Some political questions for Unitary Taxation

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



What ‘tax responsibility’ might look like in the real world

In my conversations with tax executives from multinational businesses, I’m used to hearing them talk about the decision any business makes about how aggressive its tax positioning is going to be. The position advanced by many campaigners is that a socially responsible business will make a conscious decision to be at the less aggressive end of this spectrum. The savvier campaigners try to make a business case for this, as well as an ethical one.

The tricky part comes is in clarifying what ‘responsible’ looks like. I’ve never met a tax executive who will admit that her company chooses to take a more aggressive position than others, and yet I’m sure some do. All companies are able to put out vague statements about compliance with this and cooperation with that, but I’ve never read one where I could conclude from it that particular examples of tax planning schemes would be ruled out. So if campaigners want to paint a picture of a responsible business that would require behaviour change from some companies, they need to find some concrete statements at policy level that act as a litmus test.

(Yes, I understand that many in the tax profession think this discussion is a poor substitute for fixing the law to eliminate companies’ discretion and tax enforcement by the mob…I’m not getting into that today!)

On this subject, a great paper has popped up in the journal ‘Management Accounting Research’, by a Danish researcher called Christian Plesner Rossing. It’s a study of an unnamed European multinational, referred to as ‘Global’, which appears to have formulated a tax policy that consciously changes it towards a more risk-averse position. The paper also discusses the role the policy plays in helping the tax department do its job, defined largely as risk management. Transfer pricing is a tricky area, in part because it quickly becomes so complex that senior executives struggle to supervise the transfer pricing manager effectively, and in part because the process of adjusting internal transactions can have a negative impact on the performance metrics of different parts of the group.

I hoped that the clear statement of intent to be ‘conservative’, rather than to be ‘somewhere in the middle of the spectrum’ as most companies tend to say, might lead to some clear indicators of what conservative looks like. Let’s see.

Reputation risk

According to the new policy document, the company’s aim in formulating the policy was as follows:

‘[Global] does not want its tax affairs to appear in the public domain. [Global] will manage its compliance affairs to minimize the risk of any public comment’.

Now I’m sure any company would want to minimise this risk, but this company seems to have prioritised this, as explained by the transfer pricing manager:

We will avoid [transfer pricing] penalties and we will not be on the front page – that is one hundred per cent sure.

Wanting to be one hundred percent sure would surely mean adopting a very conservative approach. More conservative than, say, Vodafone, whose tax code of conduct states:

It is not appropriate for the details of the Group’s tax affairs to appear in the public domain. Vodafone will however only enter into transactions which would be fully justifiable should they become public.

Adjustment risk

The ‘Global’ tax strategy document goes on to say:

All positions taken in the tax returns must be supportable and, on the balance of probability, be more likely than not to be agreed by the appropriate tax authority…The tax department will aim to have no adjustments to the tax returns…Group Tax will take a conservative position in respect of the tax charge in the accounts’.

Now, an aim of having no adjustments, if the tax department is assessed in this way, would surely preclude taking more aggressive transfer pricing positions that come with a risk – all be it a manageable one – of adjustment.

In contrast, Vodafone’s policy, which also invokes ‘more likely than not’, goes on to add the caveat that

there are instances in which a filing position will not meet the more likely than not standard but would still be tenable…[such as] Where there are current uncertainties or opportunities created by recognised errors in law not yet corrected.

I wonder how these two apparently different positions would apply in a developing country where the law and enforcement are weak. It’s clear that firms take liberties in countries without effective transfer pricing enforcement that would not pass the ‘more likely than not’ test, and would lead to adjustments, if they were properly investigated. That explains why, just a couple of years after Kenya began transfer pricing audits in earnest, it chalked up ten major adjustments of multinational firms.


Finally, the policy adds:

All transactions must have a business purpose. All decisions in [Global] must be based on the underlying business and not on internal tax sub optimization. The Group will not undertake nor accept purely tax driven transactions.

This sounds welcome, but hardly radical. Most companies seem to feel comfortable saying this, and my guess is that, while there are plenty of examples of purely tax-driven artificial transactions, most tax planning in a multinational firm also has some kind of underlying substance. Vodafone’s policy says the same thing, and gives quite some detail on how it defines artificiality.


We might possibly conclude two ways to start to define a more ‘responsible’ policy on the basis of this rather quick analysis:

  1. Less risk (vis a vis both the media and tax authorities) is entertained, which means that more conservative positions are taken. (It’s interesting that ActionAid’s tax responsibility guide doesn’t say this, it just states that the level of appetite for risk should be articulated).
  2. Risk is assessed in the same way in countries with weaker legislation and enforcement as it is in countries where it is stronger, so that deficiencies in these areas do not lead to a more aggressive position being taken because it is less likely to be challenged.

Double tax treaties: a poisoned chalice for developing countries?

It’s been an interesting couple of days here at Strathmore University Business School in Nairobi. I’m at a conference to launch the School’s new Tax Research Centre, which has brought together tax officials, tax practitioners and academics to address some critical issues for Kenya, including anti-avoidance, taxing multinationals and tax treaties. The quality of discussion is very high, and certainly banishes the notion that there is no technical expertise in developing countries.

I was asked to speak on the title above, and my presentation is below. There was a fascinating exchange when I put up the slide showing Kenya’s current treaties. Not one person, including the tax advisers in the room, thought Kenya should ratify the treaties it has signed with Mauritius and the UAE.And nobody was even aware that a treaty had been signed with Iran! Interestingly, in contrast to the academic literature, the participants here took it as self-evident that tax treaties have no impact on the levels of inward investment into a country. But now Kenyan companies are starting to expand abroad, some people did advocate treaties to encourage this outward investment.

Link to presentation on


Satellites in geostationary orbit: a new tax justice issue?

Side view of Geostationary 3D of 2 satellites ...

Side view of Geostationary 3D of 2 satellites of Earth (Photo credit: Wikipedia)

When I made an amused reference to item on satellites in the new UN tax committee’s agenda, I wasn’t really sure what it was about. Richard Murphy thought it might be a plan to create tax havens in space. But, now that the UN secretariat have released some preliminary documents for the committee meeting next month, I think it may be a very good example of the differing interests of developed and developing countries in international tax.

In the most recent update of the OECD’s model tax treaty, there’s a discussion about whether a satellite in geostationary orbit (that is, always above the same point on the earth’s surface) could be a permanent establishment (taxable entity) in the country over which it orbits, or to which it transmits signals. Here is the full quote from the OECD model treaty as given in the UN document [pdf]:

5.5 Clearly, a permanent establishment may only be considered to be situated in a Contracting State if the relevant place of business is situated in the territory of that State. The question of whether a satellite in geostationary orbit could constitute a permanent establishment for the satellite operator relates in part to how far the territory of a State extends into space. No member country would agree that the location of these satellites can be part of the territory of a Contracting State under the applicable rules of international law and could therefore be considered to be a permanent establishment situated therein. Also, the particular area over which a satellite’s signals may be received (the satellite’s “footprint”) cannot be considered to be at the disposal of the operator of the satellite so as to make that area a place of business of the satellite’s operator

The OECD position is unanimous and, so it suggests, inevitable based on other aspects of international law. But consider this: most of the world’s commercial satellites are owned by companies resident in OECD countries. Many (perhaps all) developing countries have satellites permanently orbiting over them and broadcasting signals onto their territory, while down at ground level they have no companies making profits from this industry. Under the OECD position, there is no possibility of developing countries raising corporate income tax from this sector.

There may be a philosophical discussion that is much broader than tax, as the OECD commentary suggests, about ‘how far the territory of a State extends into space’. But I imagine that the consequence of the point about the satellite’s ‘footprint’ is that a state has no right to treat a satellite as a taxable entity if it is, say, broadcasting commercial TV to its residents, or providing GPS positioning to people on its territory.

If my assumptions are correct, that makes for quite an interesting discussion. A quick hunt around online suggests, for example, that the fixed position of a satellite in geostationary orbit means that it is not considered as movable property as far as US state tax is concerned – which might imply that it is a fixed place of business for international tax purposes. What would be the positions of the BRICS, some of which have their own burgeoning space sectors? Already, an OECD consultation document [pdf] implies that there were disagreements on this issue among its members.

I would guess that smaller developing countries have not considered this matter at all. In any event, I will certainly look forward to the discussion in October!


BEPS Part 2: international politics and developing countries

sluto | beps

This graffiti is definitely about Base Erosion and Profit Shifting (Photo credit: feck_aRt_post)

I wrote earlier this week with some questions about UK tax policy and the OECD’s Action Plan on Base Erosion and Profit Shifting. A lot of the areas that it’s looking at are probably not going to affect smaller developing countries very much, but there are a few things worth highlighting. I also recommend Chris Lenon’s comments on the action plan, to which I’ll refer below.

Beyond the arm’s length principle

I thought it very interesting that the action plan concedes that some of the current problem with tax planning derives from the transfer pricing rules themselves:

multinationals have been able to use and/or misapply those rules to separate income from the economic activities that produce that income and to shift it into low-tax environments.

But the more significant rhetorical shift from the OECD is that it now appears to believe that solutions within the arm’s length principle (ALP) may not be enough. The ALP’s self-sufficiency has seemed to me to be an article of faith for the OECD secretariat every since I began working on tax. The action plan says:

special measures, either within or beyond the arm’s length principle, may be required with respect to intangible assets, risk and over-capitalisation to address these flaws.

Some academics are fond of arguing that the OECD abandoned the ALP in all bit name some time ago. So I wonder whether this is really a substantive change or just a rhetorical shift designed to underline that BEPS is a ‘radical rethink’.

Chris thinks that “[t]his is a clear indication that apportionment may be considered as the way to deal with high value intangibles.” It does seem to imply that the OECD may come more into line with the Chinese approach.

Tax reporting

Noting that “timely, comprehensive and relevant information on tax planning strategies is often unavailable to tax administrations”, the action plan proposes to:

Develop rules regarding transfer pricing documentation to enhance transparency for tax administration, taking into consideration the compliance costs for business. The rules to be developed will include a requirement that MNE’s provide all relevant governments with needed information on their global allocation of the income, economic activity and taxes paid among countries according to a common template.

Chris thinks that this is “very significant”, and that “business needs to develop a strategic response to the issue of transparency”. I think that it is worth considering in the context of the report to the OECD task force on tax and development last year [pdf], which outlined the information challenges faced by developing country tax authorities. The main value of a global report as proposed would be to give tax authority in country A some readily available information on a multinational’s operations in country B, if neither country is the head office. At the moment this is difficult to obtain, because the subsidiary in country A can’t be required to provide information on a sister company in country B, despite them being under common control. Tackling this problem through global documentation seems sensible.

A multilateral treaty and mandatory arbitration

I said when the original BEPS report came out that a multilateral treaty designed to update current treaties in one fell swoop has potential dangers for developing countries. They’re mostly excluded form the BEPS process, but a multilateral treaty could gain such momentum that it becomes obligatory for them to sign up, despite the difference of interests acknowledged by the existence of separate UN and OECD model bilateral treaties. The new UN tax committee‘s response to any multilateral treaty will surely be very significant.

As an example, the Action Plan implies that one area for change is in the area of mutual agreement procedures (MAPs) and arbitration:

Develop solutions to address obstacles that prevent countries from solving treaty-related disputes under MAP, including the absence of arbitration provisions in most treaties and the fact that access to MAP and arbitration may be denied in certain cases.

Alison Christians has written about her concerns about this in the past. Experience with investment treaties shows that developing countries should be wary of mandatory arbitration, yet they may find themselves with little choice if this makes it into a multilateral treaty.

G20 versus OECD

The new model of G20-OECD cooperation is intriguing. The Action Plan explains it as follows:

interested G20 countries that are not members of the OECD will be invited to be part of the project as Associates, i.e. on an equal footing with OECD members (including at the level of the subsidiary bodies involved in the work on BEPS), and will be expected to associate themselves with the outcome of the BEPS Project.

The equal footing part is new and unusual, but that last clause means that countries who have got used to stating their difference of opinion with the OECD will presumably want to think carefully. I will be very interested to see which of the non-OECD G20 members take up this invitation.


BEPS part 1: three places where the Action Plan seems to contradict UK policy

I’ve finally got around to pronouncing on the OECD’s action plan on base erosion and profit-shifting. Surely the only response at this stage is that the jury is out. BEPS is an ordering principle for a quite disparate programme of work, and so it’s hard to reach an overarching verdict.

Later this week I’ll write about developing countries. In this post I want to highlight three things that I read in the action plan published a couple of weeks ago that at first sight seem to contradict what we know about UK tax policy – all areas that have been discussed on this blog before. This is to pose questions, not reach conclusions. It will be interesting to see how the UK position develops in these areas, as I think they might be useful yardsticks to measure how radical the OECD members really want this work to be.

1. CFC rules

The report says:

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.

This was precisely the argument that we made at ActionAid when the UK relaxed some of its CFC rules, which are designed to prevent the artificial diversion of profits into tax havens. Here is the government’s response in 2011, given by Treasury minister David Gauke:

Our corporate tax system is not the best way to help those [developing] countries; it is designed to protect the UK’s taxing rights, not those of other countries. Rather, it is for the countries themselves to have effective systems that build and protect their own tax base, and to ensure that they can access and act upon tax information…Such an assessment [of the impact of changes on developing countries] would not be relevant to the task of creating the most competitive corporate tax system in the G20 and encouraging more businesses to be based in the United Kingdom.

The Treasury rejected outright the position that is now stated in the BEPS Action Plan, when it came from an NGO and a parliamentary committee. Maybe this is a non-consensual area among the OECD members, because all that is promised is to “develop recommendations regarding the design of controlled foreign company rules.”

2. Patent box

The Action Plan says that:

the “race to the bottom” nowadays often takes less the form of traditional ringfencing and more the form of across the board corporate tax rate reductions on particular types of income (such as income from financial activities or from the provision of intangibles).

Yet the UK’s introduction of a ‘patent box’ that gives a lower corporate tax rate on income from exploiting patents is precisely this kind of measure. Having said that, the actions in this section – unlike the discussion – seem to shy away from anything that might counteract competitive measures per se, unless they are used for abusive structures:

Revamp the work on harmful tax practices with a priority on improving transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, and on requiring substantial activity for any preferential regime. It will take a holistic approach to evaluate preferential tax regimes in the BEPS context. It will engage with non-OECD members on the basis of the existing framework and consider revisions or additions to the existing framework.

3. e-Commerce

Addressing “the ability of a company to have a significant digital presence in the economy of another country without being liable to taxation due to the lack of nexus under current international rules” is one of the most intriguing parts of the BEPS agenda.

Many of the high profile cases such as Google and Amazon relate precisely to this point. As the action plan describes it:

In many countries, the interpretation of the treaty rules on agency-PE allows contracts for the sale of goods belonging to a foreign enterprise to be negotiated and concluded in a country by the sales force of a local subsidiary of that foreign enterprise without the profits from these sales being taxable to the same extent as they would be if the sales were made by a distributor.

My question here is, does the UK really want this change? A shift towards greater source taxation, which is what this would entail, would cost some countries more than they would gain. The UK’s track record, for example the way in which it disregards the OECD consensus by refusing to treat an internet server as a taxable entity, suggest that it favours a more residence-based system, not a more source-based system.

According to this McKinsey survey, the UK is a world leader in the share of eCommerce in its GDP, but it also has an internet trade deficit. This is because Britons do more internet shopping than most other countries. This suggests that the UK would stand to benefit from the change implied by the BEPS action plan, but also to lose from its current policy position. I wonder what is going on?



Britain’s fracking tax incentives: do they pass the test?

It’s funny, if you’ve only ever thought about an issue in terms of other places, when it suddenly it pops up in you back yard. Gives you a different perspective. So the announcement today that the Britain is going to create the “world’s most generous shale tax regime” [£] to encourage ‘fracking’ is a chance to think about all the pontificating I’ve done about tax incentives.

As far as I can tell, we don’t yet know the details of what is being proposed, only the headline. If there’s more today I’ll update this post. But the key message is a slashing of the corporation tax rate from 62% to 30%, and compensation for local communities hosting a well of £100,000 plus 1% of revenues.

Below I have posted two sets of recommendations on tax incentives, one from the OECD, and one from ActionAid’s new campaign. Looking through them, it seems most are unlikely to create any trouble, since these are statutory incentives that will be passed through legislation. But two thoughts emerge initially.

First, will there be a published, transparent analysis of the revenue expected to be foregone, and predicted benefits? This is usually done in the UK through a “tax information and impact note” attached to proposed legislation, but I wonder how detailed it will be, and whether there will be any way to test the assumptions about how much investment the incentives will bring in. Peter Lilley, a conservative MP with an industry background, said yesterday, “I think tax breaks are unnecessary for fracking, based on my knowledge of the oil and gas industry.”

Second, from the “most competitive in the world” headline, it seems these British incentives are not simply designed to tip the investment past the point at which it has a viable net present value, but quite explicitly to entice investment away from other countries. So it’s tax competition. Why isn’t there a statement that incentives should only be designed to make investments viable, as opposed to making already-viable investments more attractive than those in other countries? Is that too vague?

Furthermore, the recommendations generally talk about regional agreements to limit tax competition, but in this case that doesn’t seem relevant: I think it’s less about regional partners/competitors and more about other countries with shale gas potential. Maybe the recommendations should extend beyond regional proximity to cooperation between countries with similar resource endowments

Here are the ActionAid recommendations:

  • Eliminate all tax holidays.
  • Publicly review all tax incentives, assessing tax expenditure (the amount of tax foregone from incentives), ensuring incentives are well targeted and commensurate with the benefits expected to citizens.
  • Ensure that all phases of new incentives require parliamentary approval, and also that any new incentive offered is grounded in legislation which makes it available to all qualifying investors, foreign or domestic. This would effectively mean an end to discretionary tax incentives.
  • Publish a costing and justification for each incentive offered, followed by monitoring of conditions and a tally of costs and benefits, so the public can see the impact of tax incentives.
  • Grant the Finance Ministry (not solely the Investment Promotion Authority) powers over tax incentive decisions.
  • Refrain from entering into stability clauses (which lock in tax incentives long term) when negotiating new tax incentives and investment agreements.
  • Ensure that tax incentives are audited to check that the investment for which an incentive is offered has actually been carried out.
  • Co-ordinate statutory tax incentives with groups of neighbouring countries, in order to counter tax competition.

Here are the OECD principles [pdf]:

  1. Make public a statement of all tax incentives for investment and their objectives within a governing framework.
  2. Provide tax incentives for investment through tax laws only.
  3. Consolidate all tax incentives for investment under the authority of one government body, where possible.
  4. Ensure tax incentives for investment are ratified through the law making body or parliament.
  5. Administer tax incentives for investment in a transparent manner.
  6. Calculate the amount of revenue forgone attributable to tax incentives for investment and publicly release a statement of tax expenditures.
  7. Carry out periodic review of the continuance of existing tax incentives by assessing the extent to which they meet the stated objectives.
  8. Highlight the largest beneficiaries of tax incentives for investment by specific tax provision in a regular statement of tax expenditures, where possible.
  9. Collect data systematically to underpin the statement of tax expenditures for investment and to monitor the overall effects and effectiveness of individual tax incentives.
  10. Enhance regional cooperation to avoid harmful tax competition.