Posted 19/12/2014 by Jaan Murphy
In October, the Senate referred an inquiry into corporate tax avoidance (the Inquiry) to the Senate Economic References Committee (the Committee). The Inquiry will examine tax avoidance and aggressive minimisation by multinational companies operating in Australia. Public submissions close on 2 February 2015, and the Committee will report in June 2015.
A report by the Tax Justice Network shows that of Australia’s largest 200 publicly listed companies, 29 per cent have an effective tax rate of 10 per cent or less, and 14 per cent have an effective tax rate of 0 per cent, well below the statutory tax rate of 30 per cent. Recent media coverage has also highlighted that some multinational companies pay little income tax, despite operating profitable businesses.
Multinational corporation tax avoidance and minimisation practices
Multinational corporation tax avoidance and minimisation are generally achieved through profit shifting to low tax countries or utilising intra-company or related party dealings among subsidiaries. In Australia, it was estimated that in 2009, the volume of related party dealings exceeded 20 per cent of Gross Domestic Product (GDP). Common jurisdictional profit shifting mechanisms include intra-company:
- sale of products and services
- provision of debt financing and
- charging of royalties for the use of intellectual property (IP) rights.
These techniques allow multinational companies to shift revenue to low tax countries and expenses to high tax countries, leading to the reduction of taxable profits in individual countries and a minimisation of the overall tax liabilities of the consolidated entity.
Tax avoidance structures and practices adopted by multinational corporations can be very complex, and can involve exploiting differences in tax rules (residence shopping) and taxation treaties (treaty shopping).
Current multinational corporation taxation legislation in Australia
Both the Income Tax Assessment Act 1936 (ITAA 1936) and the Income Tax Assessment Act 1997 (ITAA 1997) contain anti-tax avoidance provisions. Part IVA of the ITAA 1936 counters arrangements entered into for the dominant purpose of avoiding tax. Specific provisions relating to multinational intra‑company dealings, including transfer pricing, the arm’s length principle and thin capitalisation are governed under Division 815 of the ITAA 1997. Recent legislative reform in 2012-13 was aimed at strengthening the general anti-avoidance rules and implementing an internationally aligned, comprehensive and robust transfer pricing regime.
Difficulties in ‘policing’ tax avoidance
Although tax authorities in many countries impose stringent measures to ensure the genuine commercial nature of intra-company dealings, there are often difficulties in finding truly comparable independent arms-length transactions. These are often caused by the complexity of related party relationships and corporate structures, or the uniqueness of products, services or IP rights involved in intra-company transactions. These complexities significantly impact on the monitoring cost of tax authorities.
Recent international responses to tax avoidance
Organisation for Economic Co-operation and Development (OECD) and G20
In July 2013, the OECD presented to G20 finance ministers an Action Plan on Base Erosion and Profit Shifting (BEPS), outlining 15 clearly defined actions for implementation within a two-year period aimed at improving international tax cooperation and transparency. In September 2014, the OECD released the first BEPS recommendations to the G20, dealing, in part, with model tax treaty provisions.
European Union (EU)
The EU loses an estimated 1 trillion euros tax revenue every year to tax fraud, avoidance and aggressive tax planning. In response, the European Parliament passed a resolution in May 2013 calling for improved intergovernmental cooperation and information sharing, and urging member states to crack down on corporations abusing tax rules and non-transparent and non-cooperative tax havens.
United Kingdom (UK)
In the UK, the Select Committee on Economic Affairs of the House of Lords launched an inquiry into multinational corporation tax avoidance practices in 2013. The inquiry recommended the review of the existing UK corporate taxation regime and the establishment of a joint parliamentary committee to exercise greater oversight of tax settlements with multinational corporations. In December 2014, the Chancellor, George Osborne, announced that the UK Government would introduce ‘a 25% tax on profits generated by multinationals from economic activity here in the UK which they then artificially shift out of the country’, an initiative that is being closely monitored by the Australian Government.
United States (US)
Between 2012-2014, the Permanent Subcommittee on Investigations (PSI) held hearings on profit shifting by multinational corporations, and conducted case studies of Microsoft, Hewlett-Packard, Apple and Caterpillar. PSI’s recommendations included strengthening the tax code on transfer pricing and US participation in OECD multinational corporate tax efforts.
Alternative approaches to taxation of multinational corporations
Many of the proposed approaches noted above focus on combating tax avoidance to improve the existing tax base of company profits. The European Parliament for example, is of the view that ‘broadening already existing tax bases, rather than increasing tax rates or introducing new taxes, could generate further incomes for the Member States’.
One option is to tax multinational companies as a single entity, attributing company profit in individual tax jurisdictions according to a predetermined formula based on turnover, number of employees, or tangible assets in each jurisdiction. However, some argue that this ‘unitary tax’ model relies on global coordination and exchange of information, and hence would be difficult and time‑consuming to implement.
Others believe that the existing company profit tax base is in need of a radical reform and introducing an alternative tax base would be a more effective solution. For example, the UK parliamentary inquiry recommended the examination of a destination-based tax on corporate cash flows, based on a UK Institute of Fiscal Studies review. This model taxes cash sales to customers instead of company profits, and is designed to tackle the challenge of profit shifting (as, unlike profits, a company’s ability to shift its customer base is limited). As a tax base, cash sales are also easier to calculate than profit, potentially reducing monitoring cost of tax authorities and compliance effort of companies. This model also does not require cross country coordination, making it easier to implement than the ‘unitary tax’ model.
* This FlagPost was prepared by Daphne Cockerill, an intern from the University of Canberra.