WordPress can’t make its mind up if this is my 100th or my 101st post. No matter, I thought I’d mark the milestone by telling you all about who you are. So here are some of the key stats for this blog. Page views by country:

Page views by country

Page views by country

Top 5 posts by total views (or “maybe I could have stopped writing a while ago”):

  1. UN transfer pricing manual: what Brazil, India and China do differently (June 2013)
  2. The United Nations Practical Manual on Transfer Pricing: a bluffer’s guide (June 2013)
  3. What will BEPS mean for developing countries? (February 2013)
  4. ABF’s misleading statements (February 2013)
  5. Why the US and Argentina have no Tax Information Exchange Agreement (September 2013)

Words people search for to get here:

Wordle of search terms

Wordle of search terms

A few typical search terms that brought people here:

  • how taxation can help improve growth
  • base erosion and profit shifting wiki
  • do tax treaties increase gdp
  • “name-and shame campaigns”
  • tax havens for venezuelans
  • difference between un and oecd transfer pricing
  • double taxation treaties benefits to developing countries
  • what do professional advisers say on starbucks tax avoidance?
  • ngo tax studies vodafone
  • base erosion profit shifting what do you think?
  • what have uk uncut achieved?

And some less typical:

  • parental products manufacturers in india “leave a reply”
  • “margaret hodge” “politicised”
  • starbucks tax jokes
  • sol picciotto wikipedia
  • starbucks and (tax or taxes or zerga or zergak or падатак or падаткаў or данък or данъци or impost or impostos or porez or porezi)
  • how much are you taxed when you resign from public service in south africa
  • anything new in taxes

Who gets the most traffic from this blog?

  1. un.org (by a long way)
  2. actionaid.org.uk
  3. bensaunderscta.wordpress.com
  4. oecd.org
  5. guardian.co.uk
  6. ft.com
  7. imf.org
  8. green-tax.co.uk
  9. papers.ssrn.com
  10. twitter.com
  11. sbs.ox.ac.uk
  12. taxjustice.net
  13. ictd.ac
  14. lse.ac.uk
  15. storify.com
Democracy in action: David Gauke at Monday's delegated legislation committee session

Democracy in action: David Gauke at Monday’s delegated legislation committee session

On Monday the UK parliament took a total of 17 minutes to scrutinise new tax treaties with Zambia, Iceland, Germany, Japan and Belgium. I’ve complained before about how paltry these debates tend to be, and was all set for another blog along those lines. There was, indeed, much to grumble about. No questions from the opposition about the UK’s renegotiated treaty with Zambia at all, a week after the IMF warned that developing countries should exercise “considerable caution” when entering into tax treaties.

Instead, Labour’s Shabana Mahmood asked how the UK’s treaty making priorities were set, and why there is no treaty with Brazil. The response from the Minister David Gauke was considerably less informative than what I’m sure Mahmood could have found out by asking, say, her colleague Stephen Timms, Gauke’s predecessor.

But something interesting did come up when Gauke was introducing the Zambia treaty. He noted that the withholding tax rates have been reduced in line with Zambia’s treaty with China. And indeed they have. It seems to be China, often regarded as the champion of source state taxation at the UN tax committee, which is responsible for the lower withholding tax rates. I’m going to explain here why I think both the UK and China have questions to answer about these treaties.

The UK-Zambia renegotiation: a missed opportunity

The UK-Zambia renegotiation looks like a ‘balanced package’, meaning that Zambia will have gained and lost in roughly equal measure. Looking at the treaty, I don’t think it can be seen as a win for Zambia.

What it lost was withholding tax rates. Zambian tax on dividends to British portfolio investors will be reduced under the new treaty from 15% to 5%, and tax on royalty payments for the use of British intellectual property will drop from 10% to 5%. This matches what’s in the 2010 Zambia-China treaty [pdf], so it looks like Britain was keen to keep its investors competitive relative to their Chinese competitors.

By way of context, Zambia’s non-treaty rates are much higher, 15% and 20% respectively. We can argue about the economic case for this level of withholding tax, but treaties are not just about rates, they’re about the right to raise rates. It will be five years before Zambia can re-examine these low withholding rates in its treaty with the UK.

What Zambia got in return for the reduced withholding tax rates was the UN concept of services permanent establishment, which will allow it to tax services provided within Zambia by British businesses or individuals. To do so, Zambia won’t need them to have a physical fixed base in Zambia, as it would have done before, but it will need them to be physically in Zambia, furnishing services, for at least 183 days in a given year.

(There are also some modernising changes, which may in practice benefit Zambia more than the UK. This includes simple anti-abuse wording such as the “beneficial owner” clause in the withholding tax articles and a “property rich companies” clause into the capital gains article. It also includes information exchange and assistance in recovery articles. These should be good for Zambia, if it takes advantage of them. The information exchange clause could, for example, allow Zambia to get hold of country-by-country reporting on British companies if that proposal is implemented by the OECD.)

But the overall picture, taking into account the lower withholding taxes, is of a treaty that is still much more disadvantageous to Zambia than one based on the UN model would have been. I’m not even sure it’s a better position than the OECD model. Since Zambia was not nearly as aggressive at negotiating after independence as, say, Kenya, it started this renegotiation from a lower base: already low withholding taxes, no taxing rights over British airlines, limited capital gains tax rights, and no right to tax management fees, to name a few examples.

In a context in which some countries are re-examining their tax treaties with developing countries, and organisations such as the IMF are calling into question the benefit of tax treaties on current terms, there would have been a strong case for the UK to seek not a balanced negotiation, but a reapportionment of taxing rights towards Zambia, in line with the UN model. It’s a real shame that the treaty slipped through parliament on Monday without anyone at least asking about this.

China is driving the falling withholding tax rates

This argument for a more pro-source taxation treaty between the UK and Zambia would be easier to make if the 2010 China-Zambia treaty had been more generous. But in fact the terms of the two treaties are near identical. On the face of it, it seems quite likely that Zambia has been bounced into this renegotiation to help keep British mining, agriculture and manufacturing companies more competitive in the face of competition from China. These companies will benefit from the lower withholding tax rates but are unlikely to be affected by the services permanent establishment quid pro quo.

The IMF report talked about “strategic spillovers” from tax policy, in which one country’s policy pushes other countries towards a response. I’m now starting to wonder if China’s negotiating stance might be having just such a strategic spillover, contributing to the decline in withholding tax rates in treaties also picked up by the IMF. Below you’ll see that China’s treaties with sub-Saharan countries have the lowest withholding taxes in a sample of countries investing into Africa.

Withholding taxes in treaties with sub-Saharan countries, 1973-2012

Withholding taxes in treaties with sub-Saharan countries, 1973-2012

China’s treaties are newer than other countries’, so what if this trend is just an artefact of the general decline? Not so if we look at just the last 20 years, where the story is much the same, with only Mauritius (which has several zero withholding tax treaties) having a more advantageous treaty network.

Withholding taxes in treaties with sub-Saharan countries, 1993-2012

Withholding taxes in treaties with sub-Saharan countries, 1993-2012

Let’s now test whether those three Chinese treaties in Africa are typical of China’s treaties more generally. This time we’re looking at all low-income countries. Not only is China the largest signatory of treaties with this group among my sample, it also emerges as one of the most demanding negotiators.

Withholding tax rates in treaties with low-income countries, 1993-2012

Withholding tax rates in treaties with low-income countries, 1993-2012

Withholding taxes are of course only one part of the source-residence balance in a tax treaty. I took a quick look at the China-Africa treaties, and – aside from the services permanent establishment.- there is no sign that they include pro-source provisions such as withholding taxes on management fees, or a “limited force of attraction”. It’s been well-documented that China favours expansive source taxation in its treaties with outward investors, while denying them to capital-importing developing countries.

The UK-Zambia treaty seems to be an example of a strategic interaction between two countries, one (the UK) with a longstanding investment base in Zambia, and the other (China) posing a threat to that investment. It’s all very well to criticise countries like the UK for not being more generous in negotiations with developing countries, but in doing so, critics should be careful not turn a blind eye to countries outside the OECD, who may even be the ones leading the race to the bottom.

I’m at Allison Christians’ brilliant Tax Justice and Human Rights Symposium. Yesterday I began my presentation, as I usually do, by discussing the link between tax treaties and foreign direct investment (FDI). I wrote about this a while ago, but since then I’ve found some more research on the topic. It’s not as simple as saying tax treaties do, or don’t, attract investment. And here’s why.

The story so far

Until 2009, the considered view was that there’s no strong evidence that treaties affect investment, at least not into developing countries. The state of the art was collected in a book edited by Carl Sauvant and Lisa Sachs. Not one of those studies found a positive effect of tax treaties on investment into lower income countries, while they found a mix of positive and negative effects for investment into developed and wealthier developing countries.

There are some intuitive arguments for why the results might be different for developing countries. Tax competition is likely to be less significant in lower income countries, where getting the basics in place (rule of law, transport infrastructure, etc.) is much more important for investors. And large investors can often negotiate bespoke tax incentives that are at least as generous as a tax treaty would have been.

I’m going to give a quick summary of the newer papers. They all use larger or more detailed datasets than in the past to study how a tax treaty between a pair of countries in their sample affects bilateral FDI flows between those countries. I will explain at the end why I think this is the wrong way to ask the question.

New papers using aggregate investment data

Fabian Barthel, Matthias Busse and Eric Neumayer, in 2009 [pdf]  found a solid, positive effect of tax treaties on FDI stocks in developing countries, in the region of 30 percent. The main innovation of that paper was to use a more comprehensive set of bilateral FDI data purchased from UNCTAD, and it did seem to make a difference.

Using similar data but a range of different techniques, Arjan Lejour in a recent paper finds that a tax treaty increases FDI stocks between the signatories by 21 percent. He also finds that treaty shopping exists, but doesn’t attempt to quantify how much it contributes to the increase in FDI stocks.

New papers using firm-level microdata

The other papers all use more detailed microdata on the level of individual firms. These data have a couple of strengths. First, they allow us to rule out treaty shopping. Aggregate FDI data generally captures the first link in the ownership chain, as demonstrated by the prominence of tax havens as sources or destinations of investment, when in fact they’re mere conduits. But the microdata tell us the home country of the investor and the final destination country of the investment.

Second, microdata allow the studies to draw a distinction between effects on FDI at the ‘extensive’ and ‘intensive’ margins. Essentially this means the difference between an effect that encourages new companies to invest in a market for the first time (extensive), and an effect that encourages existing investors to put more resources into a market (intensive).

There are four papers. The first, in 2009, was by Ronald B Davies, Pehr-Johan Norbäck and Ayça Tekin-Koru, using data on Swedish firms’ investments abroad. Then in 2011, Peter Egger and Valeria Merlo did the same with German microdata. In a very recent paper, Bruce A. Blonigen, Lindsay Oldenski and Nicholas Sly made use of similar data from the United States. Julia Braun and Daniel Fuentes have also looked at Austrian companies, although they didn’t have access to the same level of detail.

This spread of home countries is important, because it helps to eliminate some of the natural biases in the data, although I think some still remain. To my mind, only the Swedish paper gives us a convincing answer for developing countries: the US only has one treaty with sub Saharan Africa; Austria didn’t sign many treaties with lower income countries; the German FDI data only covers 51 host countries, with a bias towards larger economies and not a single African country.

All these studies agree that tax treaties have effects at the extensive margin, although the effect is not huge. For Swedish firms, a tax treaty increases the likelihood of establishing an affiliate in a country by a small but statistically significant amount – from 0.6% to 0.7%. The German study concurs (its figures vary depending on the variables used). It also includes the effect of the corporation tax rate, and finds this to be much more important. As for the Austrian data, there is more likely to be Austrian investment in a country if there is a tax treaty.

The evidence is less clear at the intensive margin. The German and Swedish studies don’t find a significant effect, while for Austria a treaty does seem to mean a larger number of Austrian-owned FDI projects. This is where the US study comes in. Its main insight is that treaties might affect different sectors differently. It finds that a tax treaty increases both the number of new entrants into a market (the extensive margin) and the volume of sales by a given affiliate (the intensive margin), but only for some firms.

The authors suggest that the attraction to multinationals of a tax treaty is the Mutual Agreement Procedure (MAP), through which countries can settle disputes about who gets to tax them in certain circumstances. Without a treaty, in the event of a dispute the company will most likely be taxed by both countries, because they have no mechanism to resolve it.

They employ a clever test. Internal trade within some firms is dominated by ‘homogenous’ goods for which a price can easily be found, and so (they argue) determining the transfer price will be a relatively uncontroversial affair. The MAP is unlikely to be invoked, and a treaty is not so important. In contrast, firms trading in ’differentiated’ products are more likely to want a treaty to be in place, because pricing these goods is a more subjective business.

This chart illustrates this finding. Three years after a tax treaty with the US comes into force (t0), there’s a big increase in the share of activity in the treaty partner by US companies dealing in differentiated goods, compared to those dealing in homogenous goods.

Relative Foreign Affiliate Activities across Treaty Status and Time

Source: Blonigen et al 2014

Why I’m not yet convinced

I said I’d add my own thoughts on this data. Well, to begin with, there’s still the old ‘endogeneity’ question. Do treaties lead, or follow, surges in investment? Studies tend to deal with this by lagging the data by a certain number of years (they ask how much investment there was in, say, year t+1 when a treaty was signed in year t – Lejour’s paper uses time lags as long as six years). From my own research, I know that treaties are often intimately linked with particular large investments: a company planning a big investment will lobby for a treaty. Firm-level microdata should be particularly sensitive to this kind of process. But if the investment decision-making and the treaty lobbying are happening simultaneously, it’s impossible to use the chronological sequencing to untangle whether the treaty influenced the firm’s decision, or whether the firm had already made up its mind to invest.

But the more important point is this: what’s the policy-relevant question? Based on these papers I feel comfortable saying that tax treaties do influence bilateral investment flows. A treaty between A and B is likely to increase investment from A into B. But B doesn’t want more investment from A particularly, it just wants more investment. My own research leads me to believe that tax treaties are often instruments to make firms from A more competitive in B relative to firms from C, D or E. If that is the case, B needs to be sure that any new investment stimulated by a treaty doesn’t simply come because firms from A are outcompeting those from C, D and E; investment from A should be additional to, rather than at the expense of, investment from those other countries.

So actually we want a more blunt study: the effect of signing a new treaty on aggregate flows of investment into a country. The only study to date to have examined this is by Eric Neumayer back in 2006. He found that treaties had no effect. So if we combine this with the studies discussed above, the evidence seems to support the idea that tax treaties change the composition of home countries investing in a country, but not the overall volume of investment. If that’s right, then the answer to the policy-relevant research question is no, treaties don’t attract investment.


 

NB: It’s worth adding in an additional outcome from the Swedish study. Davies and Norbäck didn’t find any effect of tax treaties on the size of investments (intensive margin) but they did find that a tax treaty caused firms to export less back to their parent companies, and to import more inputs from their parent companies; these effects were stronger for affiliates that didn’t trade with the parent company as their main purpose. They interpret this change as profit shifting, which they argue is because the affiliate incurs a higher effective tax rate once the host country is able to gain information through the tax treaty. I find that interpretation hard to stomach: if firms are taxed more with a treaty in place, the whole argument for treaties would seem to have been turned on its head. It’s a puzzling finding.

In January, the UN tax committee sent out a call for submissions [pdf] to the update of its transfer pricing manual. The subgroup working on this update will be drafting additional chapters on intra-group services, management fees and intangibles, all topics that greatly interest developing countries and civil society organisations grouped around initiatives such as the BEPS monitoring group.

So who made submissions to the UN consultation? Four private sector organisations, two academics, the World Bank and the Chinese government. Not a single NGO. Meanwhile, considerable effort has been expended by civil society groups in drafting submissions to and reports about the OECD’s BEPS process, lamenting how issues of concern to developing countries are likely to be left by the wayside.

I think this is a pretty strange prioritisation. Why focus all your energies on a process that you suspect is not going to deliver results for developing countries, and ignore entirely a process with a specific mandate to do so? I debated this a bit on twitter earlier this week with, among others Alex Cobham of the Centre for Global Development, who told me he considered it “self-evident that BEPS is relevant to developing countries’ tax base in a way that UN Transfer Pricing Manual may not be.” (We were also discussing automatic information exchange, which I’ve discussed before).

I don’t agree with Alex on the detail. But let’s consider this from first principles. How do (or should) NGOs prioritise their campaigning resources? I suppose the equation is something like:

Importance = 1. Magnitude of potential impact x 2. Likelihood of success + 3. Effect on long term balance of power

In the short-to-medium term it’s important to take into account both the size of what is at stake and the capacity of civil society groups to influence it. But there’s a long term dynamic too that means it may be strategic (unstrategic) to work on something that is unlikely (likely) to succeed in itself but will contribute towards (undermine) a long term strategy.

When I ask them, NGO folks often suggest that they don’t want to prioritise the UN because it scores low on all three counts. That is:

  1. It’s just a talking shop, without the same influence as the OECD
  2. In any event, the UN’s track record shows that the OECD countries have got all the decisions sewn up
  3. And in the long term the UN would be too unwieldy and bureaucratic a forum to be a viable home for international tax politics

I’m going to try to explain why I think this calculation is wrong.

1. It’s just a talking shop, without the same influence as the OECD

Both the OECD and the UN are soft law bodies when it comes to tax treaties and transfer pricing. They set standards in the form of model treaties and guidelines, but these have no binding effect on countries unless they choose to use them in treaty negotiations and in their domestic transfer pricing rules. This applies to the outcomes of OECD deliberations just as much to those of the UN. (Nothwithstanding the OECD’s proposal for a mutlilateral convention to implement the treaty aspects of BEPS, which will presumably be offered as a fait accompli to developing countries, including negative as well as positive aspects for them).

To influence the distribution of the international tax base, then, you need to influence bilateral treaty negotiations and national lawmaking. When it comes to treaty negotiations, at the level of standard-setting you can do two things: influence the developed country position (the OECD model) and influence the developing country position (the UN and regional models). The former will be harder, but will it have a bigger potential impact than the latter?

As I mentioned in my post a couple of weeks ago, a recent IBFD study shows that, where the model treaties diverge, the OECD model seems to be used more often than the UN model, which seems like a logical outcome of differentials in negotiating strength. So before even looking at how the model treaties might be changed, the best outcome for developing countries is surely to increase the prevalence of UN model provisions in negotiated treaties. In any event, the UN model is by no means ignored. Some of its most distinctive provisions, such as the services permanent establishment and source state taxation of royalties, have been adopted quite widely..

Turning to transfer pricing, you might remember that the first edition of the transfer pricing manual created some waves. This was mainly because of its inclusion of a annex on the ‘country practices’ of China, Brazil, India and South Africa, which emphasised their points of dissatisfaction with the OECD’s predominant transfer pricing guidelines. It is perhaps too early to see how influential the UN manual will be.

Accept for a moment the view, propounded by NGOs and sketched out in Chapter 10 of the UN manual, that OECD transfer pricing rules deprive developing countries of tax revenue because of enforcement troubles and an inherent bias towards countries that can capture the intangibles and high-value services. In that case an official document written by government officials discussing these issues and articulating alternatives is clearly very useful. Some people have suggested to me that the authors of Chapter 10 might be using it mainly as a tool to influence the OECD, but on the other hand there’s definite interest in its content from developing countries. South Africa indicates in its contribution that it is considering some aspects of the Indian and Chinese approaches.

2. In any event, the UN’s track record shows that the OECD countries have got all the decisions sewn up

I realised last October that although OECD members are in a minority on the UN committee, once you include the G20 members who are full partners in the BEPS process, the figure rises to 16 out of 25. And many of the individuals in key positions on the UN committee are the same people who represent their countries in the relevant OECD committees. So it would appear that for the UN to articulate any kind of alternative to the OECD, some of these people would need to set aside narrow national interest. Cynics feel that this is unlikely.

And yet the UN is doing alright. In the face of stiff opposition from a number of developed countries and the private sector, it’s ploughing ahead with a new article in its model treaty giving source countries the right to tax technical service fees. Developing countries often want such an article included when they negotiate, and they’re more likely to get it if it’s in the UN model.

I noted above that the UN’s transfer pricing manual is quite critical of the OECD approach, if only in its annex. Early plans for the manual proper had included greater divergence from the OECD approach, including discussion of fixed margins and formulary apportionment. During the drafting process these points were largely eliminated or relegated to the aforementioned annex.

If NGOs feel let down by what they see as the timidity of the UN committee, they might do well to study how their own (lack of) engagement in processes like this contributes to the outcomes in which they express disappointment. Having sat in on several sessions of the committee, I’m in no doubt that when matters like this come up for debate they stand or fall on the strength of feeling among the committee’s members, who in turn listen to the views of lobby groups. Business groups certainly think so, as evidenced by their submissions to the transfer pricing manual consultation.

If UN committee members were being lobbied at committee meetings, held to account in their home countries, and barraged with written submissions, all on the basis of a coordinated and specific agenda such as NGOs have developed for BEPS, the outcomes really would be different. That more confident exploration of unorthodox approaches proposed for the UN transfer pricing manual, for example, might well have made it into the final draft.

3. And in the long term the UN would be too unwieldy and bureaucratic a forum to be a viable home for international tax politics

I have less to say about this, because my experience of the UN is limited to the tax committee we have today. Most international relations theories accord power to international organisations in their own right, not just the sum of their members. An organisation’s power might come from its technical dominance, by exerting social pressure as monitoring reports from the OECD and IMF do, and through agenda setting, which is also a power that NGOs have. How much attention NGOs show towards an international organisation most certainly affects that organisation’s capacity to set the agenda, and its authority to speak about developing country issues.

It’s only one part of a bigger picture, of course, but nonetheless, development NGOs’ propensity to engage in media battles with Pascal Saint-Amans, and to attend OECD meetings in force, even if making critical comments, reinforces the idea that the OECD is where the action is for developing countries too. Of course the OECD can make technical reforms that help developing countries, but, since international tax is also about political settlements, I think it’s a strategic error to focus the overwhelming share of NGOs’ resources there at the expense of the UN.

“Revenue is the chief preoccupation of the state. Nay more it is the state”
- Edmund Burke

I spent the weekend with some old friends from the development sector. One of them, it now turns out, is working for a public relations consultancy. There was an awkward moment when I explained that I was working on international tax and my friend asked, with a sheepish grin, whether I was following BEPS. We were both following it from, well, different angles.

The most interesting moment in our conversation came when my friend mentioned clients’ fear of the ‘Margaret Hodge effect’. I can understand that, I thought. No company wants to see its executives thrown to the wolves in the Public Accounts Committee. But I had misunderstood.

“What my clients are concerned about,” said my friend, “is political interference in corporate tax policymaking.” I found this quite startling. Is it possible that businesses consider corporate tax policy to be a matter for private negotiations between them and the government, rather than the subject of public (and even parliamentary) debate as part of the government’s budgeting process?

The UK’s corporate tax regime has been dramatically overhauled over the last ten years, with a plummeting corporation tax rate and vast swathes of the multinational tax base exempted. This is a serious structural change in our tax system, yet there’s been barely a peep about it in public debate. And we continue to sign tax treaties, with only a cursory discussion in parliament each time. The public attention is only ever caught by the ex post impact of policy decisions in the tax returns of multinational firms. Hence why Pfizer’s bid for Astrazenica, and not the policy reforms that encouraged it, has been front page news.

I had this in mind as I read Oxfam’s new briefing paper on “Why corporate tax dodgers are not yet losing sleep over global tax reform” and Duncan Green’s blog post discussing it. Oxfam’s entry into the tax justice campaign has brought some fresh and interesting perspectives, and this is no exception. The paper argues that developing countries are unlikely to benefit from BEPS, for two main reasons:

Firstly, the business lobby currently has a disproportionate influence on the process, which it uses to protect its interests. Correcting the rules that allow the tax dodging practices of global giants like Google, Starbucks and others that lead to tax revenue losses in OECD countries will be difficult, given the size of the corporate lobby. But worse, perhaps, is that the interests of non-OECD/G20 countries are not represented at all in these negotiations.

It goes on to analyse the contributions to OECD consultations to demonstrate the overwhelming contribution from wealthy countries and business organisations. The paper calls for a three-pronged solution:

  1. Fully engaging non-G20/non-OECD countries in BEPS decision making
  2. Working towards a World Tax Authority to improve governance of international tax, along the lines proposed many years ago by Victor Tanzi.
  3. Widening the scope of the BEPS Action Plan to incorporate tax competition concerns, the redistribution of taxing rights, and reconsideration of the arm’s length principle

Oxfam, like other development NGOs, is keen to fix the problems it has observed with the OECD’s way of doing things. It is looking to change international institutional arrangements as a way of achieving this. The paper’s only real discussion about what happens at national level concerns “helping developing countries strengthen their fiscal administrations.”

This is all important stuff, but it’s missing something: a strategy to increase political engagement with corporate tax policymaking. International institutions can shape countries’ preferences and strategies, but the decisions they take (and maybe even the ways they work) are still products of the different positions taken by their member states. National politics matters.

If, as Oxfam argues, the business lobby has a disproportionate influence at the OECD, that influence won’t only be exerted at international level: it must also be applied inside the member states, who ultimately make the decisions at the OECD council. Is it wise to open up the source/residence debate within the BEPS process, as Oxfam proposes, when businesses favour reduced source state taxation? There is certainly a case for re-examining the political settlement at the heart of international tax institutions, but the outcome of such a process will surely follow the distribution of power among its participants.

If, as Oxfam also argues, developing countries are not participating in the decisionmaking, that isn’t just because the space for them is limited. It is also because they aren’t making the most of the opportunities available to them. Many of the UN tax committee’s most developing country-friendly initiatives in recent years have been led not by its developing country members but by members from OECD countries putting themselves in developing countries’ shoes, or by members from emerging economies whose interests do not always coincide with developing countries. That’s fine so long as international tax is a technical exercise, but an inclusive political process would cast these conflicts of interest in sharp relief.

Developing countries’ failure to take advantage of the opportunities that are already available to them can be seen in the tax treaties they have negotiated, comprehensively studied in an IBFD report for the UN tax committee [pdf]. Many significant clauses from the UN model treaty, which would confer on developing countries greater taxing rights, are absent from most of the tax treaties signed by developing countries. There are some examples in the chart below. I don’t know (yet) why developing countries often get such poor outcomes, but what happens in bilateral negotiations would surely occur in international negotiations too.

Use of UN model provisions in tax treaties between OECD and non-OECD countries

Source: IBFD for UN tax committee

Duncan Green situates the BEPS process in the later stages of the “Policy Funnel” (below), when “the technical content gets greater, and the chance to mobilize the public declines.” But corporate tax policy has been at that end of the funnel since the 1920s. The aim should be to drag it back towards a public debate.

The Policy Funnel (Source: From Poverty to Power)

The Policy Funnel (Source: From Poverty to Power)

What Oxfam is proposing would lead to an even larger technocratic tax community at international and national levels (a world tax organisation, and more tax authority capacity in developing countries). That may well be necessary. But what we need even more is for politicans and the public in each country to hold the technocrats to account. It seems to me that this can be done more effectively by beginning at the national level, looking at domestic tax rates, tax incentives, and tax treaties. Until that happens, I don’t think that the politicians of developing countries will pay enough attention to BEPS or anything of its ilk to get stuck into the politics and shift the centre of gravity of international corporate tax policy.

I haven’t blogged for a while, having been away, and as other bloggers will know, it’s all about getting the momentum going. But Tuesday’s announcement by the Irish government, news of which came via Christian Aid’s Twitter feed, has spurred me into action!

Ireland has decided “to undertake a ‘spillover analysis’ to research what impact, positive or negative, Ireland’s tax system may have on the economies of developing countries.” This is great news. Whatever you think of particular policies, it’s hard to argue against the principle of checking how your tax system affects developing countries…although people have tried, and I’ll get to that in just a moment.

The starting point for this agenda is a 2006 paper by the IMF’s Peter Mullins [pdf], which discusses the potential spillovers if the US were to stop taxing US companies’ foreign profits. He proposed four questions:

(i) Will it change the level and/or location of outward investment from the US?
(ii) Will it encourage other countries to more aggressively pursue tax competition to attract that investment?
(iii) Will other countries follow the United States’ lead?
(iv) Will there be an impact on the tax revenues of other countries?

The IMF has now picked this theme up more broadly in a consultation on tax spillovers.

The UK said no

ActionAid had a go at pushing for spillover analysis in the UK while I was its policy adviser. Not the general analysis that Ireland will undertake, but a specific analysis of the potential impact of proposed changes to the Controlled Foreign Companies rules, which completed the UK’s move away from taxing British companies’ foreign profits. The Treasury is quite open about what the change was designed to achieve:

The CFC rules are essentially anti-avoidance rules designed to prevent a company from artificially moving its profits abroad, to a country with a more favourable tax rate….The new rules only tax profits which have been artificially diverted from the UK, whereas the old rules would also catch profits diverted by a CFC from any other country. This allows businesses based in the UK to be more competitive internationally, creating more investment and jobs.

At the time we said:

it is essential that a development spillover analysis for the CFC reforms is conducted immediately, or commissioned from an international organisation such as the IMF or OECD. This should incorporate:

  • the potential change in companies’ behaviour that may result;
  • the characteristics of developing countries (for example investment patterns, tax legislation, enforcement capacity) that would be likely to increase exposure to this impact; and
  • the measures that developing countries or the UK could take to help mitigate any impact.

The Treasury disagreed. In oral evidence to the International Development Committee, minister David Gauke argued as follows:

The first point to make is that it is inherently very difficult to make any assessment of this, because one has to have a full understanding of the interactions between multinational companies located in developing countries and those developing countries and their tax systems, which is a very complex matter. It is not something that, frankly, either HM Treasury nor HM Revenue and Customs is well placed to make an assessment on.

Unconvinced, the Committee didn’t just recommend a spillover analysis for the CFC reforms, but “an administrative or legislative requirement for the government to assess new primary and secondary UK tax legislation against its likely impact on poverty reduction and revenue-raising in developing countries,” something the government dismissed as not “proportionate or feasible.”

Two footnotes to this. First, the OECD seemed to concede the point in its BEPS action plan in 2013:

While CFC rules in principle lead to inclusions in the residence country of the ultimate parent, they also have positive spillover effects in source countries because taxpayers have no (or much less of an) incentive to shift profits into a third, low-tax jurisdiction.

Second, just on Monday I heard Oxford University’s Li Liu give a paper analysing how the UK’s change from worldwide to territorial taxation has affected UK-based multinationals’ behaviour within the EU. She showed pretty convincingly that companies have responded by moving their investment from high-tax to low-tax countries, which both answers Mullins’ first question and disproves Gauke’s assertion!

Step forward Ireland

The Irish government evidently thinks a spillover analysis is possible, and has opened a consultation and a tender process to conduct some research. It seems this will be heavily based on an analysis commissioned by the Netherlands last year. The terms of reference [pdf] refer to the following areas:

  • Tax treaties with developing countries – comparative review of the provisions of Irish treaties as against those of their other significant trading partners.
  • Composition effects on the structuring of investment into developing countries resulting from the Irish tax system and the Irish treaty network.
  • The relevance of features of the Irish tax system relating to payments of profits onwards to third countries, in cases where investment into a developing country takes place through an Irish entity.
  • Analysis of Balance of Payments between Ireland and developing countries, with a view to quantifying any spillover effects identified as part of this analysis.

We can look at the Dutch example to see what we might get from the Irish study. The Irish terms of reference refer to an impact assessment conducted by Frances Weyzig [pdf], who has pioneered some of the economic techniques that are starting to allow us to quantify tax treaty shopping. Here’s his conceptual framework showing the ways in which Dutch tax policy might affect developing countries:

Potential pathway effects of Dutch corporate tax policy

Potential pathway effects of Dutch corporate tax policy (Source: Francis Weyzig, 2013)

Weyzig’s report is really good, but it’s not the only study commissioned by the Netherlands, nor (importantly) the one commissioned by its finance ministry. I haven’t been able to find these other studies online, but I did find a memorandum from the Dutch finance ministry to parliament discussing them. It refers a “report conducted by SEO Economics Amsterdam” and “a government-commissioned study by the International Bureau of Fiscal Documentation (IBFD) of the tax treaties the Netherlands has with a number of developing countries.”

The memorandum concludes that Dutch treaties with developing countries do need revising to strengthen their anti-abuse provisions, but no changes are needed in terms of their content (for example, the low withholding tax rates that they specify) nor in terms of their interaction with other aspects of Dutch tax law. The reason is that it’s not a study of the Netherlands in its own right, as Weyzig’s is, but rather, it’s a comparative study, just like Ireland proposes:

The IBFD investigation of the Dutch treaties with a number of developing countries shows that these countries have generally made the same arrangements with the Netherlands as in their treaties with other countries.

Just like any other aspect of tax competition, a focus on peer comparison will never do anything other than halt a race to the bottom. To have a positive impact you have to be willing to be better than your competitors. That’s obviously going to be hard for Ireland given that its next door neighbour is after its business.

Here’s hoping that Ireland’s study and the government’s response to it is more along Weyzig’s lines, contributing to a broader reflection on how national and international tax rules affect developing countries.

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.