Pressures on the global tax system
New and big pressures are building that are going to force change on the global tax system. There are many concerns: growing inequality within countries and the shift of income away from labour to capital which has occurred over the last 50 years; aging populations; how best to tackle climate change; more generally, how to finance the UN Sustainable Development Goals (SDGs). All these increase the demand for revenues but many around the world already believe they are over taxed. Corporation tax in particular has been in the eye of the tax storm as globalisation and digitalisation create new issues about what, how and where to tax businesses. Unilateralism competes with multilateralism; the demand for simplicity with the reality of complexity. The OECD and Inclusive Framework’s work considering the tax challenges of the digitalisation of the economy is addressing some of the issues. But are we asking the right questions? Do we know what are we trying to put right and what “good” will look like? Or do different stakeholders have diverging agendas so there will be dissatisfaction whatever the outcome?
To help the thinking of the global tax community, Jericho Chambers and KPMG International convened a Roundtable in Brussels at the end of June 2019 to dig deeper into all of these issues – a space for leading business and advisory practitioners, policy makers, academics, campaigners and the media to listen, learn, share and develop their thinking.
This is an overview of the conversations held under The Chatham House Rule – which means we can report what was said, but not who said it. The output of such a rich, complex and broad conversation is unsurprisingly neither conclusive nor all encompassing. But it is of immense value as we all try to negotiate these incredibly tough but vital public policy issues. It is one element of a series of events, blogs and research that will form the basis for a new publication from KPMG and Jericho, later in the year, to help accelerate the thinking and the change process about what constitutes responsible global tax.
Issues with the current internation corporate tax accord
It is important to understand what concerns different stakeholders have with the current international corporate tax accord and agree what issue(s) any proposals are designed to address. Without such clarity there is a risk that – whatever solution is finally agreed by the Inclusive Framework – some sectors will be dissatisfied, believe they have been ignored and continue to push for further change
A fundamental issue is that when the rules were first agreed upon it was not easy for a multinational enterprise (MNE) to make significant sales in a country without the need for some kind of physical presence there (whether a subsidiary, branch, or even an independent third party). Now it is possible for an MNE to make significant sales without such a presence. The destination country therefore see large turnovers with no, or minimal, taxable profits. This has led some NGOs, politicians and commentators to argue that countries are “losing” a significant amount of tax - although some delegates pointed out that in some cases the MNE may not be making profits at all: turnover and profit are very different. Furthermore, some of the figures which are discussed are inaccurate which does not help the debate. For example the EU Commission has repeated many times that highly digitalised companies have an average tax rate of only 9.3% when this, in fact, is a purely hypothetical figure based on models; in reality the average rate of tax paid by a highly digitalised multinational business is around 26%1. Nevertheless, the key point remains, if an MNE can make considerable profits in another country without paying tax there, does there need to be a change in the a balance of taxing rights?
Another concern raised was the way technology and digitalisation can create monopolies due to network effects which make market entrance to new businesses very difficult. Where there is a monopoly the consumer bears the cost. Digital taxes sometimes appear to be designed to address such issues - the aim being to tax a particular company or subset of companies rather than to identify taxable profits in the traditional sense.
It is therefore important to be clear on the aim and scope of any changes to the taxation of corporations. Is the intention to shift part of the tax base to market jurisdictions; is the concern only about digital companies; is there a general desire to increase the tax burden on companies; is tax being used as an anti-monopoly instrument? Furthermore given the impact of politics, the media, and public interest in the debate, it is important that any solution is understandable and seen to meet the concerns of all stakeholders. It was noted that if it is not clear what question is being answered, the solution the OECD Inclusive Framework eventually proposes will be criticised by those who feel it does not address their particular concerns. This will lead to continuing pressure for more change and therefore more uncertainty and potentially more unilateral action.
Reference was made to the IMF Policy Paper of March 2019, Corporate Taxation in the Global Economy, which examines the issues and possible solutions being discussed2.
Shifting the tax base to market jurisdictions
**The current international tax system is not fit for purpose in the 21st Century and needs updating which probably involves shifting part of the tax base to market jurisdictions; but there is no agreement yet as to how this will be achieved and to what extent it must involve abandoning the current arm’s length standard **
There was general agreement that the current international corporate tax accord is outdated and needs modifying. Some attendees felt that the arm’s length principle (ALP) was no longer fit for purpose and any solution which remained wedded to the ALP was “kicking the can down the road”. Should we only be looking at incremental change or was this time for a root and branch as review of international corporation tax? The perceived limitations of the ALP have led some academics and campaigners to propose formulary apportionment – although the EU proposal for a common consolidated corporate tax base has shown how difficult it could be get governments to agree to such a system. It was thought to be unlikely that we would move to a full formulary apportionment system in the immediate future.
Some delegates also thought the ALP was technically correct and only minor changes were needed. Furthermore, the Inclusive Framework has not agreed upon a new set of fundamental principles. The original OECD Base Erosion and Profit Shifting (BEPS) initiative led to a focus on taxing where there is “value creation”. However this is not a bright line test as there are many different views on what creates value - for example the debate about whether users of certain digital services are creating value for the service provider and, if so, how much value.
There is a general acceptance within the Inclusive Framework that there needs to be some shift of the tax base to market jurisdictions. At present, some kind of modified residual profit split does seem to be the most likely way forward as it allows some greater allocation to market countries with a formulary element. Nevertheless concerns were raised that the current proposals before the Inclusive Framework are extremely complicated.
It was also thought that there is more likelihood of agreement on a global minimum tax, especially amongst the G20 countries. Furthermore, countries could implement such measures without global agreement.
Destination based cash-flow tax
**A destination-based cash-flow tax would be the most robust system to stop profit shifting and could encourage investment and economic growth. However, there has been little discussion about such theory within the Inclusive Framework workplan and there are objections that consumption taxes should be the main tax on the consumer base, not corporate tax **
Corporation tax can distort business behaviours and there are also concerns about competition between countries which could lead to a race to the bottom. A fundamental change in corporation tax which could address these issues would be a destination-based cash-flow tax (DBCT). The way it is designed, taxing the cash flows, encourages investment and should help economic growth – which none of the other proposals for change would do. The fact that it is charged where the customer base is located means it is less distortionary than other forms of profit tax as customers are an immovable asset.
A destination based tax would need to have a carve-out for extractive industries - otherwise it could shift the tax base away from the source country to where natural resources are consumed; this would be particularly detrimental to developing countries which rely heavily on such a tax base. Although there are concerns that destination based taxes in general would favour large consumer countries such as the US and China, IMF research has concluded they should also help developing countries. They believe this because developing countries tend to consume more than they export and also some of their consumption is financed out of aid or remittances from their own nationals working abroad. A concern was raised though this may mean that if country’s economy grew to a stage where it was producing and exporting more than it was consuming, the DBCT may then be a less favourable type of regime precisely at the point that the country was transitioning from developing to developed status.
It was also noted that indirect taxes and customs duties are taxes collected with reference to customers in the market jurisdiction - does it make sense to have corporation tax charged by the same criteria? Some of the attendees favoured maintaining a focus on identifying where value is created rather than making corporation tax more consumption based.
Respecting the key principles of an international accord
Whatever changes to the international accord are eventual agreed, it is important that certain key principles are respected
Businesses are largely agnostic to what the eventual outcome is or where they have to pay tax, provided the rules do not created double taxation and are as simple and certain as can be achieved.
It was generally agreed that any changes to the tax regime would need to respect a number of principles:
- Simplicity - which is particularly important to enable developing countries to properly administer the tax;
- profit based;
- one level of taxation - with no double taxation or non-taxation;
- applicable to all businesses in general - although it was accepted that it may be necessary to carve out specific industries, e.g. the extractive industry;
- agreed multilaterally - although it was also suggested there may be room for regional approaches rather than unilateral ones if a global agreement is reached;
- based on sound fundamentals, and not just a political compromise, so as to be robust and durable
Creating a more equitable society
Modernising corporation tax will not deliver all the revenues countries need; we need to be considering a much broader range of taxes and how they fit together in any one system. Furthermore, tax is only one instrument in producing a more equitable society
It was noted that there needed to be honest discussions about what public finances we needed and why.
While companies need to pay tax for a variety of reasons - including the fact that they are benefiting from services and infrastructure in the countries in which they operate and make sales - corporation tax is not the only, or indeed the main, source of tax. Changing business models have also uncoupled the historic link between profits and share value. Once the share price and so the wealth of shareholders was strongly linked to a company’s profitability. Now it is possible for a company to have losses for many years while the share price increases rapidly. It is therefore necessary to look at a broad range of taxes including for example, increasing green taxes, taxing “bads”, taxing wealth, as well as more traditional forms such as indirect taxes and income taxes.
Furthermore in considering the wider issues of concern about globalisation and inequality, tax is not the only solution: we need to look at such issues as fair wages and responsible business conduct more generally.
One delegate suggested that an increased use of technology and data analytics may even make it possible to tailor specific tax regimes depending on a company’s characteristics, including for example environmental impact, which may make taxation a more technical and less political issue.
Simplifying international tax rules
**Any changes to the international rules must not disadvantage developing countries and there are arguments for having simplified rules, for example using safe harbours, for countries which lack administrative capacity. While tax is a legitimate lever of industrial policy, unfair tax competition should be addressed **
Corporation tax is more important for developing countries than developed ones in terms of tax: GDP ratio as it is harder for the former to collect other forms of tax such as income tax. Therefore any solution needs to take into account the impact on developing countries, especially Low Income Countries (LICs). For this reason it is important that the Inclusive Framework is genuinely inclusive. A concern was expressed that as the group becomes larger it naturally becomes harder to reach consensus and in fact power becomes concentrated in the hands of the largest players; although there was no obvious answer to this paradox.
It was also suggested that to assist LICs which lacked capacity to implement complex new rules it may be necessary to have a dual system where they could apply simplified rules such as interest caps and safe harbours for transfer pricing.
Potential spillover effects need consideration to avoid tax changes in some countries inadvertently impacting on the tax base of others – which again can be a particular problem for developing countries. Countries do provide tax incentives and use tax as a lever of industrial policy and this is legitimate provided it does not become harmful competition. It was noted that tax and industrial policy had been very successful in developing the Irish economy in the 1980’s and 90’s. However, is it necessary to have a global agreement about what constitutes unfair tax competition? There are, for example, generally accepted norms about free trade and the benefits of reducing barriers and tariffs, but lesser agreement about tax policy. As regards trade, if the larger economies all agree, this affects the majority of world trade creating a global benefit. However, with tax there is the potential for small jurisdictions to influence corporate decisions so it is necessary to have broad agreement covering all countries.
Engaging all stakeholders in the debate
**While there is a general recognition that some change is needed, the end result is still very much work in progress. It is important that companies and all stakeholders actively engage in the debate **
There was general agreement that the corporation tax system needs updating and in a way that allows more profit to be taxed in the market jurisdiction but is not over complicated and is administratively workable. The basics need to reasonable understandable to the public and the solution should be multilateral. Currently there seems to be most support for some kind of modified residual profit split proposal but it is still not clear if there will be global agreement within the 2020 timeframe. The IMF is assisting the OECD with an impact assessment of the various proposals and this will be very important in deciding the way forward. It is equally important though that companies – and indeed all stakeholders – speak up and put forward both concerns and proposals.
In attendance of the discussion:
- Thomas Debeys, Vice President, Head of Tax & Financial Compliance, UCB
- Susanna Di Feliciantonio, Head of European Affairs, ICAEW
- Dr Charles Enoch, Academic Visitor, St Anthony's College, University of Oxford
- Paul Gisby, Manager, Accountancy Europe
- Ali Hamza Ali, Senior Reporter International Tax, Bloomberg Tax
- Neal Lawson, Partner, Jericho Chambers
- Ewan Livingston, Cause Strategist, The B Team
- Jane McCormick, Global Head of Tax, KPMG International and Non-Executive UK Board member, KPMG in the UK
- Ruud de Mooij, Division Chief, Tax Policy Division, IMF Fiscal Affairs Department
- Chris Morgan, Head of Tax Policy, KPMG International
- Ben Pickford, Senior Manager, International Tax, Amazon
- Stella Raventós-Calvo, Chair of The Fiscal Committee, CFE
- Erik Stessens, Senior Vice President, Tax, Europe and APMEA, Mastercard
- Koen Van Ende, Partner, KPMG in Belgium
Chris became Head of Tax Policy for KPMG UK in 2011. In this role he was a regular commentator in the press, as well as on radio and TV, led discussions on various representations with HMRC/HMT. In 2014 Chris spearheaded KPMG UK’s Responsible Tax for the Common Good initiative. In September 2016 Chris took on the role of Head of...