By G. Srinivasan
The United Nations (UN) has plumped for greater cooperation among countries to put in place a set of safeguards and rules for tax reforms the world over in the bleak backdrop of extant rules and conditions, “particularly regarding illicit flows, as well as tax avoidance” often limiting what governments can raise as domestic revenues”. International rules, policies and cooperation play a key role in ensuring that governments have the ability to raise sufficient revenue domestically as they remain by far “the largest and most reliable source for investment in sustainable development”.
In its just released flagship annual report World Economic Situation & Prospects, 2015, the UN rightly contended that while improved domestic policies in tax administration are vital to augmenting tax collection for sustainable investment, there is a limit to what they can pan out, based on the existing global policy milieu within which illicit financial flows (IIFs) have blossomed. No doubt estimates about the size of IFFS vary, with one estimate of untaxed offshore wealth holdings putting the amount between $ 21 trillion to $ 32 trillion on the high end, which if taxed at the floor rates, would yield $ 189 billion a year in new revenue globally! On the low end, other studies estimated offshore wealth holdings between $ 5.9 trillion and $ 8.5 trillion in different years.
Stating that it is intractable to estimate the relative size of the different components of IFFs, the UN report cited some researchers who argued that commercial tax evasion, which involves cross-border activity to hide money from tax administrations, is one of the principal types of IFFs. Others have noted that corruption is a more egregious source of IFFs in developing countries and that the various types of IIFs are intrinsically inter-linked. Even as the amount of money lost to IFFs is subject to interminable wrangles, the UN report said all available evidence incontrovertibly attest that it is substantial and poses a perilous risk to systemic stability, if not set right or left unabated.
The UN report hit the nail on the head by stating that existing tax codes and weak enforcement foster transfer mispricing and tax evasion on a larger scale. Multinational enterprises (MNEs) quite often engage in the dubious transfer mispricing (i.e., the mispricing of cross-border intra-group transactions) to evade taxes. Elaborating their legerdemain for naked self-aggrandizement, the report said they can shift profits to low-tax or no-tax jurisdictions, while shifting losses and deductions to high-tax jurisdictions and thereby paring down their profits and tax liabilities in the latter. National and international tax codes interact in a way that offers loopholes to companies engaged in cross-border trade and existing standards to prevent double taxation “insufficiently address the cases of no or low taxation”, the report rued. It specifically noted that the pricing of intangibles, such as intellectual property rights (IPRs), are subject to transfer mispricing because of the ease of transferring ownership internationally and the attendant difficulty in valuing unique intangibles. The provision of other intra- group services, including management, information technology and financial services are frequently subject to transfer mispricing.
A particularly disconcerting facet is that the past decades of burgeoning international trade and capital mobility have increased the levels of cross-border economic activity, resulting in greater potential for mispricing, the report said highlighting the embedded risks. To compound to the woes of tax dodged so tangibly, MNEs also engage in aggressive tax planning, including making use of complex corporate structures to exploit mismatches and loopholes in tax systems. The most unacceptable reality is that these tax dodges and ruses camouflaged as legally permissible commercial business practices under extant tax codes can “undermine the volume of revenues that government can collect to make public investment in sustainable development”.
Listing out the ill-effects of such questionable tax tergiversation widely practiced by MNEs, the UN report said that such tax avoidance and evasion distort markets and preclude fair and just competition. There are, it said, unfair advantages gratuitously conferred on MNCs that operate across borders and can cherry-pick jurisdictions to minimize their tax liabilities and score unfair cost competitiveness (often by so-called tax treaty shopping and other means to lower their own tax bills). No wonder, domestic enterprises are being left in an unfair playing field where there is no facile scope for such tax avoidance and evasion and this also leaves them with screwing up their “relative cost base” vis-à-vis MNCs and “thus limiting their opportunities for growth”.
The takeaways from this latest UN report for emerging economies like India which open up new areas for foreign direct investment (FDI) or through equity participation by foreign companies in domestic manufacturing in new areas like defense production, railways and financial services such as insurance are too enormous to be brushed aside. The domestic tax authorities must revisit their arcane tax statutes and frame policies tailored to the evolving situation so that they do not get shortchanged by companies that adversely affect their domestic resources for sustainable development. Skills and capacity gaps are large in the tax authorities of many developing countries, the UN report noted adding that international assistance such as official development assistance (ODA) could help overcome these teething problems. India can play a catalytic role here to help itself as also other countries situated in similar predicament.
The report draws attention to a key issue as to how to resolve the location of MNEs value added for the purpose of taxation. They often transact across borders through multiple subsidiaries, which are likely to apply the principle of arm’s-length transfer pricing. There is also a debate raging about whether the best way to avoid transfer mispricing is through better implementation of the arm’s-length pricing mechanism, including through capacity-building of tax administrations or through a change towards formulary apportionment, wherein the global profits of an MNC would be divided up by jurisdiction according to a fixed formula agreed in advance and intended as a proxy for the level of economic activity in each jurisdiction. But the formulary apportionment is pregnant with formidable practical problems. The fact remains that potential changes in the global distribution of tax revenues will have implications on the level of domestic resources across countries, with important consequences for financing sustainable development. This is because implementing unitary taxation on MNEs and then distributing the tax revenue according to MNC payroll levels would likely result in high gains in taxation in rich nations, where most MNCs maintain their headquarters and senior staff and potential losses for developing countries. Hence the UN report cautioned that reforms to the global framework for tax cooperation which do not properly assess or address distributional impacts, will carry the risk of being ‘counterproductive’.
Most emerging economies and developing countries today face the uphill task of marshalling domestic resources for development. They all but need the backup of the UN organization, which has a universal membership and credible legitimacy with which intergovernmental tax cooperation can get the impetus with no loopholes left for tax avoidance of business done in their territories by foreign companies. This is important because G-20 with its limited membership is not the forum to deal with tax issues while the UN with its universal membership is what matters for convincing reassurance and reforms to all member States. (IPA Service)