Here’s an interesting chart. Do you notice anyone missing? Interestingly, the United States is considerably less keen on signing tax treaties with developing countries than you might expect, given the amount of investment from it to, well, most places. Its only treaty with the whole of sub-Saharan Africa is with South Africa. When I looked in the wikileaks cables (of which more another day) it’s clear that many more developing countries want tax treaties with the US than get them.

Countries with the most tax treaties with developing countries

Source: IBFD data

I can think of a number of reasons for this. Perhaps colonial ties have bumped up the number of treaties signed by countries such as France and the UK. Perhaps the US system of deferral encourages the use of intermediate jurisdictions to structure investments, which in turn reduces the demand for direct bilateral agreements. When I asked people who know about what goes inside the US Treasury, they tend to cite limited civil service capacity as the main constraint, but I don’t get the feeling that the US has a lot less capacity than anywhere else.

The other thing I’ve heard, which sounds more plausible (or at least more interesting), is that in the US, tax treaties have to be ratified by a two-thirds majority of the Senate, and that can be a rocky ride. There are currently several treaties pending, Senator Rand Paul having made an issue out of the US-Swiss treaty. The Senate has been known to reject elements of tax treaties, including for example anti-abuse clauses in treaties with Italy and Slovakia. You can see the level of detailed examination in this report of the Senate Foreign Relations Committee.

It’s not just the US, however: the French senate rejected a proposed tax treaty with Panama a few years ago. This level of control must surely drive treaty negotiators mad, and I can quite imagine it acting as a brake on negotiations (though not, it seems, in France, which is at the top of the chart above). But surely it’s in everyone’s interests for the legislature to interrogate international tax instruments before they become law, rather than afterwards, as has happened with the Public Accounts Committee in the UK?

Well, speaking of the UK, I took a quick look at what happens here. Tax treaties are first scrutinised by the House of Commons’ delegated legislation committee, before being passed without a debate in the full house. So what does that scrutiny committee do? It turns out they have a nice little chat and then everyone votes in favour. For example, how long did it spend on 29 November 2010 considering six treaties with Belgium, the Cayman Islands, Georgia, Germany, Hong Kong and Malaysia? 25 minutes. Hungary, Armenia, Brazil, Ethiopia, and China on 1 November 2011? 25 minutes. Bahrain, Barbados, Singapore, Switzerland and Liechtenstein on 5 November 2012? 28 minutes.

In all cases, the treaties are passed with cross party consensus, perhaps in part because many were negotiated when Labour were in power. To be fair, there is a small amount of probing. When the treaty with Switzerland is discussed, a couple of backbenchers raise tax avoidance issues, while not at any point appearing to question the treaty itself. And there is this exchange during the 2011 session:

The Exchequer Secretary to the Treasury (Mr David Gauke): [...] The hon. Gentleman raises a number of detailed questions. Let me try to address them as best I can. His first question is part of the tradition of these debates, which is to ask how much will be saved and what the financial benefit is of these agreements. It is part of the tradition, because it is a question that I asked on several occasions, and, whoever has been standing in the Minister’s position, the answer has consistently been the same: it is not possible to give a precise number for the revenue effects of these agreements—or indeed of other double taxation agreements. The overall cost or benefit of an agreement is a function of the income flows between the two countries, and the agreement itself is likely to change both the volume and nature of those flows by encouraging cross-border investment. It can be somewhat difficult to make any predictions about the impact of any one agreement.

Clearly, there is consensus on the point that it is in the UK’s interest to have an extended number of double taxation agreements, and the fact that we have such an advanced set of agreements is one of the advantages that the UK offers to international—multinational—businesses, but, as I say, it is not possible to identify particular sums.

Owen Smith: I fully accept the Minister’s point about the difficulty of prospectively projecting precise revenues, but does he feel that taken together these agreements—the Chinese one in particular—are revenue-positive for the UK?

Mr Gauke: I can go so far as to say that, in the round, these agreements are beneficial to the UK as a place to do business, and that that in itself has revenue advantages, but it is difficult to say whether each individual agreement works out revenue-positive or negative. In truth, it is not a zero-sum game. As with all international trade, there are advantages to being an open, outward-looking economy and to trading with other countries. The UK will benefit from being able to do that, and our advanced set of double taxation agreements will play a role in it.

And that’s the end of the matter. From this brief survey, I can’t tell whether this rather lacklustre scrutiny in parliament is a temporary blip, whether the Labour party are being a particularly compliant opposition, or whether this is how it has always been.

It is, however, more than occurs in many developing countries, where tax treaties can often be ratified by the executive without any legislative approval. That includes India, whose parliament has been powerless to change the controversial treaty with Mauritius. And even in countries where there is a vote, the tax officials I’ve spoken to say it usually descends into mud-slinging about all kinds of tax issues. After all, this is technical stuff that would require MPs to do a lot of homework, and is unlikely to catch the public imagination.

Getting the right balance is tricky. But tax treaties are not just arcane bits of bureaucracy, they’re actual tax policy, setting the tax rates paid by taxpayers and thus affecting the amount of public revenue available, as well as tax equity issues. And that deserves a proper scrutiny.

January was a busy month and so this is my first blog of 2014. I didn’t intend for my comeback to be a self-promotion post, but that’s how the timing has worked out!

Last year I was pleased to be able to work with the U4 anti-corruption centre in Norway on an introductory briefing on illicit financial flows, which has just been published. U4′s main audience is people working for development agencies such as DFID or Norad, and so we wanted to briefly cover all the areas that such people might find it helpful to know about, without assuming any prior knowledge. We tried to offer up an even-handed summary of the different viewpoints, rather than coming down on one side or the other. I’m sure not everyone will think we achieved that even-handed balance, but you can’t please all of the people all of the time!

Also recently published is a short policy briefing by Mick Moore at the University of Sussex on the G8/G20 tax reform agenda and developing countries. He also picks two areas of priority for developing countries to address by themselves, outside these international processes: tax incentives and property taxes.

One point that both papers make is about the lack of coherence in developed countries’ tax policies. Mick says this:

experience suggests that the governments of the economically and financially powerful OECD countries will behave ambiguously. They find it relatively easy to close some international tax loopholes by pressuring jurisdictions that have little geo-political clout, like Ireland, Luxembourg, Switzerland, and tiny Caribbean tax havens. They are less likely to accept limits on their own capacities to attract investment and ultra-rich tax immigrants by granting tax ‘incentives’ of many kinds. Virtually all governments compete heavily for investors and investment, and are willing to forego quite a lot of their potential tax revenue in the process. While the British Prime Minister has been promoting the G8/G20 tax reforms, the UK Treasury has continued actively to develop new tax ‘incentives’, such as reduced corporate taxes on income attributable to intellectual innovation, to attract capital from abroad.

Whereas in the U4 paper we put the point as follows:

it would be paradoxical for a donor government to devote billions of dollars each year to overseas aid when much of this aid is plugging a revenue gap that could be closed through its own tax policies. In some instances, such as the negotiation of tax treaties with developing countries, this is a matter of adopting an enlightened approach to international tax that supports development priorities. In many other cases, however, developed and developing country governments have a shared interest in tackling illicit capital flight. The challenge is to develop sustainable, multilateral solutions that allow poorer countries to use taxation to raise public revenue for investment in economic development, to direct private wealth into productive investments, and to distribute the proceeds of growth fairly.

We’ll all think more about how to do this in the coming year, I hope!

It sometimes feels like, when discussing unitary taxation [pdf], one is expected to self-identify as either a UT advocate, interested in how it could be made a reality, or a sceptic, determined to defend the status quo. I’m neither. As a political scientist, I want to understand (among other things) how our international tax instruments came about, how they affect what individual countries do, and how different actors influence national and international policymaking. These are empirical questions that I think are relevant to the UT debate.

Unitary tax is certainly a case in point for each of these questions. If it really is a better system than transfer pricing, then a political economist would want to explain the persistence of the latter. It seems clear enough that developing countries, when they decide to get serious about taxing multinational companies, head almost automatically down the transfer pricing route. Yet the people making these decisions are often, in my experience, very sharp, with a healthy scepticism of the international tax institutions from which transfer pricing standards have emerged. So have they considered other options? Are their decisions based on legal or economic preference, political calculation, or the hegemonic power of the OECD guidelines? I’d like to know.

There is a tremendous body of legal literature arguing that unitary taxation would be a more effective way to administer corporation tax than transfer pricing. I find this more convincing than the argument for the status quo, as made for example in the OECD guidelines. This seems to boil down a political impossibility theorem: to prevent double taxation there would need to be global agreement on a formula, but this would be impossible, so we should stick to the status quo.

What I find odd about it is that the same surely applies to transfer pricing, and yet there has never been a global agreement on those standards: just an agreement between OECD countries. Everyone should do what the OECD countries do, it seems, not because of its technical merits, but because it would be too difficult to do anything else.

I’ve argued elsewhere that moves in some of the BRICS countries are specifically undermining any notion that there’s an international consensus on the arm’s length principle. What India and China are doing is not, like Brazil, just based on the idea that they have found a better way to approximate the arm’s length price: they seem to argue instead that they are entitled to a larger-than-arm’s length share of taxing rights, because that’s what they consider fair.

If there has been a breakdown in the transfer pricing consensus, and one that leads to double taxation, that substantially lowers the bar for UT: it no longer needs a tight global consensus in order to match transfer pricing. Furthermore, if a debate is opening up over the fair distribution of taxing rights, that’s comfortable territory for unitary taxation, where the debate is articulated clearly over the choice of formula.

In making a judgement about which international tax system is best, we need to ask ‘best in what way?’ I think we can look at it through the classic three-way lens of tax policy valuation:

  • Equity: does it produce a fair (we might say ‘progressive’) result?
  • Efficiency: does it minimise the role of tax factors in shaping economic decisions?
  • Administrability: can it be administered and enforced effectively without imposing too large a burden on taxpayers and revenue authorities?

Looking at one of Sol Picciotto’s recent papers, it seems that his main argument in favour of unitary taxation is an administrability one: under UT there would be less avoidance and evasion than under transfer pricing. (He also touches on the impact of tax planning on economic efficiency, and we could discuss how it affects equity as well). Efficiency is interesting, but I am certainly not able to do the kind of economic modelling that we’d need to predict behaviour change under UT.

But what if we start from equity? There is the question of equity between taxpayers, and in particular how the tax treatment of multinationals compares to domestic firms – a matter of vertical equity. But I am interested in ‘inter-nation equity’. How would (or indeed could) unitary taxation affect the distribution of taxing rights between countries, and in particular between developed and developing countries? Sol’s paper ends on this point:

Some might also wish to see even more ambitious projects for global taxes, which might be used for international redistribution to assist development. Those, however, are topics for another occasion.

To me, this is a political question. Considering how different formulae would change the distribution of taxing rights is the starting point, but you can’t end there: you have to ask what a politically viable settlement would look like. If global consensus is needed, is it possible to imagine one in which developing countries have a bigger share of taxing rights than under transfer pricing? If global consensus is not needed, how are developing countries likely to act? One hypothesis might be that larger, more powerful economies would adopt formulae that maximise their tax revenues, just as they are doing with their transfer pricing standards, while the choice of formula could become a matter of tax competition for smaller countries.

Of course it may not be a zero sum game. If avoidance and evasion are reduced under UT, the overall cake to be divided up would be bigger. In that case, it may just be a question of working out how to divide up the spoils.

My view is that these questions can’t be asked through only thinking about unitary taxation in the hypothetical. Key to determining if unitary taxation produces a more equitable outcome is developing a model of how countries behave in international tax. To do this, we need to study how countries act under the current international tax system – both unilaterally and in international negotiations. Coincidentally, that is what I am trying to do!

PS: on the technical side, I’m also watching the International Centre for Tax and Development’s unitary tax workstream and the unitary taxation project on Andrew Jackson’s blog with interest

 

There are two big ‘policy coherence’ issues when it comes to taxation and the way that development assistance works. The first is the way donors often demand tax exemptions for aid-funded projects. If you think about how aid can be quite a large share of GDP in some low-income countries, these are large sums at stake, so I’m pleased that this is back on the agenda of the UN tax committee.

The second area is the way that development finance institutions (DFIs), which use aid money to invest in private sector projects, often make investments that are structured through tax havens. While DFIs vocally defend this practice, NGOs have been complaining about it for a while, arguing that such structuring is often aggressive tax avoidance, and that it builds, rather than reduces, the role of offshore jurisdictions with respect to developing countries. But NGOs’ position has always been weakened by the absence of an authoritative ‘blacklist’ of jurisdictions to be avoided.

That changed last week with the publication of the OECD Global Forum on Transparency and Exchange of Information’s long awaited peer review results.Here we have a list of four jurisdictions (The British Virgin Islands, Cyprus, Luxembourg and the Seychelles) that are officially ‘non-compliant’ with OECD standards, and two more (Austria and Turkey) that are only ‘partially compliant’.

This put me in mind of a Guardian article earlier this year in which Luxembourg was one of the six offshore jurisdictions through which Britain’s DFI, the Commonwealth Development Corporation, makes its investments. According to that article, “DfID said it will ensure CDC only invests via jurisdictions deemed to have substantially implemented tax standards, according to the OECD global forum on tax and transparency.”

So, what does Luxembourg’s ‘blacklisting’ mean for CDC? Will it cease to invest through Luxembourg? And what of its “new long-term financial commitment” through this country?

A more detailed policy is that of the World Bank’s International Finance Corporation [doc], which states:

IFC will not submit to the Board for approval any new IFC Investment in any IFC Investee Company organized in an Intermediate Jurisdiction, or controlled by an entity organized in an Intermediate Jurisdiction, that has not met international norms for tax transparency by reference to the published results of the Peer Review Process. An Intermediate Jurisdiction will be deemed not to have met international norms for tax transparency if, subject to paragraph 9 below:(i) a Phase 1 review has been completed and, based on a report publicly issued as part of the Peer Review Process, the Phase 2 review is deferred because the jurisdiction does not have in place crucial elements for achieving full and effective exchange of information; or

(ii) a Phase 2 review has been completed and, based on a report publicly issued as part of the Peer Review Process, the overall assessment of the jurisdiction is “partially compliant” or “non-compliant;”

The outcomes of the policy are summarised in the following table:

Summary of the IFC's tax transparency policy

Summary of the IFC’s tax transparency policy

So it seems to me that investments made through those six jurisdictions that were labelled partially or non-compliant in their phase 2 reviews are now off the cards for the IFC. But it also looks from the policy wording like the 14 jurisdictions that did not progress to phase 2 (Botswana, Brunei, Dominica, Guatemala, Lebanon, Liberia, Marshall Islands, Nauru, Niue, Panama, Switzerland, Trinidad and Tobago, the United Arab Emirates and Vanuatu) should also be excluded.

There is some language about how these outcomes can be ‘rebutted’, “if the World Bank Group is satisfied that the jurisdiction is making meaningful progress.” So it will again be interesting to see how the IFC’s policy, which up until now has been largely a theoretical exercise, holds up in practice.

Postscript: If we wind back to the OECD’s classic 1998 definition of tax havens, information exchange is neither a necessary nor sufficient criterion: the core criterion is low tax rates, and then other things such as economic substance requirements and tax treaty networks, as well as information exchange, come into it as secondary criteria. So we can’t say that, by not using these jurisdictions, a DFI would definitely not be engaged in aggressive tax planning or supporting the ‘tax haven’ industry. We don’t have a list for that. But this is a start at least!

Sunday’s Observer carried a story, prompted by ActionAid, based on a presentation given by Deloitte to a group of Chinese investors. The presentation explained how to avoid withholding tax and capital gains tax in Mozambique by routing the investment through Mauritius. It’s great to see this kind of common or garden tax arbitrage highlighted and controversialised.

What caught my eye was Deloitte’s response. The company said:

It is wrong to describe applying double tax treaties, such as the treaty between Mauritius and Mozambique, as tax avoidance. Such treaties are freely negotiated between the Governments of the countries involved.

Double tax treaties exist to enable the countries concerned to strike a balance between the need to encourage investment, including cross-border investment, to raise tax revenue, and to work together with other countries who have the same legitimate concerns to raise revenue and promote business.

The absence of such treaties could result in a reduction of investment, and less profit subject to normal business taxes in the countries concerned.

Any discussion of tax treaties by tax professionals would typically be around the technical and administrative aspects of the treaties and not an expression of favour of any particular country at the expense of any other country.

Leaving aside the questionable empirical basis of the tax treaties-investment link, what interests me is the way the statement completely glosses over the difference between “applying double tax treaties”, and treaty shopping, i.e. structuring investments through an intermediate jurisdiction like Mauritius in order to obtain more preferential treaty benefits. It raises a couple of questions for me.

First, is that obfuscation just a good PR strategy, or is it the case that tax advisers don’t see this distinction as valid? Is advice on tax treaties always aimed at getting the best treaty rates available, with no conceptual (or ethical) difference between a direct investment and one via a tax treaty conduit?

Second, how can we say whether this is tax avoidance or not? At first sight, I’d argue that the intention of the Mozambique-Mauritius treaty is to provide benefits to Mauritian investors in Mozambique, and vice versa, while the absence of a Mozambique-China treaty reflects those governments’ intention that a Chinese firm investing in Mozambique should incur taxes at the non-treaty rates. In that interpretation, tax treaty shopping contravenes the intention of the treaties and is tax avoidance.

But it’s more tricky than that. It’s technically fairly easy to include an anti-abuse clause in a treaty, to spell out this intention. If there isn’t one, it might be because of poor negotiation by Mozambique, or Mauritian unwillingness to renegotiate, but it might also be that Mozambique intends investors from other jurisdictions to use Mauritius as a route to invest, since this reduces the perceived need to negotiate treaties with every potential source of investment. After all, Mozambique only has a handful of treaties, and its Mauritius treaty was signed just after Mauritius adopted the offshore regime that creates the problem. Meanwhile, China is a pretty aggressive negotiator, and those African countries that have signed treaties with China seem to have ended up with less taxing rights than Mozambique has from its treaty with Mauritius. So Mozambique may actually be better off letting Chinese investors exploit its treaty with Mauritius, rather than negotiating a treaty with China. Though it would be better off still in terms of taxing rights if it had neither!

And what about China? It only has a few treaties with African countries, but it does have a treaty with Mauritius. China has foreign tax credits, so the less its multinationals pay abroad, the more revenue it gains (of course a lot of its overseas investment is by state-owned enterprises, and there again, tax savings abroad go straight into government coffers). So maybe China doesn’t see any urgent need to change the status quo. That said, at least half of the African countries with which it has signed tax treaties also have treaties with Mauritius, which suggests a preference for its multinationals investing directly.

One of the main issues in all this is that we don’t know what developing countries intend when they negotiate treaties. To make matters worse, in many developing countries, including (I think) Mozambique, the executive has historically had the power to ratify treaties. So there’s no ‘will of parliament’ to look for, and no public record of any debate among decision-makers. Mozambique’s treaty was signed almost 20 years ago. If my experience talking to officials in other countries is anything to go by, it will be hard to find anyone who can remember how and why this treaty came about. The tax landscape has changed in the meantime, as has the economy, not least with the growth of cross-border services. This would be a good time for Mozambique to review its treaty network.

I’m at the United Nations tax committee annual session this week, where I’ve learnt that I have to be careful what I write here, after a couple of posts from this blog were included in an input document [pdf]. Erk!

I’ve been taking the opportunity to discuss with delegates the recent article [£] by the chief of the UN committee’s secretariat, Michael Lennard, on the inclusion of arbitration in tax treaties with developing countries. Lennard begins from the concern that I’ve raised here too, which is that the BEPS Action Plan implies the use of a multilateral treaty to introduce mandatory arbitration clauses into existing tax treaties.

There are a number of potential problems with arbitration from a developing country perspective, which Lennard outlines, drawing on the experience of investment treaty arbitration. Briefly:

  • the cost of a full blown arbitration could be prohibitive for developing countries, forcing them to capitulate on some occasions, or alternatively stacking the process in favour of more wealthy countries who can afford the most skilled and experienced legal representatives.
  • Because transfer pricing expertise is limited in developing countries, it’s likely that most arbitrators themselves will come from developed countries, in which case their neutrality – or at least their sensitivity to the realities of developing country tax administration – might be questioned.
  • There is a range of concerns about the lack of transparency in arbitration outcomes, which is a problem for scrutiny (I’ve shared before a paper by Alison Christians on this topic), but could also mean that countries and lawyers only have their own experience to learn from, further biasing the arbitration process against developing countries to whom arbitration would be new.

Lennard also talks about a range of ways that arbitration might work better for developing countries. I’m just going to focus on one aspect of this, which is the ‘simplified procedure’ that is used in the UN model’s optional clause. (It’s also known as ‘baseball arbitration’, because it’s used in pay negotiations in the US baseball league).

Under the simplified procedure, the arbitrator doesn’t have to produce her own solution that tries to synthesise the concerns of the two sides. Instead she just chooses between one side’s position or the other.

Delegates I spoke to here said that the analogy with investment arbitration doesn’t hold when the simplified procedure is applied:

  • The costs are much lower, because there’s no need for lengthy meetings, the process demands much less time from the arbitrator, and – so one committee member said to me – you don’t need a lawyer to prepare written submissions.
  • The arbitration tends to move countries’ positions closer together, because it’s an all or nothing outcome, and a more conservative position might be more likely to succeed.
  • The democratic scrutiny point notwithstanding, transparency isn’t such a concern because the arbitrator is only permitted to choose one side, not to explain her reasoning – so there is very little to learn from past experience.

These discussions have certainly changed my thinking a bit, but I’m not sure that it is as clear-cut as those who favour arbitration suggest. In a judgement-based process, as opposed to a purely rules-based one, the quality of submissions is sure to affect the outcome. And it’s inevitable that an imbalance between countries in resources, expertise and experience will translate into an imbalanced outcome. Isn’t it?