Michael Durst: Rethinking the conventional wisdom on taxing multinational corporations.
Now Michael Durst, former director of the US Internal Revenue Service’s advanced pricing agreement programme, has written a forceful new article in Tax Notes indicating that one very important aspect the world’s dominant system for taxing multinational corporations, formulated and pushed forwards by the OECD, is not working. (TJN also notes that the global accountancy profession, derives substantial income from helping multinational corporations design their transfer pricing abuses, and has a massive vested interest in keeping the unworkable system going.) Durst goes on to explain aspects of the superiority of alternative approaches that have been repeatedly attacked by the OECD.
Durst's article is available here: we reproduce with kind permission from Tax Analysts.
Durst frames the issue in terms of ‘ad hoc’ methods of taxing multinationals (notably those put forwards by the OECD, where multinationals' accountants put together a particular, contorted legal structure for the corporation, typically with a key objective of minimising tax) versus ‘pre-established’ methods, such as the so-called ‘fixed margin’ methods used by Brazil, or a system of taxing multinationals known as "formulary apportionment," which is widely used by U.S. states and by Canadian provinces (and is being considered for Europe); where tax is levied according to fixed formulas based on sales, assets and payroll (more on that on those issues on the TJN transfer pricing page.)
Durst starts by taking apart the objections by the OECD and others who oppose the use of pre-established methods: notably that because different countries would adopt conflicting methods under a preestablished system, it might lead to corporations unreasonably getting taxed twice on the same income. Essentially, it is this argument that his article takes to task. Durst says:
"this conventional viewpoint is not only mistaken, but diametrically so."The argument is wrong for two key reasons. First, the "ad hoc" methods create as least as much conflict between countries' tax systems as the pre-established methods do:
"ad hoc transfer pricing methods almost certainly result in double taxation at least as frequently as do preestablished methods"The OECD even confesses that transfer pricing "is not an exact science," he notes, and
"the most that typically can be hoped for is not a single but instead a range of results, all of which might be seen as correct. . . . those ranges can be astonishingly broad"Second, preestablished methods do a better job than ad hoc methods of protecting taxpayers against uncertainty of effective tax rates:
"The taxpayer has no way of predicting the manner and extent to which the two countries’ approaches will differ [and] face a high degree of uncertainty as to the combined tax burden they are likely to face. . . . That uncertainty can be expected to discourage business investment."When 'pre-established' methods are used, companies will not face this uncertainty: to the extent that double taxation does happen, they will know this in advance, and can make a good decision on whether or not to invest. The OECD guidelines ignore this huge issue. Durst gives some numerical examples to illustrate his point.
TJN would add a third objection: the OECD seems paranoid about the possibility of double taxation, but seems rather unconcerned about what is sometimes called 'double non-taxation' - that is, where the income is taxed nowhere. But whose interests are more important here? Those of the multinationals? Or those of the wider societies upon which they depend, which provide these multinationals with so many benefits that many seem unwilling to pay taxes to support?
On the subject of double taxation, TJN would also add that one might consider it an issue that is being framed in the wrong way. It is complex, but typically a company subject to 'double taxation' might suffer it only to a certain degree, so it may suffers an effective tax rate of, say, 25 percent instead of 22 percent if it weren't suffering 'double taxation'. If one talks about 'double taxation' then accounting firms and multinationals will complain bitterly - but if you talk instead about a somewhat higher effective tax rate, then you have the basis for a far more reasonable discussion.
This will be added to our transfer pricing site.