Ireland does spillover analysis: the proof of the pudding will be in the eating

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.

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