The UN ECOSOC Meeting on International Cooperation in Tax Matters convened in New York on 7th April 2017. Discussions covered evolutions in tax policy with the goal of stabilising sustainable growth in developing countries. A key theme which emerged was the delicate balance between revenue raising and encouraging investment.
Main issues covered included:
- The behaviour of MNEs and how they interact with government structures, often with both sides thinking the other unreasonable. It is clear meaningful discussions are needed to correctly identify possibilities to encourage inward investment while protecting and improving revenue collection in host countries.
- The need for legislation to keep up with changes in business models, especially given developments in digital technology.
- Rebalancing source and residence taxation.
- The importance of drawing a clear distinction between illicit financial flows and aggressive tax planning, and how to effectively combat IFFs.
Democratically agreed objectives across all taxes
Given the complexity of these concerns, magnified by the fact each country has its own particular problems and priorities, a single blueprint for a tax policy does not appear to be a legitimate aim. It is essential policies are crafted to target democratically-agreed objectives specific to each situation and which include all taxes, not just corporation tax. A lesson which emerged was the need to create open and constructive dialogues on tax in the developing world – one that involves all stakeholders.
UN Economic Social Counsel Special Meeting on International Cooperation in Tax Matters
On 7 April I attended the UN Economic Social Counsel Special (ECOSOC) Meeting on International Cooperation in Tax Matters in New York. It was a fascinating day which gave a snapshot of both some of the positive developments of tax policy relating to the developing world and also of some outstanding issues and concerns.
The key note address by Ms Tumusiime Rubagumya, Commissioner, Legal Service & Board Affairs, Republic of Uganda, set out many of the themes that ran throughout the day. There was a significant concern amongst delegates from developing countries about the behaviour of multinational enterprises (MNEs) such as artificial structuring, treaty shopping and abuse of transfer pricing. There was also a concern about the impact on the tax base of new business models, in particular where it is possible for MNEs to sell into developing countries via the internet without having a taxable presence. A third area of concern was illicit financial flows.
Strengthening compliance vs attracting inward investment
The Commissioner noted the tension between a country strengthening compliance and also needing to attract inwards investments. What struck me was that these should not be in opposition: it would be a mistake to encourage investments by relaxing compliance. Rather, tax laws should be set with promoting economic development in mind (as one factor) and should then be correctly enforced. This accords with the conversations I have with multi nationals and with the annual tax survey which KPMG in the UK carries out where respondents from the business community consistently say that stability and predictability are the most important aspects in a tax system.
My biggest take away from the whole day was the real need for continual, in depth, open dialogue between all stakeholders involved - including developed and developing countries, business, advisors, supranational bodies and civil society – to address both the issues of revenue raising and encouraging investment. I have set out below some of the things emerging from the different panel sessions to highlight why such collaboration is necessary.
The UN Model Tax Treaty and Division of Taxing Rights
One of the sessions dealt with some updates to the UN Model Tax Treaty, in particular an optional article allowing for withholding tax to be charged on technical fees. This was presented by various speakers both as a way to address changing business models which are eroding the tax base in developing countries (as technology is making it easier to provide services to a country without having a physical, taxable presence there) and to stop avoidance. This is a good example of the need for clarity on what a measure is designed to achieve.
The issue of the impact of digital services on a country’s tax base continues to be hotly debated. It was Action 1 in the OECD BEPS program and no solution was found. Imposing a withholding tax on fees, especially when paid from a developing country, may be a legitimate way of rebalancing taxing rights between the source and resident state. But as one delegate noted, this is a landmark article and there is a delicate balance between extending taxing rights of the source state and encouraging inward investments.
Another delegate presented a scenario of a MNE which has a subsidiary in a developing country which is paying tax on all its profits which it then dividends to its parent incurring a further withholding tax. If the MNE changes the structure and extracts most of the profits by way of a technical fee, under current laws the subsidiary obtains a deduction for the payment and there would usually be no withholding tax. The tax take in the developing country is significantly reduced. The Model treaty therefore allows a withholding tax to be applied to that payment. However this is confusing two issues. One is a policy decision about the taxing rights between resident and source states and the other is about anti-avoidance rules. In the example given the solution should be for the developing country to deny a deduction and impose a withholding tax on a deemed distribution if the payment has simply been made to shift profits out of the jurisdiction.
In other words it should not be assumed that all fees paid from a developing country are abusive and should be countered by the general imposition of a withholding tax. If a payment is abusive it should be challenged under anti-avoidance rules. If it is genuine and made at arm’s length, the question is one about who has primary taxing rights. It is necessary to consider if a withholding tax should be applied and at what rate that might result in double taxation which would undermine investment and increase the cost to the developing country of receiving those services.
Collaboration and the UN Practice Manual on Transfer Pricing
Another session discussed the newly released UN Practice Manual on Transfer Pricing for Developing Countries. The Manual was developed by the Platform for Collaboration on Tax which is a collaboration between the IMF, OCED, UN, and World Bank. The initiative will provide a valuable resource for developing country tax authorities. Stig Sollund, Coordinator of the Sub-Committee on Transfer Pricing, expressed gratitude for the practical assistance given by business in developing the Manual. Presentations from delegates did show, though, where a further open is required.
More than one of the delegate believed that MNEs charge management fees in order to shift profits out of their jurisdiction. Concern was expressed that often the local tax authority does not know the entire cost base in the head office for providing the services, or how it is recharged between all the various subsidiaries including those in developed countries. However in our experience MNEs do not use management services for profit shifting purposes. They incur costs in the head office - e.g. for the finance, marketing or IT departments - because they believe the services benefit the group as a whole. They then need to recharge these to all their subsidiaries as the parent jurisdiction will not give them a tax deduction for these costs under normal transfer pricing rules. If there is then a denial of a deduction by a developing country, the result is double taxation. A number of different of solutions could be proposed but clearly there is a need for greater dialogue and transparency in this area as both parties think the other is acting unreasonably and the result is protracted disputes and increased costs.
How do we counter illicit financial flows?
Illicit financial flows (IFFs) were also the subject of discussion. It was recognised that there is no one definition but delegates agreed it generally refers to funds that are illegally earned, transferred or utilised. What was noticeable was that, despite this definition, delegates then spoke mostly about transfer (mis)pricing and tax avoidance. Clearly this needs to be dealt with but my view is that confusing it with IFFs is not helpful as tax avoidance/aggressive planning is a different phenomenon from criminal activity and different responses are required. Two examples serve to show this.
There are increasing calls for MNEs to publicly release country by country tax information in the belief it will dissuade aggressive tax planning. Often the need to stop IFFs is also used as a justification. However such reporting is unlikely to affect IFFs – such as tax evasion, bribery and money laundering - as criminals will not be using MNEs which would be required to report and, in any case, will be deliberately trying to conceal information not make it public. Tackling IFFs requires different tools such as regulation of corporate service providers, giving relevant authorities access to beneficial ownership information, automatic exchange of information under the Common Reporting Standard and international money laundering rules.
The second example concerns asset recovery. During one of the breaks I had a discussion with some of the delegates who wanted to know what KPMG would do if they discovered that a client had illegally accumulated funds in an offshore jurisdiction. I explained how we apply money laundering rules; but their concerns were that there are inadequate international mechanisms for recovering stolen assets. I pointed out that if the issue is one of tax avoidance - e.g. transfer (mis)pricing - recovery mechanisms already exist. In such a case both primary and secondary adjustments can be made to rectify the position. If there is a problem in the recovery area it appears it needs to be focused on repatriation of funds which are the product of evasion, bribery and other illegal activities.
Corporation tax is not the panacea
The final session dealt with strengthening tax capacity in developing countries. It is encouraging to see that the OECD, UN, IMF and World Bank were working together under the Platform for Collaboration on Tax. Pascal Saint-Aman said that whilst the speakers were from four different organisations they spoke with one voice. He then presented eight practical tool kits for assisting developing countries covering.
This session also touched upon a key area which was not covered in the ECOSOC meeting in general. Marijn Verhoeven of the World Bank noted that it is generally considered that countries need to raise tax revenues equal to more than 15% of GDP in order to have sustainable growth. However, the way in which it raised - to promote trust, good governance, fairness, economic growth - is as important as the figure. Returning to the key notes speech of Ms Rubagumya, it seems to me that the focus is sometimes only on how to collect more tax from MNEs. But as Jane McCormack points out in her article “Developing Thinking on Responsible Tax” (11 January 2017) this is only part of the story.
There are various figures estimating how much tax is lost to developing countries through tax avoidance and exemptions but the consensus is about $100-$200bn annually. However, as Maya Forstater1 has pointed out this relates to all developing countries including China, Brazil, Mexico and South Africa, not just low income developing countries. That equates to about $20-40 per person average. While this is not an insignificant sum, it is clear that increasing the tax to GPD ratio to the levels required to reach the Sustainable Development Goals would require much broader measures.
This raises the issue of how to levy more tax domestically. Part of the problem that developing countries face is a large informal sector where many professionals and small business are not paying tax. The OECD 2014 paper, Illicit Financial Flows from Developing Countries: Measuring OECD Responses, notes that on average about 40% of GDP in developing countries is in the informal sector, and up to 60% in some. The VAT gap can be 50-60%. But deciding which taxes to raise and by how much is not simple. The advantage of increasing direct tax is that it can be made progressive through exemptions and rate differentials. However, if it is too high it will stifle entrepreneurships and economist generally agree that tax on business profits is the least efficient in terms of economic growth. By contrast consumption tax can have a broader base, be harder to avoid and have the least impact on economic growth; but consumption tax is regressive, although it may be possible to offset some of the effects through cash transfers.
Ultimately there will not be one blue print for a perfect tax. Tax policy must be drafted according to a country’s specific environment including its natural resources, size, wealth etc. And it should focus on a variety of democratically agreed objectives such as development, redistribution, promoting growth, and protecting the environment. What will be required is a mixture of taxes - corporate, personal, employment, consumption, property, transactional and specific duties such as on alcohol and tobacco. It is clear therefore that no one person is likely to have all the answers. Crafting a regime that is right for any particular country will require an open dialogue with all the stakeholders.
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...