Not as simple as it may appear

‘Tax havens’ & tackling tax avoidance by multinationals

« For a country like Mauritius, it might well be a serious advantage to persuade firms to bring their headquarters and central decision-making to Mauritius in case it is claimed most of their gains are generated here. We have yet to see whether corporations will eventually yield to the clamping down upon them by the local tax authorities or whether, as they have demonstrated time and again, that they are capable of shrugging off the latest of the tax clamp-downs on them… »

Governments of the world’s rich countries have for long made strenuous efforts to make multinational companies pay their due taxes in the countries in which their core activities are based. The view has been taken by them that a number of companies avoid taxes – even evade them – by setting up “places of business” in numerous countries. The corporations then shift the tax base to their business units in those countries where they are liable to pay the minimum by way of tax. The governments chasing the corporations qualify such countries as “tax havens” and direct punitive actions against the latter.

The rich countries have often felt that the larger companies were often employing artificial constructions of their structures in order to cheat upon the amount of tax they should have been paying in the places where they are effectively carrying out their activities. This fight between governments and companies in the individual government’s quest to make the latter pay up their fair share of taxes, has been going on over numerous past decades. The companies have always found out lawful devices by which to avoid paying as much tax as the governments wish for.

In 2013, governments of certain other countries joined the ranks of the rich countries in a larger grouping called the G20. The latter commissioned the OECD to make proposals which will deal effectively with huge tax losses when corporations undertake what they have called Base Erosion and Profit Shifting (BEPS). It is estimated that the European Union alone loses a trillion euros each year due to such tax evasion. This work has been going on and a first set of 15 actions has been drawn up by the OECD to tackle the problem.

Basically, the objective is to target the various methods employed by corporations to shift their revenues and expenses among their numerous units in different countries, as a device to deny the governments of the countries in which they actually operate their fair share of contribution to the taxes.

Corporations are usually taxed in their “countries of residence”. They can therefore allocate to one place or another their current revenues and expenses to escape having to pay a huge tax bill, based on the principle that they are liable to be taxed in the country in which they “elect” their residence.

Doubts have been expressed in the light of the OECD’s latest proposed set of actions as to whether those measures will be effective to make corporations book their profits in countries where tax rates are typically high. In this context, it is not clear that the additional documentation that tax authorities in individual countries will call up from corporations having a presence in multiple countries and, also, the seeking after the cooperation of other individual countries’ tax authorities to chase up on this, will be as simple as the OECD recommendations make it out in their proposed solutions.

Overlapping probes in different jurisdictions may make all this extremely onerous and probably not yield what the tax authorities expect from as broad a spectrum of internationally operating corporations such as Amazon, Apple, Google, Microsoft, Starbucks and others. An investigation carried out in 2011 showed that just ten corporations controlled 55% of the global trade in pharmaceuticals, 67% of the trade in seeds and fertilisers and 66% of the global biotechnology industry. This kind of business concentration shows that in this era of globalised corporations, it is not readily seen how easily one can infer independent pricing of inputs and outputs to earmark the taxation of profits neatly in each one of the multiple jurisdiction.

The BEPS might well yield some additional amount of tax revenues to governments that are being denied those revenues due to complex arrangements of production structures made by companies across many jurisdictions with different tax rates. It might. But making things more complex by sorting out through a maze of documentation, as the OECD’s response to the BEPS seems to be recommending, from a diversity of countries in which corporations have a presence, will not be as simple as it may appear.

The world stands a little removed now from a condition in which companies might have been subjected to a system of unitary taxation in one place, no matter all the places from which they put their production together. Such a simplification would have removed loopholes and made corporations amenable to a fair contribution to individual countries’ tax efforts. It makes sense too. You can’t be selling most of your steaks in the UK and earning profits in that location actually but in your financial statements, all these incomes get attributed to, say, Jersey.

The question still remains whether the targeted corporations will take it lightly if governments clamp down heavily on them. For, it should be recalled, those corporations are being served by hordes of tax and legal advisers who have a sense of the direction in which fiscal authorities are moving. Such advisers will act pre-emptively in the well-structured financial centres of the world to avoid having to incur the tax liabilities.

The corporations will accordingly be prepared enough to shun additional tax burdens sought to be imposed on them. The world is no longer the static environment corporations once had to operate in. Business is becoming increasingly more globalized and footloose. Supply chains may be stretching from China to Peru, depending on the advantages firms in the production line can reap from each location.

In the final recourse, countries in which firms declare most of their earnings are actually located, will themselves demand that such firms have more substance in such places in terms of executives, expenses incurred and local decision-making. If this kind of shift actually occurred, there is a risk to the taxing countries that they might lose part of the business base already found in their locations.

For a country like Mauritius, it might well be a serious advantage to persuade firms to bring their headquarters and central decision-making to Mauritius in case it is claimed most of the gains are generated here. We have yet to see whether corporations will eventually yield to the clamping down upon them by the local tax authorities or whether, as they have demonstrated time and again, they are capable of shrugging off the latest of the tax clamp-downs on them.

This episode is still unfolding and one has to wait to see whether businesses will move away from low-cost to high-cost production centres, in answer to the eager taxmen’s call upon them.

• Published in print edition on 9 October 2015