The huge sums mentioned above are instances of this issue. The laws and treaties of many developing countries need strengthening if they are to tax gains on such indirect transfers.
Rethinking the roots of the architecture
The underlying policy issue in all this is one of spillovers – externalities – in international taxation – the effects that, through the ways in which business reacts, one country’s tax decisions have an impact on others. These can take various and sometimes complicated forms. A low or zero tax rate on income arising in a country is only the most obvious route by which one country may affect the tax bases of others. There are plenty of others – network externalities arise from the signing of treaties (if A, which has a treaty with B, signs another with C, that can in effect create a treaty between B and C without any participation or consent from B); and countries can compete over tax bases by granting special regimes for various types of income or activities. The essential policy challenge is to deal better with these. For that, one has to start by looking at the basic architecture of international taxation.
The present framework emerged from the League of Nations, since when the world has been transformed by the growth of intra-firm trade, massively increased importance of services and intangibles (patents and the like), and increased digitalisation (no need any more to pick up that newspaper). All this poses considerable tax challenges. This is now widely recognised, and the ambitious G20–OECD Base Erosion and Profit Shifting Action Plan aims to address many current problems.
Welcome and critical though that project is, it is widely recognised that it will not in itself remove spillovers. And, reflecting both this and concerns with the ‘fairness’ of the allocation of the tax base across countries, there is also now a lively debate on more fundamental reform of the architecture itself. For instance, some have suggested that instead of trying, as now, to use internal transfer prices to allocate a multinational’s profits across all the countries in which it operates, we should simply allocate their consolidated profits by some formula, based for instance on shares of assets, payroll, and/or sales in each. But such formula apportionment involves significant risks of creating new distortions (with plenty of scope for game-playing in manipulating the weights) and (unless sheer labour input is given a large weight) might not benefit developing countries. In some respects more attractive, not least in being closer to where the world may be in effect heading, is the idea of moving toward a combination of arm’s-length pricing on transactions where this is relatively easy (such as for most tangibles) and a formulaic profit split where it is not (such as for most intangibles) (see Avi-Yonah et al. 2009). And there are other suggestions for fundamentally different international tax policies, such as that for destination-based corporate tax, which mimics a VAT but with a deduction for the cost of labour (Auerbach and Devereux 2013).
We do not have a blueprint to offer for a new international tax architecture. What is important now is to recognise that beyond the current initiatives, important though they are, lie deeper unresolved issues that have hardly begun to be addressed. Some of these are technical – understanding whether and when, for instance, offering special regimes for the most mobile businesses may serve to beneficially ease distortions. Some are political – how, for instance, to develop effective institutions for tax cooperation, not least to protect the interests of developing countries, which have so much at stake. The headlines may fade away in a year or two, but the need for more and better-informed analysis and debate can only increase.
Auerbach, A and M Devereux (2013), “Consumption and Cash Flow Taxes in an International Setting”, NBER Working Paper 19579.
Avi-Yohah, R, K A Clausing, and M C Durst (2009), “Allocating Business Profits for Tax Purposes: A Proposal to Adopt a Formulary Profit Split”, Florida Tax Review, 9(5): 497–553.
IMF (2014), “Spillovers in International Corporate Taxation”, IMF Policy Paper, 9 May.
OECD (2013), Action Plan on Base Erosion and Profit Shifting, Paris: OECD Publishing.