Business decisions and tax decisions – can they ever be frictionless?

BY: ROB MANDER

No company pays international tax and no revenue authority collects international tax. Instead, there are independent national tax codes that were not designed in harmony with one another, and tax authorities around the world that are struggling to get to grips with modern business and digital economies. While the answer would likely be best found in transparency and cooperation, what we are seeing instead is a shift towards friction and protectionism.

"A race to the bottom of the international tax ladder, where revenue authorities constantly adapt tax rates in order to be the country that presents the most attractive offer, would be terrible for middle market businesses."

Corporate income tax has historically been considered as a tax on the goods or services produced in one country (an origin-based tax). However, the production of goods and services can be extremely difficult to track and the production process can stretch all over the world. Ensuring tax is fair for both the state collecting it, and the company paying it, is no easy feat.

While there have been huge increases in the net profits of multinational companies, this has not been matched by a rise in corporate income tax contributions. The decline in corporate tax collection has led to corporations being accused of shifting profits to territories where they will be taxed the least. Transfer pricing is a tool often used to shift a company’s profits, allowing different parts of the same business, based in different locations, to trade with one another at altered prices in order to manipulate where the bulk of their profits are declared. This is all possible because national tax codes were not designed in harmony with one another.

"If tax policies are constantly adjusting to global competition, it would be impossible for middle market businesses to consistently alter their strategies accordingly."

As the world became more connected via global trade throughout the 1900’s, the mobility of capital increased. This mobility had knock on implications on how states tax capital, creating somewhat of a tax competition between states, as governments attempt to create an attractive environment for large corporations by lowering their effective tax rates.

"The middle market is key to successful economic growth. In today's digital and global environment, tax measures that restrict entrepreneurs and limit middle market growth will have a direct impact on where and how businesses operate."

A race to the bottom of the international tax ladder, where revenue authorities constantly adapt tax rates in order to be the country that presents the most attractive offer, would be terrible for middle market businesses. While multinational firms have large pools of resources and can adjust their tax planning strategies or move to different locations around the world to find the lowest tax rate, those firms that reside in the middle market don’t have the luxury of cherry picking where they do business. When a business that doesn’t fall under the umbrella of big business crosses borders, it is often a costly operation that requires significant business resource. If tax policies are constantly adjusting to global competition, it would be impossible for middle market businesses to consistently alter their strategies accordingly. The middle market is key to successful economic growth. In today's digital and global environment tax measures that restrict entrepreneurs and limit middle market growth will have a direct impact on where and how business operate.

The LuxLeaks scandal in November 2014 revealed how more than 300 companies with operations in Luxembourg had cut their tax bills by playing national tax systems against one another and shifting profits around different arms of the business. This scandal and other perceived planning abuses resulted in the formation of the Base Erosion Profit Shifting (BEPS) project by the OECD. The BEPS project aims to address the concerns illustrated by high-profile disputes relating to origin definitions and the use of tax havens. However, global implementation of the project is taking time to weave into both domestic tax systems and the tax treaties that deal with the interaction between states, creating uncertainty in the business environment.

Personally, I am less concerned about the impact this will have on multinational corporations, as they have the resources and financial capability to cope with the changes that BEPS will bring. I worry about the impact this will have on ambitious, growing businesses that don’t have the scale or resources to throw a team of local experts together as issues arise.

The global business landscape is changing. Protectionism, turning inwards, deglobalisation – are the emerging themes of geopolitics. The US, for example, had always been the champion of global cooperation between states. Now they have a different political approach based on President Trump’s doctrine of “America first”. Brexit is another example, as the governor of the Bank of England stated recently “(Brexit) will be, at least for a period of time, an example of deglobalisation not globalisation”. The ever more uncertain state of geopolitics is making it more pertinent for businesses to be able to adapt and change in a quick timeframe.

There will always be friction between the tax thresholds of revenue authorities and business decisions. Revenue authorities have to assess how they can tax fairly for their purposes, which differs greatly per country. Even with initiatives like the BEPS project, where the aim is to bring common best practice and a uniformed approach to international tax, there is concern that it won’t create the desired outcome.

Interpretation of rules and policy varies the world over. This is a large part of what causes these disparities in supposedly international systems. Businesses, governments and people need to accept that rules will always change. As the world develops, economies shrink and grow, and the nature of business changes, the rules will have to adapt. This is why simplicity and transparency should be king.

The world is fragmented politically, but global companies are still generating value across borders. By setting out clear and simple guidelines, reducing the reporting burden on companies, and tax authorities explaining clearly why they need the information they are requesting, we can go some way to encouraging global cooperation in regards to tax.

Just as no taxpayer thinks they pay too little tax, states are unlikely to concede they collect too much and willingly hand it over to others. It's not a zero sum game where everyone is a winner at the same time. Reasoned compromise and open negotiation will be required to find international solutions that will stand the test of time. If the global community comes together, it is very possible that a fair approach can be developed.