The Australian Treasury has just released its much anticipated report on the "Risks to the Sustainability of Australia’s Corporate Tax Base". And on Friday in Moscow last week, the G20 adopted the OECD’s comprehensive list of 15 action items, to be implemented within two years, dealing with the international tax system. The OECD is quite blunt, and ambitious, about its action plan, stating that it “marks a turning point in the history of international tax co-operation” and warning that if countries do not work together to implement its action plan, then we will risk nothing less than “global tax chaos”.
The Treasury report recommends Australia endorses the OECD’s action plan. The two reports analyse, in some detail, international tax issues and their complex interaction. But distilling this analysis and stripping away the tax jargon leaves two distinct ideas that lie at the heart of the reform agenda: profit shifting and base erosion. Profit shifting concerns the effectiveness of our tax net – does it catch what it is supposed to catch?
The net can be strengthened by ironing out anomalies, plugging loopholes, forcing greater disclosure and transparency, and investing more in enforcement. This time the plan is to do it differently, through the unprecedented coordination among governments. In practical terms, these action items translate into tighter tax rules, much more information sharing between governments, new self-whistle blowing requirements and a new and targeted wave of ATO activities. Base erosion is the second part of the reform equation. It is about the size of the tax net. The question is whether valid tax arrangements that fall outside Australia’s tax net be caught in the future. The current rules were developed after World War I, against the backdrop of the second industrial revolution, in an era where you needed substantial physical presence in another country to make substantial profits there. The tax rules reflected that reality by allocating taxing rights to countries chiefly on the basis of large, tangible things that you can touch, such as factories, warehouses and shops. The world has moved on. The tax rules have not. Today you can generate substantial profits in Australia by having just a “digital presence”, without being exposed to Australian taxes. The argument is that every dollar spent on a foreign online business is a dollar that is not spend on an Australian business, and thus a dollar that Australia does not tax.
Robust transfer pricing rules
This suggests that we are entering a tax roller coaster. But will this actually happen? After all, we have seen numerous “breakthrough” and “game changing” tax plans that have quietly disappeared into the quicksand of politics and bureaucracy or into those tricky gaps that exist between policy ideas and practical law design.
The main focus of profit shifting is transfer pricing. This is of particular interest in Australia which has just enacted a new set of comprehensive and robust transfer pricing rules. Would any OECD recalibration of transfer pricing rules matter here? Most probably yes. A novel aspect of the new law is the incorporation by reference of OECD transfer pricing rules. This means that changes at the OECD level will have a direct impact on our transfer pricing law. The main target of the rules are multinational groups, and not only the leading technology brands but also industries such as banking and finance, pharmaceutical, media, entertainment, and mining and energy, as well as global franchises and private equity.
However, base erosion presents more challenges than profit shifting. Politically there will be winner countries and loser countries, so a consensus should not be taken for granted. Legally this will require very careful and accurate surgery on the backbone of international tax principles, with the obvious risk of collateral damage. And only after you bounce over these hurdles can you start thinking about the practicalities, for example, how do you collect tax from an e-tailer based in an exotic island?
But it seems, this time, we may witness some changes, at least at the profit shifting front. It is almost a perfect storm. Firstly, plenty of political goodwill has been invested from the G20 down. Secondly, the political goodwill seems to rely on broad public support. Thirdly, the focus on the digital economy adds an attractive, cutting-edge flavour with a sense of urgency. And most importantly, while the world does not revolve around tax, much in the world revolves around tax revenues, and we are not in a time where countries are swimming in budget surplus.
And there is another twist to this story; there is a notable absence of clear evidence quantifying profit shifting and base erosion in dollar terms. Nonetheless, the OECD and Australian reports convey the belief that these are real and identifiable risks. And this will probably suffice. If governments believe that they are reaching a critical mass of lost revenue, they are very likely to react.
Dr Niv Tadmore is a tax partner at Clayton Utz and member of Treasury’s reference group on ways to address tax minimisation of multinational enterprises.
This article was first published in The Australian Financial Review, 25 July 2013