Published daily by the Lowy Institute

Profit shifting: digital fat cats in national tax gaps

Companies should make a fair contribution to running the countries in which they create value and earn profits.

Profit shifting: digital fat cats in national tax gaps
Published 27 Mar 2018 

Company tax is in the news again. While the Australian Government attempts to garner Senate approval for its corporate tax-cut proposals, the EU is moving in the opposite direction, searching for ways to raise corporate taxes. What’s driving these two diametrically opposite policies?

Since 2000, multilateral company tax has fallen from 34% of profits to 24%. This reflects a variety of factors. Some countries have reduced their corporate tax rate to attract enterprises, and others have responded competitively. The extreme examples are the zero-tax havens, but Singapore, Switzerland, the Netherlands, Ireland, and many others offer very low tax rates. Ireland has been so successful that these footloose profits now make up 23% of its GDP, mostly from companies with no substantial presence in the country.

Companies have become much more adept at shifting profits to these low-tax* jurisdictions. While globalisation, the greater importance of intellectual property, and the burgeoning digital economy have all facilitated such shifting for digital companies, more conventional companies may be able to achieve similar outcomes through inter-company borrowing, tax deferral, and transfer pricing.

The OECD has long recognised these issues. The Base Erosion and Profit Shifting (BEPS) initiative has laboured to find a solution which can be applied globally, or at least uniformly in the OECD, with a further report to be published in April. Unsurprisingly, achieving consensus among OECD members, with so many varied and vested interests not only between countries but also within them, is proving very challenging.

Without globally uniform solutions, various countries, including Australia, are taking their own measures. This option is clearly second-best, but understandable. Perhaps hoping to head off the complexity that would come from these disparate and inconsistent national solutions, EU bureaucrats in Brussels have been working on their own Common Consolidated Corporate Tax Base (CCCTB) for some years, with prospective application in the EU only.

But the CCCTB is on a slow track, held back by the same factors that constrain the BEPS initiative. Thus, the EU Commission has developed a proposal to tackle just one aspect of this problem: the difficulty of taxing the burgeoning digital economy.

Companies such as Facebook, Apple, Netscape, Uber, eBay, Airbnb, and Amazon accrue large revenues from advertising, sale of data, platform revenues, and subscriptions which are readily channelled to low-tax jurisdictions. Tech-based companies are the fast-growing sector. In Europe they pay less than 10% company tax, compared with 23% for conventional companies. Value-creation through interaction with customers takes place in one country, while profits accrue in another.

The EU proposal is to impose a 3% tax on total revenue (rather than profits), distributing this to the countries where the product earns revenue. This is seen as a temporary measure pending the arrival of the CCCTB.

Recognising the likely long wait for CCCTB, the alternative view is that the EU proposal might prevent similar proposals being developed among individual EU countries (France and Germany in particular), in the hope of at least getting some intra-EU consistency in taxing the digital economy. Even this lesser objective seems beyond reach as it needs agreement from the 28 EU members, including some (for example, Ireland and Luxembourg) that do very nicely out of the existing defective system.

Australia’s proposed tax reductions have a different motivation: the fear that the global tax reductions noted above will adversely affect capital inflow. These fears seem grossly exaggerated, but the business lobby is campaigning strongly.

The proposed modest cut to 25% doesn’t mean that we are leading the charge in the “race to the bottom” to attract footloose global capital. If tax was the dominant investment determinant, companies would still have an incentive to go to lower-tax jurisdictions (for an anecdote on Singapore’s use of low tax to attract enterprise, see here).

Nevertheless, BEPS and the EU objectives seem a far more worthwhile goal: to put in place a tax system which requires companies to make a fair contribution to running the countries in which they create their value and earn their profits.


* An earlier version of this article referred to “low income”.


Photo by Flickr user Mr Thinktank.

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