Adopting a unitary approach to taxing multinationals - here and now

Guest blog, by Professor Sol Picciotto

The main response to my paper on unitary taxation published last week has been that it would take too long or be impossible to agree. Pascal St-Amans, the OECD’s head of tax said it would take 150 years, and even Margaret Hodge M.P., chair of the UK Public Accounts Committee (PAC) is quoted as saying that although it seemed like a `really good idea’, it would take `forever’.

Not so. The paper itself lays out a clear road-map, which includes steps which could be taken immediately to begin adoption of a unitary approach.

Unfortunately, some people have spent too long labouring in the salt mines of the OECD’s Transfer Pricing Guidelines: They need to get out and look at the real world. Only a few days after my report was published, Jesse Drucker reported for Bloomberg that Google avoided about $2b in taxes worldwide in 2011 by shifting about 80% of its total pre-tax profit, some $9.8b, to Bermuda.

The trouble is that the OECD approach starts from the wrong end. Its starting point is, for example, the accounts of Google UK, Amazon UK, and Starbucks UK. Not surprisingly, the declared taxable profits of these entities are low or zero, despite the enormous business they do here. Equally unsurprisingly, a large part of the enormous revenues generated by that business is channelled to companies such as Google Bermuda, Amazon Luxembourg, or Starbucks in The Netherlands. The OECD view is that these entities must be treated as if they were completely independent of their UK sisters - which is nonsensical.

A unitary approach would do what any sensible person would, as even the M.P.s on the PAC did, and compare the profits shown in the UK with the share of the companies’ worldwide business actually done in the UK. If they are seriously out of line, as they have been shown to be, the UK companies’ taxable profits should be adjusted accordingly. 

HMRC’s lawyers should show themselves to be as ingenious and determined in interpreting the law as those working for the tax-dodgers. They could challenge Amazon’s attribution of profits from UK sales to Luxembourg when they are plainly inextricably tied to Amazon’s UK distribution and sales support operations. They could apply the profit split method, accepted in the OECD Transfer Pricing Guidelines, to adjust the intra-firm accounts of Starbucks, instead of being bemused by chimerical `comparability’ claims for royalty rates and coffee bean prices. HMRC’s failure to require this has now been shown up by Starbucks’ own voluntary acceptance of such an adjustment, under public pressure of course.

The OECD Guidelines acknowledge that `transfer pricing is not an exact science but does require the exercise of judgment on the part of both the tax administration and taxpayer’. It seems that the companies’ judgment is a lot better than that of the tax authorities.

The international tax rules were first formulated a century ago. As my report shows, they aimed mainly at international lending (portfolio investment). In this context, the separate enterprise principle made sense, so it was adapted to apply also to foreign direct investment by multinational companies. But tax authorities well understood that multinationals could exploit the opportunities for profit-shifting. They used simple but effective counter-measures. The UK report to the League of Nations study of transfer pricing of 1932 stated that in 45% of cases the profits of local affiliates of multinationals had to be adjusted by reference to their percentage of turnover or another appropriate factor. This had a salutary effect, since `the fact that the revenue authorities have the alternative of basing profits on a percentage of turnover prevents the taxpayer taking up an unreasonable attitude’.

In the past few decades, international tax regulations have become extraordinarily complicated, and equally incredibly ineffective. Rewriting them will clearly need a fresh start, and that will indeed take time. But, as Pascal St-Amans well knows, the building blocks are already available. The European Union already has a draft Directive, approved by the European Parliament, under current consideration by the Council of Ministers. It could certainly be improved, but it is a step in the right direction. UK government support would give it a great boost, but until now it has expressed steady opposition, along with Luxembourg, Ireland and The Netherlands.

International agreement on an allocation formula would indeed take some time. But the US experience of formulary apportionment of state corporate taxes shows that such an agreement is not necessary. States must counter-balance their claims to tax with their desire to attract investment, and this produces an acceptable degree of convergence. The German report to the same League of Nations study in 1932 hoped that the experience gained by ad hoc adjustments of accounts by tax authorities would lay the basis for more general principles for profit apportionment. Eighty years later we are still waiting.

In the meantime, tax authorities could use the weapons already at their disposal much more vigorously. The meek attitude they have shown to multinationals is not all their fault: they may have fallen into line with the pro-big-business views of their bosses in the UK Treasury and most government ministers. Perhaps now that they all are beginning to understand that public opinion will no longer find this acceptable, they will see the need for a new approach.

Sol Picciotto