Today sees the crystallisation of two potentially pivotal moments in the development of international tax rules towards the Tax Justice Network’s long-favoured approach: unitary taxation.
In Paris, the OECD is hosting a public consultation on the biggest reform to the taxation of multinational companies in almost a century – and there is a growing demand for a comprehensive shift to unitary taxation. And in London, the UK Labour party has today become the first major political party in one of the world’s leading economies to make a manifesto commitment to introduce unitary tax.
What is unitary taxation?
Unitary taxation is the approach that treats a multinational group as the taxable unit, rather than the individual subsidiaries in different countries that make up the group. Current international tax rules are based on separate entity accounting, where transfer pricing mechanisms are used to establish the taxable profit that each entity within the multinational group would obtain, if it was operating at arm’s length (independently) from each other entity in the group. This allows gross abuses, with huge volumes of profits being shifted from where they arise, into low- or no-tax jurisdictions. Unitary tax recognises that in reality, profits are maximised at the unit of the group as a whole. ‘Formulary apportionment’ is the name for the process that allocates those global profits as tax base between the different countries where the multinational has real economic activity (employment and final customer sales, say).
The OECD Base Erosion and Profit Shifting (BEPS) process of 2013-2015 had the single, agreed goal of reducing the misalignment between where profits are declared, and where multinationals’ real economic activity takes place. BEPS failed because OECD countries could not agree to move beyond the arm’s length principle. But the new reforms, sometimes dubbed BEPS 2.0, start from an explicit acceptance of the need to move beyond arm’s length pricing. Each of the proposals under consideration include aspects of unitary taxation, of which the proposal from the G24 group of countries is the most comprehensive. The Tax Justice Network has long called for such a reform, estimating the failure to align profits with the location of real economic activity imposes global revenue losses of around $500 billion each year.
What’s at stake at the OECD?
The OECD consultation addresses ‘pillar one’ of the organisation’s policy reforms. While pillar two focuses on the introduction of a global minimum tax rate for all countries, pillar one is concerned with the distribution of the tax base between countries. This is crucial to ending the corrosive practices of profit shifting, through which multinationals, their professional advisers and corporate tax havens such as the Netherlands have conspired to deny taxing rights to the countries where companies’ real economic activity takes place.
The consultation addresses the ‘unified proposal’ put forward by the OECD secretariat, which was put forward following bilateral agreement between the US and France, and then received support from the G7 group of countries before being made public. The proposal claims to combine elements of the three proposals that are in the agreed work programme of the Inclusive Framework group of 134 countries. All three move beyond the arm’s length principle and the transfer pricing approaches that have dominated international tax rules since the key decisions of the League of Nations in the 1920s and 1930s.
The Inclusive Framework group includes many lower-income countries, not only OECD members, and they have been promised an equal say in the changes to be made. However, the unified proposal sets aside entirely the one approach in the work programme that had been proposed by lower-income countries: the proposal for unitary taxation made by the G24 group. Our analysis indicates that compared to the G24 approach, the unified proposal would be likely to redistribute a much smaller volume of profits away from corporate tax havens, with much smaller revenue gains for other countries – especially non-OECD members. Simulations for the French government, just published, confirm “a negligible impact on tax revenues” is likely.
From our partial review of the thousands of pages of submissions now made public, a number of key points stand out. These can be grouped into areas with broad consensus, and areas where business and other respondents are relatively sharply divided. We identify three areas of relatively broad consensus:
- Scope. There is a near-universal rejection of the OECD secretariat’s proposed scope. While most independent submissions criticise aspects of the attempt to reduce the scope to only the largest, ‘consumer-facing’ businesses, with a range of other industry carve-outs, most business submissions seek a more limited scope, higher size thresholds, and where relevant that their own sector be excluded through an additional carveout.
- Complexity and uncertainty. An overwhelming share of submissions reviewed, and from all types of participants including business and civil society, highlight the risk that the OECD secretariat proposal would increase complexity of the rules and uncertainty of outcomes for taxpayers and tax authorities.
- Impact assessment. Across all types of respondents, there is a clear desire for the OECD to release data and analysis on the projected revenue impact of the proposals. Civil society has made this a core demand. The US Chamber of International Business said: “USCIB members believe a completed impact assessment is critically important to enable progress on the proposed Unified Approach framework.” The intergovernmental South Centre said: “The South Centre supports the call for the OECD to make public its country-by-country reporting data on MNEs headquartered in its member states so that countries can carry out a more thorough assessment of how the Unified Approach proposal will affect their tax base. At present the OECD has planned to release this data only after early 2020, potentially after key elements of the reform proposals have been pushed through.”
In areas with a divide between business respondents and others, we identify four main areas:
- Curbing profit-shifting. There is little engagement from business respondents or their professional services providers with the question of whether the reforms would reduce the scale of tax abuse. The major lobby group Business at the OECD (BIAC) goes so far as to ask that the label ‘BEPS 2.0’ not be used for the process: “that language is quite unhelpful and, indeed, misleading. Pillar 1 is – should be – about constructing a new tax system for new business models and a new economy. That needs to be a tax system which takes account of the way business is working (and even more importantly, will come to work); a system that allows governments to raise money based on new value-creating forms of activity; but also a system that fosters and enhances cross-border trade and investment and creates inclusive growth. To impose an anti-avoidance narrative on Pillar 1 could frustrate that.” Non-business respondents, meanwhile, consistently criticise the proposals for the likely failure to address the scale of profit shifting.
- Fair distribution of taxing rights. Here again, there is little engagement from business respondents and their professional services providers, but a clear consensus among civil society respondents and those from non-OECD countries that the secretariat proposal will not redress the stark inequalities in taxing rights that characterise the current system.
- ‘Equal say’. A position common to many of the civil society responses and those from non-OECD countries, is to highlight the extent to which the OECD secretariat proposal has disregarded the key tenets G24 approach, casting doubt on the commitment to give non-OECD countries an equal say.
- Dispute resolution. Here is perhaps the sharpest divide. While many business respondents call for rapid, binding arbitration, often conditioning acceptance of any other changes on this, it is anathema to respondents from non-OECD countries and to civil society – often appearing to be a red line, even if other elements of the proposal were to be accepted.
Three main outcomes can be envisaged. First, and perhaps most likely given the recent history of the BEPS project (2013-2015), is that the OECD delivers a limited reform meeting the constraints of major members including the US, which neither curbs profit shifting to a significant degree nor provides substantial benefits to Inclusive Framework members.
In this scenario, trust in the OECD to act as the forum for international tax rule-setting would be damaged perhaps to the point of being beyond repair. The power of major OECD members, however, might be enough to prevent any shift of forum to the UN. That would leave countries with the option of pursuing unilateral measures, from the digital services taxes that are already proliferating, to more comprehensive unitary tax approaches. The resulting pressure from business for an international solution would likely see a quick return to negotiations – but would they be at the OECD?
A second scenario sees the current process collapse, due to the lack of trust. Here, a move to the UN becomes conceivable, if major OECD members were to accept that a more genuinely inclusive process was necessary since unilateral proliferation would not represent a stable equilibrium. Again, a return to the OECD process, or the start of a new one, would seem more immediately likely than a shift to the UN; but the quid pro quo to achieve this might be a much more serious commitment to the ‘equal say’ for non-OECD members.
The third scenario is that the current OECD process is reset. Recognising the depth of opposition to the secretariat proposal, key actors might decide that the aim of completing the process during 2020 is incompatible with a full assessment of the options and obtaining broad agreement. That would in turn open the door to more serious consideration of the Inclusive Framework’s three approaches, including the G24 proposal.
The starting place is the recognition in the current process that the old transfer pricing rules are not fit for purpose in an age of complex globalisation. In each of three scenarios, the medium-term prospects are increasingly positive for a complete shift to a unitary approach – whether led by the OECD or UN, or simply as the result of cumulative, unilateral actions.
Unitary taxation has moved from a radical civil society demand in the early 2000s, to being a core element of the international policy debate today. It offers the potential to reprogramme international tax, making profit shifting abuses of multinational companies a marginal problem rather than the major cause of revenue losses that they are today.
What’s the Labour manifesto commitment?
In the UK, the Labour party has today committed to introducing unitary taxation by the end of the next parliamentary term. This is significant internationally because it marks the first such manifesto commitment from a major political party, with a realistic prospect of election success, in a major OECD member country. Coupled with the leadership of the G24 group of developing countries, the Labour commitment represents an important further normalisation of unitary taxation, and a potentially important step to ending the great damage done by corporate tax abuse internationally.
How much revenue would the Labour policy bring in for the UK?
The Labour party estimates that in the fifth year of the next parliament, the tax would bring in £6.3bn. This comes from the work of Prof Sol Piccciotto, who is perhaps the leading international expert on unitary taxation and a Tax Justice Network senior adviser, and Daniel Bertossa.
Picciotto and Bertossa lay out a full proposal, and refer to our analysis (with Prof Valpy FitzGerald of the University of Oxford, and Tommaso Faccio of the University of Nottingham) of data on US multinationals for the revenue impact. We found a revenue impact of nearly $4bn for the UK, from an international shift to unitary taxation with full formulary apportionment. Scaling up to include non-US multinationals, and depending on the approach taken, this implies a total revenue gain of between £6bn and £14bn.
The Labour party have taken the lower extreme of this range (i.e. the most conservative estimate). They then reduce it by 30% to allow for possible behavioural changes (multinationals moving away, or finding other ways to dodge tax). This seems on the high side for a behavioural response, so this again looks a conservative assumption. Finally, they roll forward five years, allowing for inflation. That gives an estimate of revenue at the end of the next parliament of some £6.3bn.
Can the UK do this unilaterally?
Yes. Countries including OECD members have quite different approaches to international tax, whether in terms of defining the tax base or setting the rates, so there is no reason the UK couldn’t go ahead and do this. As above, however, there is an increasing chance that this would be in line with an emerging international consensus to adopt unitary taxation, so the UK could be well positioned to play a leading role in that process.
Wouldn’t the UK have to renegotiate all its double tax treaties?
Many believe that current tax treaties would not pose an obstacle, just as they already allow the application of related ‘profit split’ approaches. However, a renegotiation is not out of the question. The OECD secretariat has confirmed that its current, more complex proposal, for example, would require revisions to the whole global tax treaty network. As George Turner of TaxWatch has written, instead of renegotiating it is also possible for the UK parliament to “legislate to unilaterally disapply the provisions of tax treaties. This last happened in the UK in 2008, when the government legislated to unilaterally override all of their tax treaties to close down a disguised remuneration scheme (FA 2008 ss 58 and 59, which amended ICTA 1988). The action by the UK government was subsequently upheld by the European Court of Human Rights, which noted that double tax treaties should do no more than seek to relieve double taxation, and should not be permitted to become an instrument of avoidance.”
Wouldn’t multinationals leave the UK rather than pay this tax?
Multinationals operate in the UK because they make money in the UK. A distribution of some percentage of that profit towards the UK exchequer, just as any domestic business makes, doesn’t stop it being profitable to operate in the country. While there would no doubt continue to be a lot of work from professional service firms including accountants and lawyers trying to game the system, unitary tax offers a much simpler way to determine taxable profit than the current rules and so is likely to be much less open to abuse. As noted, the Labour party’s revenue estimate assumes a 30% reduction due to behaviour change, which may well be on the high side.
Is the information available to make unitary tax work?
Yes. Following the G20 decision in 2013, the OECD has developed a version of the Tax Justice Network’s proposed standard for country-by-country reporting. This, together with corporate tax returns, provides all the information needed to apply unitary taxation. It would be advisable to ensure that the data to be relied upon is fully audited, and to sharpen the definitions in places to reduce scope for chicanery, but the instruments are in place.
Unitary tax infographic