Over the past quarter-century, global capital has become far more mobile and some foreign investors have become more sensitive to company tax issues. Much ingenious effort has been devoted to shifting company profits to tax jurisdictions with low rates and to avoiding company tax entirely. Perhaps in response, the global trend has been to reduce company tax rates. Australia has lagged this downward trend, although the current government has used substantial political capital to begin moving in this direction. But why bother? The reductions envisaged won’t have much effect on foreign investment.
In international comparisons of company tax, Australia is always shown as having a rate of 30% (compared with an average OECD level of around 25%). But nothing is simple in the world of tax. Since 1987 Australia has had a system of company tax imputation, whereby Australian shareholders get a credit or refund for the tax which their company has paid: for Australians, the effective company tax rate is zero. Foreigners, however, cannot claim these imputation credits. Thus a foreign company contemplating investment in Australia might be tempted to shift its investment to a country with a lower rate.
For some, this anxiety about discouraging foreign investors might be a hangover from the days before the 1983 float of the Australian dollar, when funding our chronic current account deficit was a constant policy concern. Since 1983, if the attraction of Australia for foreign investors diminished for whatever reason, the exchange rate would adjust, depreciating to keep the current account and the capital inflow balanced.
The 2010 Henry Tax Review was concerned about Australia’s attractiveness for foreign investors, but put forward a more esoteric argument for reducing company tax. In a world of perfect capital mobility, the cost of capital would be set in global financial markets and any corporate tax imposed by Australia would impinge ultimately on the other factors of production: labour and land.
We are very far from this world of perfect capital mobility. Foreign companies invest in Australia for a variety of reasons. They identify above-average investment opportunities (where ‘economic rents’ are available), often based on their own profitable know-how and intellectual property. For portfolio investors, they similarly identify characteristics of the Australian market that they find attractive. Separated from global financial markets by our exchange rate (and a multitude of other factors), the real world is far distant from the textbook-perfect capital market.
Of course there are many other real world factors at work. To start with, it looks like the large tech companies such as Facebook, Amazon and Alphabet (and perhaps many others as well) don’t pay much tax here anyway. Offering a lower rate will make no difference. And for those foreign investors who pay tax in their home country, lowering our company tax rate would often just mean that foreign investors pay more tax at home.
Whatever the intellectual attraction of this ‘global capital’ argument, even its economist proponents accept that the effect of lower company tax on Australian national income would be minuscule.
Instead of lowering the company tax rate for everyone, why not give the foreign shareholders the benefit of imputation, allowing them a credit against any income tax they might pay in Australia? After all, the core logic of imputation is that the company structure is just a legal veil: to tax both the company and the shareholders amounts to double taxation. In practice this would be complicated and probably few of them pay Australian tax anyway.
If the foreign shareholders pay little or no Australian tax, then taxing the foreign company here seems a good - if imperfect - answer. Foreign companies have the benefit of Australia’s governmental and administrative infrastructure, protecting their physical security and providing legal backing for their contracts and intellectual property. They should make a contribution to the upkeep of this system, just as Australian shareholders do.
So the status quo might be judged to be a reasonable and fair outcome, with little reason for the government to assign such priority to reducing the corporate tax rate (and finding replacement revenue). Could there, however, be other motivation?
Ken Henry, who led the review, noted that it had long been a desirable tax principle that the top marginal income tax rate should be close to the company tax rate, so as to negate the incentive for high-tax-bracket Australians to shift their personal income into a company or trust structure, in order to delay taxes (benefiting from the time value of money). Some measures were taken to address this, but they seem to have left considerable loopholes. Perhaps some of those lobbying for lower company tax rates are the beneficiaries of such schemes.
The other conclusion we might draw is that, as this is a global problem reflecting the rootlessness of mobile capital, then a global solution may be needed. There are vexed issues of deciding where the tax obligation should lie: in the country of the shareholder; where the goods are produced; or where they are sold. As a starting point, however, we can leave aside this complexity to make a simple point: an enterprise that benefits from the deep social and legal infrastructure needed to make its operations possible should pay a fair tax somewhere. This is clearly not the case at present, with daily press reports of derisory amounts of company tax paid by large multinationals because of transfer pricing and accounting arrangements in tax havens and low-tax jurisdictions.
The OECD has struggled valiantly with its Base Erosion and Profit Shifting (BEPS) measures. It may be that this G20-promoted effort to force greater transparency on some of the most blatant tax havens - such as Switzerland, Luxembourg, Singapore and Ireland, to name just a few - might have some impact over time. But vested interests, particularly in the large economies with loud voices in the BEPS negotiations, will delay and limit what can be done. As globalisation becomes more deeply entrenched, the paucity of consistent global rules will limit equitable solutions to problems such as company tax. In the meantime, awaiting these global rules, there seems no strong case for lowering the company tax rate in a misguided attempt to attract more foreign investment.