This month it was revealed 343 Australian and foreign companies had forged secret tax deals with Luxembourg to siphon profits into tax havens to slash their tax bills – some to nearly nothing.
What happens when big multinational companies use the infrastructural benefits of one country to generate income and then park the major portion of that income in another country in order to take advantage of favourable tax laws in that low tax country? The country that actually helps the business to prosper loses their fair share of tax and the country in which the income is parked is rewarded for doing nothing other than being a low tax country. This is not only deceptive but distorts the world economy by placing a disproportionate burden on honest tax payers who end up paying for the infrastructure used by those not paying their fair share of local taxes. It also discourages innovation by removing capital from productive economies whilst it is parked in low tax economies.
Yet, many big brand companies are not afraid to exploit the gaps in these tax laws defending such practices by claiming “they are not breaking any laws.” But these same companies would not get into prostitution even though it is legal in many countries but using the laws permiting prostitution to increase profits would be seen by those same company directors as unethical and disgraceful.
Hense transparency is a good start and exposure of low tax bills in the UK caused Starbucks to agree in 2012 to make £20 million in voluntary tax payments. Citizen outrage on such unethical practices is building momentum for change and has seen Australian Prime Minister Tony Abbott push tax reform to the top of the agenda at G20 meetings this weekend.
Who is paying low or no taxes in Australia?
Amazon’s first Australian accounts declare the online retail giant generated revenue last year of just $1.5 million. But senior Australian publishing figures say the real figure for their local turnover is around $250 million a year, or 166 times the sales figure reported by Amazon. That would make the American retailer one of the biggest players in the Australian book market. After operating expenses of $1.2 million for technology, content and “fulfilment”, Amazon Australia Services paid a tax rate in the US of 36 per cent, or $96,000. The net profit was $170,000.
Amazon EU’s 2009 accounts reported €5.5 billion ($8 billion) of income. Yet Amazon EU only reported profit of €15 million. It paid €4 million tax.
The Australian Tax Office alleges multinational oil giant Chevron used a system of loans and related-party payments worth billions of dollars to slash its tax bill by up to $258 million. Chevron is disputing the tax bill, which could amount to $322 million once penalties are included.
The Australian Financial Review revealed on March 6 this year that Apple had moved more than $8.9 billion in untaxed profit from its Australian operations to Apple Sales International in the last decade.
What makes Profit Shifting Possible?
International tax laws are said to be efficient in ensuring that each country gets its fair share of tax when business is conducted across multiple territories. What then are the causes of such large scale base erosion and profit shifting (BEPS)?
When some wealthy nations started raising their concern about tax erosion, the OECD (Organization for Economic Cooperation and Development) noted that the international tax laws have not kept abreast of the changing business environments. Laws that were set up to ensure multinational corporations would not be taxed in two countries for the same profit have now been used by some of those companies to avoid paying almost any tax in either country.
Transfer pricing is also used to minimize tax. The value of some goods and services sold by one entity to another entity of the same corporation (that are in different locations) are difficult to validate. This provides an opportunity for companies to shift profits to jurisdictions that have favourable transfer pricing laws and low taxes.
Special purpose entities (SPEs) and hybrids are a few of the other favourite approaches used for profit shifting. A SPE is a unit within an organization that may not have a physical presence and usually has few employees. A Hybrid is a technique by which a transactions of similar nature can treated differently in different countries in order to minimize tax.
The expansion of the digital economy blurs geographical boundaries when businesses are carried out – making it difficult to determine the jurisdiction in which the income was generated. The usage of cloud computing systems and business models that heavily rely on intangible assets poses a challenge for international tax laws. It has become necessary to understand how enterprises in the digital economy provide value and make profits.
Beware of unintended consequences
“If we sell coal to Japan, is the profit derived in Australia or is the profit derived in Japan?” said Mr Goyder in the AFR earlier this month, whose company owns some of Australia’s largest coalmines.
“Clearly from our perspective the profit is derived in Australia, and that’s where we pay the tax. But you don’t want complex arguments about the fact that, ‘you know what, some of this profit is derived in Japan’ and that sort of thing.” Said Goyder.
What can be done?
The OECD has proposed an action plan to address the problem of BEPS. The first step is to identify the difficulties that the digital economy has created for the effective application of the international tax laws and develop detailed methods to address these difficulties.
The other important actions proposed by the OECD are:
- Neutralize the effects of hybrid mismatch arrangements.
- Strengthen CFC (Controlled Foreign Corporation) rules.
- Limit base erosion through interest deductions and other financial payments
- Revamp the work of harmful tax practices with the goal of improving transparency.
- Prevent the abuse of treaty.
- Change the definition or PE (Particular Entity) to prevent the artificial avoidance of PE status.
- Develop rules that will prevent BEPS by moving intangibles among group members.
- Formulate rules that will allocate excessive capital to group members or transfer risks among group members.
- Develop rules to control BEPS by engaging in transactions which would not, or would only very rarely, occur between third parties.
- Establish methodologies to collect and analyse data on BEPS, and take actions to address it.
- Require taxpayers to disclose their aggressive tax planning arrangements.
- Re-examine transfer pricing documentation.
- Make dispute resolution mechanisms more effective.
Except for a few, most the above proposed actions are expected to be implemented within a period of two years as BEPS is becoming a highly critical issues. The G20 in Brisbane this weekend is expected to bring about a drastic change in the international tax laws and with the agreement of these country .