As Copenhagen Business School’s Brooke Harrington points out, in a world where 0.7% of the global population owns 41% of its total assets, it is difficult to argue without reproach that the current global economic system is working fairly and well for all. There is growing agreement that the status quo is not sustainable. As a tax professional I firmly believe that tax needs to be part of this global debate. Although tax alone cannot solve this problem, the “global south” needs governments, business and civil society to embrace a Responsible Tax approach together.
0.7% of the global population owns 41% of its total assets
However, as with most things in life, and seemingly everything to do with tax, there is rarely an easy answer.
In this article, I discuss some of the issues and challenges of the developing world from a Responsible Tax perspective. I also set out my views on where the debate could be more profitably focussed and what is required to keep momentum going in this space. I should start by declaring an interest. This is a personal as well as a professional passion. I am not just an advocate for Responsible Tax practice but also someone who cares deeply about the African continent in particular. I have lived in West Africa and consider the continent in many ways my second, if not spiritual, home.
1.Corporate Income Tax is not necessarily the “correct” answer
Much is said of the fact that developing countries are more dependent on corporate tax revenues than developed countries (in that a bigger part of their revenues come from this source). This is true, but it does not necessarily mean that the answer is to increase the amount of corporate tax charged on inbound investors. The other side of the coin reveals the difficulties developing countries have in collecting tax from a wider spectrum of taxpayers. The OECD document Illicit Financial Flows from Developing Countries: Measuring OECD Responses (2014) calculates that the informal economy of these countries is 40% on average and up to 60% in some while the VAT “gap” can be up to 50-60% in comparison with 7-13% in developed countries.
Much (mis-)information swirls about low corporate tax rates in developing countries and/ or “major corporates” being excused obligations on corporate income tax. Too often, however, commentators and activists look in the wrong places and vilify some players unfairly.
So let me restate, corporate income tax is not always the answer – as many economists point out, it can cause fiscal drag and damage the local economy more than other taxes.
I understand that a corporate tax adviser, suggesting that corporate tax is not necessarily the best answers to closing the inequality gap and building a strong and sustainable economy welcomes cynicism. But I care about this debate and its impact on developing countries. So let me restate, corporate income tax is not always the answer – as many economists point out, it can cause fiscal drag and damage the local economy more than other taxes. The goal for developing countries should involve the search for long-term, more stable forms of taxation – a greater diversity of revenue and taxation sources. The recent collapse in global commodity prices is relevant: any nation-state which pinned its tax-take hopes on the corporate income tax collection from a particular multinational or group of multinationals (say, in the extractive industries) a few years ago, might find themselves staring into a tax vortex right now.
There may well be a case to say that we should look again at how taxing rights are allocated between source and residence countries. However this still leaves us with the answer that taxing gross income (in the form of withholding tax) instead of profits often makes investment uneconomic and reliance on taxing profits is a dangerous place to be. In the long run I believe that an over-dependency on corporate income tax impedes development.
2. Finding the best resources to tax
it is obviously important that the global system for taxing corporate profits is as fair (as it ever can be!) to all concerned and specifically protects the interests of the poorest
Having said this, corporate tax remains an important source of revenues in most countries so it is obviously important that the global system for taxing corporate profits is as fair (as it ever can be!) to all concerned and specifically protects the interests of the poorest.
A lot of coverage on this issue in recent years has given the impression that tax planning activity, which could be loosely described as “base erosion and profit shifting”, was directed at diverting profits from developing countries. There is little evidence that this has been the case – instead this activity (which is now largely, though not completely, a thing of the past) tended to reduce taxable profits in developed countries. As an example, many of the high profile State Aid cases launched by the EU Commission effectively involve a debate about whether US companies have eroded their tax base in Europe or whether the EU is trying to tax what is in fact US profits.
Similarly, commentators and activists too often see tax competition being waged between the developed and the developing countries – sometimes portrayed as the global north only taking from the global south. This is misplaced. The real competition for the tax take is usually between “peers”. The developing nations compete for inward investment between themselves in particular areas, especially the extractive sector. The “developed” are themselves frequently in tax competition related to intellectual property, head offices and finance activities. Any business making tax a factor in choosing where to invest will only do so where other factors (such as access to resources, the quality and availability of workforce etc.) are broadly similar. However it is important that developed countries should continually consider, as Ireland have, what spill over effects their international tax policy has on developing countries.
In other words, there is unlikely to be significant concealed stashes of corporate tax revenues available to those working in the developing world. My concern is that this belief diverts attention from the real issues which need to be resolved if tax is to play its true role in development. Each country needs to build resilience, continuity and stability in its own system, first and foremost. And the focus needs to be on what system and combination of taxes is right for each country rather than a sterile debate about just the rate of corporate tax.
3. Holidays tend to be a political negotiation
One note of caution I would sound on this relates to tax holidays. There has been much criticism of the tax holidays negotiated by nation-states with large multi-nationals. In my experience, this is usually a political, not technical, negotiation – and one which recognises the trade-off between scale, stability and circumstance. As tax advisors do not tend to get involved in these negotiations I have no personal experience. I do share the concern that, in some cases, businesses may have been able to use significant bargaining power to obtain a tax relief which is not fully justified. On the other hand, I do know from personal experience that the cost of operating in developing countries is very high and that some projects would not go ahead if the post tax return on investment is too low to be sustainable. I also think that governments of some developing countries are more able than they seem to be given credit for in making wise decisions.
4. Zero-rate tax does not always spell “haven”
Nought per cent corporate tax should not automatically put a country on a “tax haven blacklist”. 0% might in fact be a legitimate business proposition that supports the life-blood of a particular national economy, including its poorest members. Of course, one might argue about whether the balance between different taxes is right or fair within a particular economy but the choice of 0% is as valid as the choice of any other rate. What is important is that there is sufficient transparency to ensure tax payers are not evading tax in their home jurisdiction (and many of the so-called tax havens have been quicker to embrace tax transparency than their on-shore cousins).
In terms of tax planning and using 0% locations, international investment structures are mostly designed not to evade or avoid tax but to prevent economic double-taxation – at the other end of the “unfairness” spectrum. Providing tax neutrality is a legitimate exercise – as long as it does not move the tax base from somewhere else, where it would otherwise have been taxed. Of course, specific reliefs and exemptions may exist elsewhere (most notably, via the US tax code) but – in this instance – this is the policy choice of another sovereign government (e.g. the US) and it is that country which is either relinquishing or deferring its tax take. This, as PresidentTrump may be focused on – is not, for example, Bermuda’s issue – but one of US policy. A change in strategy here could well lead to significant consequences elsewhere but that is a manifestation of tax co-operation (or a lack of it) and not a function of 0% corporate tax.
5. Where the debate should be focussed?
As I have said, one of my concerns about the focus on corporate tax is that it diverts attention from the bigger issues. The questions that I would like to see discussed include:
- What is the right balance of different taxes that would lead to sustainable revenues of the type needed to fund infrastructure development?
- Should there be new “green” taxes on limited natural resources?
- Given their efficiency, how can we design and implement indirect tax systems which are effective and progressive?
- How can we combat corruption and evasion and build mutual trust in national tax systems in developing countries?
- What can be done to build capacity in the tax policy capability and tax authorities of developing countries to ensure that they are able to police their tax borders?
6. What do we need to do?
I have often said that the historical tax debate has been dominated by men on mountaintops (and it is usually men) shouting through megaphones. Megaphone diplomacy – as the world has come to understand – rarely works and that is why, in the Responsible Tax project, we have created a series of safe spaces for a range of diverse and often dissenting voices to be heard. Continuous conversation is essential – and that conversation is often richer and more productive when the various parties can demonstrate and open, humble and vulnerable approach to one another. This builds confidence as well as trust.
We need to challenge those countries, for example, that are resistant to transparency of reporting under CRS.
Unhelpful “outliers” of course exist – both in business and in certain national governments. We need to challenge those countries, for example, that are resistant to transparency of reporting under CRS. Our instinct is that this probably allows continued tax evasion, and possibly worse, the funding of terror and the laundering of the proceeds of crime. But this needs targeted action, not a blunderbuss approach. In an age of populism and demagoguery, we can all see – but should resist - the temptation to jump aboard the noisier bandwagons. A Responsible Tax approach means we cannot confuse the guilty with the innocent, and therefore stifle real progress elsewhere. Nowhere is this more important than in understanding the needs, hopes and aspirations of the developing world.
While I believe there is no easy, silver bullet, to resolve the problems we face I do believe that we can develop a better, fairer and more responsible system. I think the groundwork for that needs to be laid in a broad based dialogue that involves the tax profession, business as well as government and civil society. For my part I commit to engaging to the fullest extent I am able with everyone who shares the ambition of developing a more responsible tax system.
by Jane McCormick
Areas of expertise Operating Effectiveness Pensions and Retirement Funds Tax Tax planning Tax strategiesEducation and qualifications MA St Hugh's College, OxfordAccreditation HM Inspector of TaxesProfessional Associations Forum for Tax Professionals Tax Policy Committee of the ICAEW