The OECD has opened up a comprehensive review of international tax rules, and the International Monetary Fund paper, signed off by their board and published today, represents an important intervention. Tax Justice Network chief executive Alex Cobham said:
“The arm’s length approach has let multinational corporations get away with profit shifting to the tune of $500 billion in dodged tax across the world each year. The OECD has asked the question of whether it is time to for radical reform – and now even the IMF has joined the call we’ve been making for decades.
“The IMF has stressed that international tax rules should be reformed to prioritise reducing the glaring inequalities that lower-income countries face when it comes to their taxing rights. We also welcome the IMF’s support for replacing the arm’s length approach with unitary taxation and formulary apportionment, so that tax is paid where real business happens – not where profits are surreptitiously shifted to. As the IMF report says, this ‘would greatly reduce the scope for profit shifting’. The IMF’s research confirms that if multinationals were to be taxed in line with where their employees actually work, developing countries would see their tax revenue rise by over 30 per cent on average, with the greatest benefits for smaller and lower-income countries.
“It is odd though that the IMF seems cautious about including employment in the formula for taxation – despite its own analysis. That they even contemplate a destination-based cashflow tax (DBCFT) – which is a different way of allocating tax base on the basis of sales – suggests that they have not considered the development implications seriously. Since the idea was briefly raised to prominence in Trump’s US tax reform debate, it has been savaged for reasons of practicality as well as the likely impact in exacerbating inequalities both within and between countries. On this, we suggest the IMF think again.”
The Tax Justice Network has been leading global demands for radical reform of international tax rules since 2003. Now, finally, the door has creaked open – and both the OECD and the International Monetary Fund are recognising the need for dramatic change.
Since the 1930s, following a League of Nations decision, the rules have followed the ‘separate accounting’ approach. This treats each company within a multinational group as a separate entity for tax purposes, assuming that each is individually maximising profits. The approach rests on the arm’s length principle: the economically illogical idea that companies within a multinational group will carry out transactions with each other as if they were unrelated parties, trading at arm’s length in an open market – rather than part of a multinational group which maximises profit at the group level.
The leading alternative to the arm’s length approach is unitary taxation with formulary apportionment. This approach assesses a multinational group’s profits at the global level (in line with economic reality) and then apportions that profit between the different countries of operation based on their share of real economic activity. The IMF’s report notes that the approach ‘would greatly reduce the scope for profit shifting’, and would lead to a major rebalancing of tax rights towards lower-income countries as long as the formula included employment.
When the OECD Base Erosion and Profit Shifting (BEPS) initiative was announced in 2013, hopes of unitary taxation being adopted and real progress ushered in were swiftly dashed when major OECD member countries insisted on retaining the arm’s length principle. The Tax Justice Network said then that the BEPS process would be seen as the last great defence of arm’s length, and so it seems.
The OECD is now running a consultation, nominally on ‘digitalisation’ but uniformly understood to address the guiding principles for international tax rules – and all the options under consideration move beyond the arm’s length principle. Most importantly, unitary approaches with formulary apportionment are being seriously considered.
The Tax Justice Network submission to the OECD consultation can be downloaded here.
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About the Tax Justice Network
The Tax Justice Network is an independent international network, launched in 2003. It is dedicated to high-level research, analysis and advocacy in the area of international tax and financial regulation, including the role of tax havens. The Tax Justice Network maps, analyses and explains the harmful impacts of tax evasion, tax avoidance and tax competition; and supports the engagement of citizens, civil society organisations and policymakers with the aim of a more just tax system.