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Tax avoidance

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COMMENTS

13 October 2015 09:03

A thousand pages addressing corporate tax shenanigans is not normally the sort of thing that captures the public imagination. But the 5 October launch of the OECD and G20 base erosion and profit shifting or 'BEPS' package of 15 reforms of the international tax system to tackle tax avoidance belies the length of technical detail and its dry and bureaucratic title. Within those pages lies some of the most fundamental governance developments of recent years.

As Mike Callaghan has noted, whether tax laws can keep up (http://www.lowyinterpreter.org/post/2015/04/13/Why-the-UK-Google-tax-is-...) with globally operating businesses and constant technological change is a fundamental challenge confronting governments.

In The G20 and the Future of International Economic Governance (http://www.lowyinstitute.org/publications/g20-and-future-international-e...) Miranda Stewart suggests that tax governance is still at an embryonic stage, with no global accord and the world remains heavily reliant on bilateral cooperation. Some key elements of global tax arrangements are not far advanced from what was agreed by the League of Nations (https://en.wikipedia.org/wiki/League_of_Nations) back in the 1920s.

International tax rules have evolved slower than the globalised economy. Technical progress was made at the OECD throughout the 1990s and 2000s on modern and cooperative international tax systems, but the research didn't translate into policy because of a lack of political drive. This changed with the elevation of the G20 to the leader level in 2008 and a shift in public opinion in light of incriminating examples of tax avoidance strategies by big multinational corporations such as Google, Starbucks, and Apple.

The final BEPS package that the OECD has outlined has been agreed by 60 countries and was endorsed by G20 Finance Ministers in Lima last week. It is complex but can be understood in three broad areas.

The first is substance, and ending a divorce between the location of profits for tax purposes and the location of value generated. There are a number of technical areas here. Notable is an agreement to cooperate on strengthening guidelines around transfer pricing (the practice of lowering a multinational company's tax bill in the pricing of offshore transfers between its subsidiaries). Redressing a weak interpretation of the arms length principle (https://en.wikipedia.org/wiki/Arm%27s_length_principle) will make it much harder for creative risk accounting to mean that profits accrue in very low tax jurisdictions.

Work is also ongoing on the interest deductibility of a companies' inter-group lending. The head of the BEPS work in the OECD, Pascal Saint-Amans, has predicted (http://www.oecd.org/tax/beps-2015-final-reports.htm) that countries should converge over time to between 10-30 per cent of earnings before investment, taxes and amortization (http://www.investopedia.com/terms/e/ebita.asp) (although it will vary by institution and industry). It has the potential to change effective tax rates over time.

The second is transparency. There will be more and more exchange of information between tax authorities. G20 countries have already agreed (https://g20.org/wp-content/uploads/2014/12/Communique-G20-Finance-Minist...) to the automatic exchange of tax rulings by 2018. This will be joined by country-by-country reporting to tax authorities by large multinationals with annual turnover of more than $750 million. This covers 10 per cent of multinationals, but 90 per cent of profits, and is a significant accomplishment, although it already appears that a quarter of companies may miss the first deadline for country-by-country reporting (http://economia.icaew.com/news/october-2015/quarter-of-businesses-to-mis...).

The third is implementation. A lesson of the post-financial crisis era has been that even agreed, good governance policy is hard to ratify, and the delivery of a policy package needs to be seen as the 'end of the beginning'. The effectiveness of the project will be determined by widespread and consistent implementation of agreed actions. Some actions like the transfer pricing interpretation can occur instantaneously, but reforms requiring amendments to tax treaties will take much longer. In another positive development, almost 90 countries are collaborating on a multilateral instrument, to be signed in 2016, that will fast track changes BEPS provisions for as many as 3600 bilateral tax treaties.

The risk remains that countries will go their own way to escape multilateral tax avoidance efforts, like the UK introducing a diverted profits tax earlier this year - a development that caused embarrassment (http://www.accountancyage.com/aa/news/2404326/oecd-embarrassed-by-google...) at the OECD. Global fragmentation in tax arrangements that undermines the hard-won multilateral agreements of the past two year will continue to be a threat.

In all these areas, will also be important to ensure that efforts to raise global tax standards do not come at the expense of the already stretched tax administration capacity of developing economies. Building enduring tax administration capacity is not a simple exercise, and it will require a concerted emphasis from G20 countries and technical bodies such as the OECD, IMF and World Bank.

Critics (http://www.smh.com.au/business/the-economy/beps-a-recipe-for-disagreemen..., including the grumpy tax ideologues at The Economist http://www.economist.com/news/business/21672207-plan-curb-multinationals...) will argue that package could be stronger and even more transparent, less complex, that in a perfect world we might not tax corporate income at all, and complain that we now face a long and messy path of implementation. There is truth to these criticisms, although they often ignore the pragmatic realities of truly global decision-making.

The bigger picture is that BEPS is just one part of the broader tax story, and needs to be viewed as just one aspect of a broader fundamental change in international tax governance arrangements.

But the BEPS agenda should also be seen as a success story for global economic governance. It is a case for future textbooks about the interaction of technical expertise and political drive in provoking substantive real change.

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