Last week's budget contained two taxation measures affecting foreign investment in Australia: one lowering tax while the other aims to increase it. The first lowers the rate of company tax, which will fall from 30% to 25% by 2026. The second aims to tax more effectively those large multinational companies, such as Google, which have so far paid derisory amounts of tax considering their Australian revenues.
The reduction in company tax has been promoted as a measure to attract more foreign investment. The argument is that Australia's 30% rate looks high compared with many international jurisdictions, particular low-tax countries such as Singapore and Ireland. The Treasurer himself said; 'Australia has the seventh highest company tax rate of the 34 OECD countries and it is much higher than our neighbours in the Asian region.' This debate, however, has missed some key issues.
First, is the effective company tax rate high? Australia has a system of imputation, which means that Australian shareholders effectively receive a credit for the tax paid by an Australian company in which they have shares, thus reducing their own income tax. The laudable outcome avoids taxing both the company and the shareholder on the same income. With imputation, lowering the company tax rate makes no difference to the return for Australian shareholders: the company tax was already effectively zero.
Foreign shareholders don't get the benefit of imputation. Is it fair to require them to pay tax in Australia, and if so, how much? The logic for taxing foreign companies operating here is unassailable. They benefit from a well-functioning economy where their intellectual property is protected, the legal system is second-to-none, the regulatory framework is sound and the business environment conducive to enterprise. This secure environment of good governance costs money to maintain and the foreigners should pay for the benefit, in the same way that domestic shareholders pay income tax to fund these services.
We want foreign investment, but there is no reason to discriminate in favour of foreigners by allowing them a better tax deal than domestic shareholders have. Domestic shareholders typically pay more than 30% tax on their income, so why give the foreigners a discount? Let's not argue about where the 'value add' of the production has occurred: these companies make more profit because they have the benefit of operating in Australia.
Fairness between foreign and domestic investors didn't figure in the discussion of company tax. The debate was settled by esoteric Treasury modelling showing that lower company tax would raise GDP. In econometric modeling there is a counterpart to Newton's third law: for every model there is another model with an opposite result. This model demonstrated that GDP might rise if company tax were to be cut, but foreigners' dividends would increase, so Australians would lose out.
In any case, the unspoken purpose of the company tax cut may have been quite different – business groups have been lobbying for lower company tax so that wealthy Australians can benefit from the substantial difference between tax on companies and that on individuals by incorporation, with their income accruing to the corporation.
As far as the foreigners are concerned, many foreign companies don't pay much tax here anyway, so a lower company rate wouldn't make much difference. Hence the interest in the so called 'Google tax' – the second change in taxing arrangements. The previous budget had already contained measures to make it harder for foreign companies to shift profit to lower-tax jurisdictions. The main change in last week's budget was to boost tax compliance staffing to enforce the latest version of the measures, which includes copying Britain's 'diverted profits' legislation.
The underlying problem is that the long-standing tax rules, ossified in difficult-to-change international treaties, have not adapted to a globalised world; companies can readily shift profits to a subsidiary in a low-income jurisdiction. These actions aren't confined to foreign companies: the locals do it too. The arguments against the budget's course of action were set out here. The OECD has been working hard to put in place a consistent response to these vexed issues and if individual countries address the problems with their own laws, the global outcome will be an incoherent mess.
The counter-argument for doing something is more compelling. Despite the earnest endeavours of the OECD and the G20, it seems unlikely that any consensus will be reached which leaves the beneficiaries of the current system (basically, the mature investor-states of the G7 countries) with a smaller share of company taxes than they have at the moment.
It can be argued that the improvements in international tax that have occurred over recent years have not been a result of consensus reached in international negotiations at the OECD or G20, but from fortuitous leaks of information about existing practices (the Panama Papers are just the latest instance). These practices have been so blatantly contrary to any notion of fairness that transparency is enough to bring about voluntary changes in behaviour, at least among companies concerned about their reputation, without any revision to principles or regulations. Company directors who have had to defend in public their current egregious practices may be shamed into changing their ways. Putting more pressure on the global compliance norms through uncoordinated action by individual countries may not be the best-practice way to develop global 'rules of law' but may at least put reformist pressure on a system which has allowed these rorts to flourish.
Photo courtesy of Flickr user Denise.