The Panama papers and the OECD: re-reading Havens in a Storm

Last week I re-read Jason Sharman’s classic Havens in a Storm, described by Tax Analysts’ Martin Sullivan as “one of the best books out there for tax experts trying to make sense of big countries’ policies toward tax havens” (Sullivan’s review includes a length summary of the book). I was looking for a hook for this blog and, well, it was provided by Jürgen Mossack and Ramón Fonseca.

The OECD has published a curious Q&A on the Panama papers leak, according to which the problem is “Panama’s consistent failure to fully adhere to and comply with international standards”, which it contrasts with “almost all international financial centres including Bermuda, the Cayman Islands, Hong Kong, Jersey, Singapore, and Switzerland.” But the Panama papers story isn’t just about Panama, it’s about the other financial centres that were used by Mossack Fonseca (see the chart below), most of which are rated as “largely compliant” by the Global Forum, the OECD satellite body that peer reviews information exchange compliance.

panama

Arguably the OECD have a point: the Mossack papers show how the world was before the G20 got involved and these jurisdictions reformed, in which case there’s been a lot of unnecessary hot air on British TV news over the last few days. There is certainly some evidence on the ICIJ’s data page to support this view:

Mossack Fonseca’s clients have been rapidly deactivating companies since 2009, records show. The number of incorporations of offshore entities has been in decline for the past four years.

But the main groundswell of opinion, as anticipated by Rasmus Christensen (Fair Skat), is that it’s time to use some serious economic and (in the UK’s case) legal power to overturn haven secrecy. That’s Global Witness’s position. France has wasted no time in restoring Panama to its tax haven blacklist. According to Richard Brooks, with his typically powerful prose:

To tackle the cancer of corruption at the heart of the global financial system, tax havens need not just to reform but to end. Companies, trusts and other structures constituted in this shadow world must be refused access to the real one, so they can no longer steal money and wash it back in. No bank accounts, no property ownership, no access to legal systems.

Turn the clock to 1998…

Havens in a Storm gives us some important context about why we are where we are. The OECD’s Harmful Tax Competition project has come to be seen as the defining international political tax project of a generation of global tax actors – both OECD bureaucrats and governments – in the way that BEPS is for the current generation.  The initial 1998 report [pdf] is still a reference point, primarily for its classic definition of ‘tax haven’, and the list of ‘uncooperative tax havens’ published in 2000 has not ceased to be cited, even though the last jurisdictions were removed from it in a 2009 update.

The four characteristics of the OECD’s 1998 tax haven definition
1. No or only nominal taxes
2. Lack of effective exchange of information
3. Lack of transparency (i.e., bank secrecy)
4. No requirement that activities booked there for tax have economic substance

Yet the 1998 and 2000 reports are also anachronisms. They raised the spectre of sanctions against countries meeting the tax haven definition, but within a few years, the project had been dramatically scaled back and watered down. The initial threat of specific sanctions against jurisdictions that did not commit to comply by 31st July 2001 became a partnership approach accompanied by what Sullivan refers to as “a series of toothless pronouncements, a mixture of cheerleading and scorekeeping.” Furthermore, the OECD’s ambitious original aim of dealing with harmful competition for mobile capital was abandoned for a focus exclusively on the exchange of tax information on request.

According to Sharman, these failures came about because the OECD lost a battle of ideas and language, not an economic (or, for that matter, military) one. Central to this analysis is that “the technocratic identity of the OECD as an international organisation comprised of ‘apolitical’ experts” resulted in a battle waged in a rhetorical and normative space, rather than a political one dominated by the calculus of economic power. “The OECD made the struggle with tax havens a rhetorical contest, that is, one centred on the public use of language to achieve political ends.” The OECD is able to do this not because of the economic dominance of its members, but because of the secretariat’s use of “expert authority” to create influential regulative norms. The power of ‘blacklisting’ tax havens lies not in the economic might behind the implied threat of sanctions, but in the very act of labelling, with its reputational consequences (“the bark is the bite”).

Opponents forced the OECD to abandon key planks of the project by turning its rhetorical weapons against it. First, they portrayed the idea of sanctions as a contravention of the principle of fiscal sovereignty, suggesting that by its implied advocacy of sanctions, the OECD secretariat was breaching norms of reasonable conduct. Second, they turned the term ‘harmful tax competition’ back on the OECD, forcing it to defend its pro-tax competition stance and eventually to replace the term with ‘harmful tax practices’. Third, they alleged hypocrisy among OECD countries, pointing to Luxembourg and Switzerland’s (and later Belgium and Austria’s) refusal to be bound by the project’s outcomes. In the world of rhetorical power, such ‘rhetorical entrapment’ is a powerful tool..

If the project had been primarily a manifestation of raw state power, these rhetorical skirmishes would have mattered little to the eventual outcome. Yet Sharman makes a powerful case that they were its main determinants. One important example is that he attributes the decisive intervention of the Bush administration not to its being ’captured’ by multinational businesses with material interests in the project being scaled back, but to the ideologically-driven machinations of lobbyists from the Center for Freedom and Prosperity.

So what does it mean that, in 2016, language continues to be the OECD’s main weapon? As its Q&A on the Panama papers makes clear:

As part of its ongoing fight against opacity in the financial sector, the OECD will continue monitoring Panama’s commitment to and application of international standards, and continue reporting to the international community on the issue.

On one hand, the OECD’s normative claims are more powerful because of its claim to be the custodian of ‘international standards’, a claim that probably has more weight as a result of the increasing involvement of some non-OECD countries in its various tax projects. On the other hand, the peer review approach seems to implicitly concede a conservative notion of procedural fairness (reasonable behaviour, again) towards secrecy jurisdictions.

And the allegations of hypocrisy among its members don’t help its authority: the US’ ambivalence [pdf] towards sharing tax information automatically on a reciprocal basis is the standout example; there is talk about the use of US states as tax havens by Mossack Fonseca; the list of non-compliant jurisdictions that marked the G20’s entry into tax information exchange in 2009 gave Hong Kong and Macao special treatment.   This is perhaps also one sense in which the UK’s actions towards its overseas territories could have some bearing on how Panama behaves.

…now turn the clock forward to 2013

To finish, the parallels between the Harmful Tax Competition project and the Base Erosion and Profit-Shifting (BEPS) project on multinational corporate taxation are worth pointing out. Consider: an initial ground-breaking report from the OECD secretariat that has become an intellectual reference point, a whittling away of that initial ambition in intergovernmental negotiations, and an inevitable feeling after the fact that the policy reforms agreed won’t quite fix the problem so eloquently framed by the OECD in the first place. It would be too soon, of course, to judge how successful BEPS has been in comparison to its predecessor.

But it’s more interesting, I think, to look at the rhetorical battle. In inventing a new term, ‘Base Erosion and Profit Shifting’, the OECD succeeded in owning the construction of the problem just as it did by defining ‘tax haven’. ‘BEPS’ refers simultaneously to a set of corporate practices that, because they are brought under this umbrella, are hard to define, but it also refers to the OECD’s own project to tackle them. In using the term, critics and supporters alike endorse the OECD’s intellectual leadership. The rapid and widespread adoption of the term illustrates that in 2013, just as in 1998, the OECD knew how to operate in a rhetorical battlefield.

The hypocrisy concern applies here too: for example, several OECD and EU members are in trouble for providing selective tax advantages to multinationals. It’s quite noticeable that, from the start, the OECD secretariat has tried to neutralise this problem by tackling it head on. For example, its tax chief, Pascal Saint-Amans, told the Financial Times in 2012:

The aggressive tax planning of the last 20 years was achieved with the complicity of governments themselves to cope with tax competition

An interesting research question is whether Sharman’s analysis of why the Harmful Tax Competition project struggled can still explain developments in its successor, the Global Forum, or indeed the outcomes of the BEPS project. Do OECD tax projects always stand and fall on the secretariat’s skill at owning the rhetorical space, or do we need to acknowledge governments’ material interests and incentives to fully explain outcomes? (In their commentary on the Panama papers, Len Seabrooke and Duncan Wigan, political scientists who believe in the causal role of ideas, seem to emphasise the latter, how “big, powerful states…themselves may benefit from sheltering other countries’ hot money.”) Answering that question might help us resolve a second, prescriptive one: can the problem of offshore tax avoidance and evasion ever be fully addressed on the technical, normative and rhetorical terrain occupied by the OECD, or does it require an institution with a more political modus operandi? This is certainly an interesting time to be studying the politics of international tax!

The tax treaty arbitrators cometh

Next month sees the results of the OECD’s Base Erosion and Profit-Shifting project, as well as a discussion at the UN tax committee on alternative dispute resolution in tax treaties. India has apparently vetoed the inclusion of mandatory binding arbitration by default in the OECD model tax treaty, and it remains an optional provision within the UN model too. This post will show that arbitration provisions in treaties with developing countries are nonetheless on the march, and it will discuss some of the issues that this raises. It is taken from some comments I submitted alongside Todd Tucker on a draft paper for the UN committee’s discussion.

I’ve just returned from a field visit to, among other countries, Vietnam. With around 60 tax treaties in force, it’s been one of the most enthusiastic concluders of tax treaties over the last two and a half decades. It’s also quite clear that the General Department of Taxation regrets some of the things that the country gave away in its early negotiations. It is endeavouring to apply some provisions of these treaties in unconventional ways, and coming under pressure from foreign businesses who say that by doing so it is breaking with international norms. I sat in on a large meeting between the Vice Minister of Finance and Vietnam Business Forum (VBF) members, at which these concerns were raised. According to a typical statement from the VBF [pdf], Vietnam’s interpretations have “made the application of DTA[s] of foreign enterprises impossible, effectively it obliterate[s] the legitimate benefit of enterprises.”

As a consequence, Korean investors have recently begun to invoke the mutual agreement procedure (MAP) in the Korea-Vietnam tax treaty. Vietnam’s first ever MAP negotiation was taking place while I was there. MAPs, remember, do not require the two countries to reach an agreement, just to try their best. The resulting backlog of disputes among OECD countries is the reason why the OECD now seems to favour mandatory binding arbitration. Vietnam does not want to see mandatory binding arbitration clauses in its tax treaties, having already had its fingers burnt with investor-state arbitration. I am informed that such a clause was proposed by the US and rejected by Vietnam when the two countries negotiated their new tax treaty.

Vietnam said no, but others have not. One outcome of the Netherlands’ programme of renegotiations with developing countries, which is supposed to be about adding anti-abuse clauses, has been the insertion of binding arbitration clauses in several treaties with African countries. Here are all the arbitration clauses in African tax treaties to date (based on searching the IBFD tax treaties database for the term ‘arbitration’). They key column to look at is “how triggered”. Whereas the Canadian and Italian arbitration clauses require both countries’ consent before the case enters arbitration, all the others, following the OECD and UN model provisions, are binding on the developing country and can be triggered by either the other country or the taxpayer. The rest of the typology indicates that, as per usual, OECD-type provisions are more common than UN-type ones, even though the latter are supposed to be better for the developing country.

Arbitration clauses in African tax treaties

If we search for the term ‘arbitration’ in the IBFD tax treaties database, there are 219 results (caveat: not all of these references might be to ‘an arbitration clause’ as such, and some foreign-language treaties may have been missed). As the table below shows, arbitration clauses are of particular importance to jurisdictions whose treaty networks are used as part of tax planning strategies. By far the most arbitration clauses are in the treaty networks of the Netherlands and Switzerland, although the presence of Liechtenstein and Luxembourg in the top 10 list may also be indicative. At least two of the Swiss clauses, in its treaties with Peru and Argentina, are actually Most-Favoured Nation clauses triggered if the Latin American countries agree to binding arbitration with a third country. This suggests that, for Switzerland at least, arbitration clauses are important for its competitive position.

List of countries by number of tax treaties with some kind of arbitration clause

Here are a few issues that are presented by the spread of arbitration provisions that are binding on developing countries:

  1. There is barely any MAP experience in many developing countries. Interviews with revenue authority staff across numerous developing countries indicate that, outside perhaps the BRICS, many countries have yet to enter into a single MAP. Vietnam is a typical example. So the case for arbitration based on the huge backlog in OECD and G-20 countries is simply not there in many other countries, and may never be. Furthermore, that developing countries do not have the same experience of MAP negotiations as developed countries is a further reason why they should wait before agreeing to mandatory binding arbitration. If arbitration is designed primarily to increase pressure for a resolution in MAP, then the pressure on a developing country to capitulate at this stage will surely be increased by its inexperience in arbitration as well as MAP.
  2. The current UN model provision does not provide for the possibility of optional arbitration. If arbitration helps solves a structural problem in tax treaties, it is good for developing countries to consider it. But one way for them to take it slow is to sign up for clauses that create the option of arbitration without forcing them into it, such as those in the Italian and Canadian treaties with African countries. With such a provision, developing countries could build up some experience before deciding whether mandatory and binding arbitration is right for them. Unfortunately, this is not the current path taken by the UN committee, and so there’s little chance of developing countries obtaining it in negotiations.
  3. Arbitration enhances the negative impact of negotiation oversights. We know that, as in the case of Vietnam’s early treaties, the present impact was often not anticipated at the time the agreements were signed. While this situation has improved in some developing countries, in others, treaties are still being concluded now without adequate awareness among all parties of how they will bind future governments. There are various reasons for this, including: lack of technical expertise at the time of negotiation; politically driven negotiations in which the content of these treaties is barely considered; changing tax systems and economic conditions, especially the growth of e-commerce and services; new tax planning mechanisms; the relative autonomy of a small set of negotiators; weak or non-existent parliamentary ratification processes. Binding arbitration will further enhance this ‘golden straightjacket’ impact of tax treaties, reducing room to manoeuvre in cases where latter day tax treaties frustrate present day policy goals. This would especially be the case if a multilateral instrument were used retrospectively to add arbitration provisions to existing tax treaties.

A final thought. There are lots of reasons why eliminating all forms of double taxation faced by cross-border investors is a sensible thing to try to do. It is what tax treaties are supposed to be for. But sometimes governments, especially in developing countries, might deliberately choose to prioritise the maximisation of their tax base even when that leads to some double taxation. This is, arguably, what China, India and Brazil have done by adopting their own approaches to transfer pricing. Perhaps it is good if tax treaties leave sufficient space for this, so long as countries take seriously the repercussions of making use of that space.

Capital gains tax avoidance: can Uganda succeed where India didn’t?

Zain

Uganda is pursuing Zain for $85m capital gains tax on the indirect sale of its Ugandan subsidiary

I’m writing this post from under a mosquito net on a close Kampala evening. Since arriving on Wednesday I’ve had a whistlestop tour of the issues facing Uganda as it embarks on a review of its tax treaties. So far I’ve met with four tax inspectors, two finance ministry officials, four (count ’em) tax advisers, one academic and three NGO people. I also spoke at an event to launch a a report on Uganda”s tax treaties written by Ugandan NGO SEATINI and ActionAid Uganda.

This post is about “indirect transfers” of assets, where a sale is structured to take place via offshore holding companies, thus escaping capital gains tax. It turns out there is an $85m tax dispute on this between Uganda and the mobile phone company Zain. This is just about the biggest issue in Ugandan tax right now: the tax inspectors are even tweeting about it.

“Indirect transfers” were highlighted in the recent (and generally solid, I thought) OECD report to the G-20 development working group [pdf].* It says:

Developing countries report that the profit made by the owner of an asset when selling it (for example, the sale of a mineral licence) is often not taxed in the country in which the asset is situated. Artificial structures are being used in some cases to make an ‘indirect transfer’; for example through the sale of the shares in the company that owns the asset rather than the sale of the asset itself.

Unfortunately, it is pretty lame on the solutions. As far as I can tell from the G-20 response [pdf], what is going to happen on it is this:

(deep breath…)

As part of its multi-year action plan, the G-20 development working group will consider calling on the OECD, in consultation with the IMF, to report on whether further analysis is needed.

(…and exhale)

I don’t hear the sound of tax positions unwinding.in response to that one.

To remind you, the big daddy of indirect transfer cases is the Vodafone-India dispute. In that case,  according to this handy summary:

In 2007, Vodafone’s Dutch subsidiary acquired the stock of a Cayman Islands company from a subsidiary of Hutchinson Telecommunications International Ltd. (the subsidiary was also located in the Cayman Islands). The purchase price was $11.1 billion. The Cayman company acquired by Vodafone owned an indirect interest in Hutchinson Essar Ltd. (an Indian company) through several tiers of Mauritius and Indian companies.

Like India, Uganda is trying to tax the sale of a mobile phone company when the transaction took place via offshore holding companies:

Zain International BV owned Zain Africa BV, which had equity in 26 companies all registered in the Netherlands, but effectively owning the telephone operator business in as many African countries. One of them, Celtel Uganda Holding BV, owned 99.99 per cent of the Kampala-registered Celtel Uganda Ltd. On March 30, 2010 Zain International BV sold its shares in Zain Africa BV to Bharti Airtel International BV. As all three companies are registered in the Netherlands, and as the transaction was a sale of shares rather than assets, the company said it did not attract capital gains tax.

The cases are of course not identical. For one thing, Uganda is going after the firm that actually made the capital gain. But the Indian jurisprudence is being used in the Ugandan case.

Just last week, an appeal court ruled that the Uganda Revenue Authority does have the jurisdiction to assess and tax Zain on the gain. Zain will now argue that the transaction was exempt. One of its core arguments is sure to be the Netherlands-Uganda tax treaty.

In common with 86% [pdf] of tax treaties signed by developing countries since 1997, this treaty does not contain the UN model treaty provision that would have allowed Uganda to tax gains on the sale of shares in Ugandan companies made by Dutch residents. It may be that Celtel Uganda counts as a ‘property rich’ company because of all its infrastructure assets, in which case Uganda would have been able to fall back on the OECD and UN model provision permitting it to tax those…except (oops!) even that isn’t included in its treaty with the Netherlands. Yes, this treaty is worse for Uganda than the OECD model, never mind the UN.

So instead we come to Section 88(5) of Uganda’s Income Tax Act [pdf] . This is an anti-treaty shopping provision, which denies the benefits of the treaty to a company whose ‘underlying ownership’ is mostly in a third country:

Where an international agreement provides that income derived from sources in Uganda is exempt from Ugandan tax or is subject to a reduction in the rate of Ugandan tax, the benefit of that exemption or reduction is not available to any person who, for the purposes of the agreement, is a resident of the other contracting state where 50 percent or more of the underlying ownership of that person is held by an individual or individuals who are not
residents of that other Contracting State for the purposes of the agreement.

Sounds like Uganda has it in the bag, right? Unfortunately, this matter will turn on whether Uganda’s domestic law can override its treaty commitments. It is quite likely (certain, if you ask Zain’s tax adviser) that a court will decide it cannot. What everyone I have spoken with agrees on (apart, perhaps, from Zain’s tax adviser) is that it would be preferable to have some certainty about this unresolved question.

The URA has recently begun denying treaty benefits under section 88(5), and until now taxpayers have accepted its reasoning. But, speaking in genera terms at the SEATINI/ActionAid public meeting, a tax official said that the URA doesn’t know if its position will stand up to a court challenge. Tax advisers in the private sector say that, as well as the question of treaty override, the meaning of “underlying ownership” needs to be clarified. Because the Zain case has so far been fought on technicalities, “we were robbed of the opportunity to see how it [Section 88(5)] would work in practice,” one told me.

Perhaps the next stage of the Zain case will answer this question. If it does, it should give some welcome guidance to developing countries struggling with these indirect transfers. If they can’t use their domestic law to override their treaties, they will need to insert an anti-abuse clause into their treaties, strengthen their source taxing rights, or consider cancelling them.

This brings us back to BEPS, and the action on tackling treaty abuse. The OECD is proposing a limitation of benefits clause based on that used by the US, which is similar to that in Uganda’s domestic legislation, only a lot more detailed about who is ruled in and out. This would do the trick, but the challenge would be getting it into treaties that have been already signed.

To solve that, the OECD is pushing a multilateral convention to modify treaties all at once, built on a flexible level of commitment. It concedes [pdf] that the multilateral instrument “has not been identified as high priority by developing countries.” For it to work for them, I think it would need two things:

1. Genuine flexibility so that developing countries can opt into only the bits they want, such as the anti-abuse clause.

2. Willingness on the part of high-risk jurisdictions for treaty shopping (in Uganda’s case the Netherlands, Mauritius, and perhaps now the UK) to opt in to the anti-abuse clause as well.

For Uganda, it might not make sense to wait for this, since we are only talking about two or three treaties. It could ask its partners for a protocol containing a limitation of benefits clause right now. Or, of course, it protect itself and raise more revenue by strengthening all its treaties’ capital gains articles, as the UN model provides for in the first place.

*thanks to @psaintamans for the link!

What is the UN tax committee for, anyway?

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.

From theory to practice: development finance institutions and Global Forum peer reviews

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!

‘Spillover analysis’ as a frame of reference for tax and development policy

Last year, when Parliament’s International Development Committee was conducting an inquiry into tax and development, ActionAid (where I worked) was calling on the government to assess the impact of changes to the UK’s Controlled Foreign Companies (CFC) rules on developing countries. At the time, we were citing a report from the IMF, World Bank, OECD and UN to the G-20 [pdf], which recommended that:

It would be appropriate for G-20 countries to undertake “spillover analyses” of any proposed changes to their tax systems that may have a significant impact on the fiscal circumstances of developing countries…in moving, for instance, from residence to territorial systems.

The term ‘spillover’ is hardly new, appearing in the OECD’s famous 1998 Harmful Tax Competition report [pdf], which notes a concern that “countries may be forced by spillover effects to modify their tax bases, even though a more desirable result could have been achieved through intensifying international co-operation.”

When ActionAid raised the spectre of spillover analysis, the British government was adamant that it would be a useless exercise. But that didn’t stop the International Development Committee recommending that,

there should be 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, and to publish that assessment alongside the draft legislation

Since then, the Netherlands has decided to review its tax treaties with developing countries in exactly this light. And a few other publications lead me to wonder if the tide is turning against the UK government’s position.

The OECD’s BEPS action plan, for example, echoes precisely the argument we made at ActionAid, when it notes that:

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.

A recent IMF paper [pdf], which sets out a workplan on international tax issues, goes further still:

The work plan is focused on macro-relevant cross-country spillovers from national tax design and practices. The issues of tax avoidance by multinationals and evasion by individuals that are the focus of immediate concerns and initiatives are important instances of such spillovers. But there are many others too, and issues would arise even in the absence of compliance problems: for instance, the current trend among advanced countries away from residence-based taxation of active business income arising abroad and toward territorial taxation can have powerful spillover effects, including for developing countries.

I think the IMF’s thinking builds on a working paper from 2006 [pdf], which explores the implications were the US to move from a worldwide to a territorial system. It asks four questions:

(i) Will the territorial system change the level and/or location of U.S. FDI?

(ii) Will the territorial system encourage other countries to more aggressively pursue tax competition (i.e., lower rates or increase tax concessions) to attract U.S. FDI?

(iii) Will other countries follow the United States lead and move to a territorial system?

(iv) Will there be an impact on the tax revenues of other countries?

Finally for now, the UK’s Liberal Democrat party seems to have adopted the spillover policy recommended by the International Development Committee (which it chairs). A policy paper [pdf] for the party’s autumn conference last week says that it “would assess all new primary and secondary UK tax legislation against its likely impact on poverty reduction and revenue-raising in developing countries.”

With such a range of voices arguing for this, I’m hopeful that it will become more widely adopted. After all, it says nothing about the content of tax policy, just about the due diligence that should be done when it’s made.

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?