No Country for Large Profits: G20 Endorses Plan to Update Tax Rules

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OECD plan lays out new rules for addressing corporate tax avoidance.

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Headlines about corporate tax avoidance by multinational companies have grabbed the attention of the public for years.  Recently, the G20—a group of finance ministers and central bank governors from twenty major economies—endorsed a fifteen-point Action Plan developed by the Organization for Economic Cooperation and Development (OECD) that is designed to equip governments with the domestic and international means to tackle tax avoidance by major corporations.

Among the leading developed economies that make up the membership of the OECD, corporate income tax provides revenues equal to around 3% of Gross Domestic Product (GDP) on average, or about 10% of total tax revenues, according to an OECD report.  The OECD’s recent Action Plan responds to a call from G20 Finance Ministers to address the growing problem of corporate tax avoidance by multinational companies known as base erosion and profit shifting (BEPS).

In remarks announcing the Action Plan, OECD Secretary-General Angel Gurría called the current international tax rules (many from the 1920s) “laudable” in ensuring that businesses do not pay taxes in two countries.  However, since companies were abusing the rules to produce double non-taxation, Gurría said the Action Plan is needed as a remedy so that “multinationals also pay their fair share of taxes.”

The plan is the latest from the OECD’s BEPS project, which analyzes whether current taxation rules in OECD countries allow for the “allocation of taxable profits to locations different from those where the actual business activity takes place.”  The new plan “recognizes that greater transparency and improved data are needed to evaluate and stop the growing disconnect between where the money and investments are made and where [multi-national enterprises] report profits for tax purposes.”  For example, the plan seeks to “stop the abuse of transfer pricing, by ensuring that profits can’t be artificially shifted through the transfer of patents, copyright or other intangibles away from countries where the value is created.”

In addition, the OECD plan recognizes the importance of “addressing the digital economy, which offers a borderless world of products and services that too often do not fall within the tax regime of any specific country, leaving loopholes that allow profits to go untaxed.”

The OECD justifies its BEPS work and Action Plan as central to its role in helping countries foster economic growth by creating predictable business environments in which businesses can operate.  An environment where some multinationals end up paying 5% in corporate taxes when smaller businesses are paying up to 30% undermines the entire tax system in the eyes of the public, the OECD argues.

According to the OECD, opportunities for multinational companies to pay less than their fair share of taxes ultimately harm everybody.  When tax rules allow businesses to shift income away from where it was produced, a country’s tax base is eroded, and the burden is shifted to individual taxpayers.  The resulting lack of tax revenue can even harm other businesses and society if those funds are not available for public investment that could promote growth.  From a competition perspective, the OECD claims that “small businesses, businesses working mainly in one national market, and new firms can’t compete with [multinational enterprises] who shift profits across borders to avoid or reduce tax.”  A multinational company that does not shift income is at a disadvantage to its income-shifting competitors.

The OECD plan identifies a number of complex methods by which companies legally shift profits across borders to take advantage of tax rates that are lower than in the country where the profits were made.  These methods are complex and have come under intense inquiry by government officials.

The issue of tax base erosion and profit shifting is of particular concern in the United States.  The share of corporate income taxes has fallen in the U.S. from 32.1% of federal tax revenue in 1952 to just 8.9% in 2009.  Over the past two years, a subcommittee in the U.S. Senate has called executives from Apple, Inc. and Microsoft Corporation to testify on methods allegedly used by the companies to shift their profits overseas.  Various tax practices by these companies came under questioning during the hearings, including alleged efforts to shift profit-generating intellectual property rights to offshore subsidiaries in lower or no tax jurisdictions.

The OECD has made clear that its goal in recommending new tax standards is not to punish the business community, but rather to ensure fairness and predictability in nations’ tax systems.  The actions outlined in the OECD plan will be addressed  in the coming eighteen to twenty-four months by the joint OECD/G20 BEPS Project, which includes all OECD and G20 member-countries on an equal footing.