"This action plan, which we will roll out over the coming two years, marks a turning point in the history of international tax co-operation. It will allow countries to draw up the co-ordinated, comprehensive and transparent standards they need." -- OECD Secretary-General Angel Gurria
"They know the golden age of 'we don't pay taxes anywhere' is over." -- Pascal Saint-Amans, OECDDirector of the Center for Tax Policy and Administration
Over the coming months and years the international tax community will be busy as beavers reacting to the process the OECD has set in motion with its new action plan. A plain reading of the document would lead you to believe that in a few years multinationals will no longer be able to park large portions of their worldwide profits in tax havens where they have little or no physical business activity.
But the path to this result is by no means clear. Two years is a long time, and it should not surprise anyone that multinationals will devote great resources to blocking any effort that would stymie their tax planning. After all, it is their fiduciary responsibility to maximize shareholder value.
To achieve their objective of minimizing any upheaval the action plan might cause, representatives of the multinational community are likely to make the following arguments:
- Our current international tax rules work well in most cases. So all that is needed are some targeted anti-abuse rules to thwart the most aggressive varieties of tax planning.
- The problem of base erosion and profits shifting is overstated and not well understood by the public. In particular, when it is observed that a large proportion of multinational profits are in tax havens, this is not necessarily an indication of inappropriate profit shifting because subsidiaries in tax havens have paid for valuable intangible assets that are generating those profits. Nobody can tell whether a multinational has inappropriately shifted profits without an exhaustive facts and circumstances study of each case.
- Not only would a wholesale change from the current arm's length standard to formulary methods (i.e., mechanical allocation of profits in proportion to share of sales, assets, payroll, etc) be unacceptable, but any leaning in the direction of formulaic methods (such as employing the profit split method, where allocation of profits is made by reference to measurable business activity) should only be adopted as an absolute last resort.
- Comparable third-party transactions which can be used to set transfer prices between related parties within a multinational corporation -- even in the case of unique intellectual property -- are not as difficult to find as is commonly portrayed.
- Contracts between related parties within a corporation should be respected for tax purposes. Therefore, multinationals by writing contracts should be able to shift intangible assets and risks to affiliates in tax havens with a relatively small number of employees. This type of "restructuring" serves important business purposes. Also, except in extreme cases, multinationals should also be able to shift profits by having a high-tax subsidiary borrow from and pay interest to a low-tax finance subsidiary.
- If a low-tax subsidiary of a multinational pays its share of costs of developing an intangible asset, it is entitled to its share of the profits -- regardless of the level of real business activity undertaken by that subsidiary. If business activity is required to book profits in tax havens, the rules should require only a minimal physical presence. In particular, the rules should allow outsourcing of functions so requirements can be met by employees assigned to the subsidiary but not physically present at the location.
This is only a partial list. None of these arguments detracts from the simple fact that governments have a totally defensible claim to the taxing rights for profits generated by physical activities taking place within their borders. This include profits from intangible assets employed in conjunction with those physical activities.
One important thing to keep in mind is that time is on the side of business. In the coming years the world's economy will likely improve, and so budget deficits may fall and austerity measures may be scaled back. Also, it is hard to believe that press coverage of the issue can be any more intense than it has been over the last year. In two years time the public outrage over aggressive corporate tax planning and the political pressure to do something about will almost surely recede.
Martin Sullivan is chief economist at Tax Analysts. He also blogs at TaxAnalysts.com.