OECD unveils major (and welcome) report on corporate taxation

The OECD has published a major new report on corporate taxation, entitled Addressing Base Erosion and Profit Shifting.

Although there are plenty of things we would disagree with in the report, and some sniffy references to "non-governmental organisations" (meaning, substantially, TJN and its close allies), we welcome this new report as a potential game-changer: an excellent start to a potentially serious overhaul of the international tax system. The OECD tax project has serious political tailwinds behind it now, thanks in no small part to the efforts of TJN and our various allies in different countries, and this report suggests to us that they are using these tail winds to grasp seriously this opportunity to open up and push for decisive action. They seem, at least on the evidence we have at this stage, to be willing to move fast on a re-evaluation of international tax rules, and to get something firm into place quite quickly.

Here is a quote from the text, which is a(n important) detail in the larger scheme of things, but shows how the report is prepared to challenge old shibboleths:

"the major challenge is not only to identify appropriate responses, but also the mechanisms to implement them in a streamlined manner, in spite of the well-known existing legal constraints, such as the existence of more than 3 000 bilateral tax treaties. It is therefore essential that countries consider innovative approaches to implement comprehensive solutions."

That is a tacit admission by the OECD that the network of international tax treaties, which are drawn up substantially under the guidance of OECD models, constitute an obstacle to progress. Does that last sentence open the door to the potential for a multilateral tax treaty among key states, overriding the current mess of bilateral treaties that collectively help cement the separate-entity principle? Time will tell.

The OECD has also in the past spoken repeatedly about the perils of 'double taxation' of corporations due to overlapping tax claims of different jurisdictions, but has been far less interested in talking about '“double non-taxation” - that is, where the corporation gets taxed nowhere. We are delighted to see several references to double non-taxation in this report.

TJN Senior Adviser, Prof. Sol Picciotto, said in a brief summary:

Positives in the Report:

• It accepts that there is a serious problem of under-taxation of TNCs, which it calls `double non-taxation’. 

• This is allowed and indeed encouraged by some features of current international tax rules. 

• Comprehensive solutions are needed. 

• Nothing is excluded, the aim is to provide effective solutions.

• Significant changes are needed to current rules including tax treaties.

The Report identifies six problem areas. In the view of TJN, the main structural cause of all these problems is the reluctance of tax authorities under the current system to look at TNCs (transnational companies) as global firms. Instead, each tax authority looks only at the local affiliates of the TNC, and then tries to understand the economic and other relationships those affiliates have with other parts of the TNC. It's a bit like trying to identify an elephant by feeling one of its legs.

This `separate entity’ approach unfortunately became a dogma for the OECD especially in the 1980s, and has been embodied in many of the rules it has developed since then. This approach results in artificial shell companies, for instance, being treated as real entities, when they are in fact just shells that could and should be disregarded. The problems can be seen most clearly in the OECD's Transfer Pricing Guidelines. However, the emphasis on the 'separate entity' approach also underlies the failure of CFC rules, which states are now abandoning. The need for a more systemic solution in place of the piece-meal approach to `harmful tax practices’, which the OECD now recognizes, also points to the importance of tax rules which treat TNCs on a unitary basis.

We therefore welcome the new approach signaled in the BEPS report, aiming at a comprehensive solution. This does not require abandonment of the current system and its wholesale replacement with an alternative. Many elements of a unitary approach have long been part of international tax rules, and some remain today.

We agree that the main aim should be to end the systematic avoidance which leads to large tax losses overall, or double non-taxation. This offers a win-win for both developed and developing countries. Business will also benefit if the changes result in a more level playing field, fewer incentives to engage in aggressive and expensive tax planning, and a more rational basis for decisions on location of investments. At the same time, care should be taken to ensure that both transitional and longer-term arrangements safeguard and if possible improve the position of countries which are mainly capital-importing, as regards both tax revenues and their ability to attract investment without sacrificing them. We suggest that this is a better way to understand the issue than the opposition between source and residence, which is one of the damaging results of the reliance on separate entity concepts.

 Update: others are less impressed by the OECD report. As Martin Hearson puts it:

"Vanessa Houlder at the Financial Times [£] is in the unusual position of being more sceptical than TJN, writing that there is “no sign of going back to the drawing board in this report” and noting instead a “lack of enthusiasm for a radical rethink.”

We disagree with some of his analysis, and we hope he is wrong in terms of the thrust of it. Given the OECD's track record, his caution is certainly justified.

This time around, we thought we'd focus on the positives. And there certainly are many. Remember, though: these are merely openings to change, rather than change itself.