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OECD avoidance plan is no quick fix

29th Jul 2013
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The long awaited report on combating corporate tax avoidance by the OECD sadly has to deal with a corporate tax system which is unfit for purpose, says Prem Sikka.

The OECD's tax avoidance report is a follow-up to the G8 meeting last month in Ireland which ended with lots of nice statements on curbing tax avoidance but with little commitment.

Unfortunately, companies such as Google, Microsoft, Amazon, Starbucks and others are able to use the system to avoid taxes in countries where their sales, assets and employees are located, by creating complex corporate structures and transactions. In fact, a considerable part of corporate profits are not taxed anywhere.

So the OECD plan cannot be evaluated without considering the fault lines in the current rules for corporate taxation which were designed nearly a century ago. Three stand out.

First, the rules, often enshrined in international treaties, specify that companies should be taxed at the place of their residence rather than where the economic activity took place.

Second, companies such as Amazon, eBay, Barclays and HSBC have common ownership, control and strategic direction, but they are not taxed as unified entities. Their hundreds of subsidiaries are treated as separate tax entities. The FTSE100 companies have about 22,000 subsidiaries. Thus, for tax purposes it is assumed that the authorities will deal with 22,000 separate entities rather than just 100 companies.

This encourages companies to arbitrage the global tax systems by devising all sorts of intragroup royalty payments for using intellectual property, management fees, interest payments and other transactions and pass them through subsidiaries located in low/no tax jurisdictions. Through such devices, companies bump up their costs in one country (for example, the UK) but collect the same amount in another place (say, Bermuda) which has a low/no tax regime.

Third, in principle, the artificial relocation of profits could be checked by using an accounting technique known as transfer pricing. Under this method, all intragroup transactions were to be valued at what the OECD calls “arm’s length” principle, or prices set by the free market. However, in the era of monopoly capitalism, finding free market prices or even any remotely comparable to it has become difficult. Around 70% of the world’s trade is controlled by 500 corporations. A handful of companies dominate coffee, pharmaceutical, internet and other sectors and thus “arm’s length” prices cannot easily be obtained.

The OECD report acknowledges that tax avoidance is disabling government’s ability to stimulate the economy and forcing ordinary people to pay higher taxes for a crumbling social infrastructure. It calls for curbs on artificial shifting of intellectual property to jurisdictions with little trade. It calls for limits on the deductibility of expenses from taxable profits relating to intergroup loans and other transactions.

The real problem is that the report is trying to patch up the current tax system rather than promoting any fundamental reform. The fault lines identified above are not addressed. The OECD has rejected the consideration of alternatives.

The OECD report has intensified the debates, but does not offer any immediate solutions. That will depend on the responses of various nation states as they respond to demands of local politics and also compete to attract corporate investment by offering lower taxes though the OECD warns against harmful tax competition. It will be some time before tangible outcomes, if any, can be delivered.

The Conversation

For the full article by Prem Sikka, accountancy professor and co-founder of the TaxJusticeNetwork, visit The Conversation website.


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