Gi­ants cost SA bil­lions in lost taxes

Al­ter­na­tive think­ing sug­gests that coun­tries could use dif­fer­ent ways to tax er­rant multi­na­tion­als

Mail & Guardian - - Business - Lyn­ley Don­nelly

Rev­e­la­tions that South Africa is los­ing an es­ti­mated R7-bil­lion a year be­cause of tax avoid­ance by multi­na­tion­als has high­lighted calls to rethink how coun­tries tax these en­ti­ties.

In­ter­na­tional ef­forts to en­sure that cor­po­ra­tions are taxed where eco­nomic ac­tiv­i­ties oc­cur and re­duce profit shift­ing to low-tax ju­ris­dic­tions have been crit­i­cised as not do­ing enough to stop this, a prac­tice that is par­tic­u­larly de­bil­i­tat­ing for de­vel­op­ing coun­tries.

But there are al­ter­na­tives, ac­cord­ing to a tax jus­tice ad­vo­cate, and if re­gional leader South Africa was to ex­plore these, it would pave the way for oth­ers.

Widely pub­li­cised re­search re­leased late last year by the Sa-tied (South­ern Africa — To­wards In­clu­sive Eco­nomic Devel­op­ment) project, sug­gests that 98% of the tax loss is linked to profit shift­ing by the big­gest 10% of multi­na­tional cor­po­ra­tions. It es­ti­mates that the coun­try is los­ing about R7-bil­lion in tax an­nu­ally.

About half the prof­its moved out of South Africa end up in Switzer­land, the re­search found. It also high­lights the im­por­tance of fac­tor­ing in firm size when con­sid­er­ing the ex­tent of profit shift­ing and says not ac­count­ing for this could lead to un­der­es­ti­mat­ing the ex­tent of the prac­tice.

Us­ing in­for­ma­tion from the South African Rev­enue Ser­vice for the pe­riod 2010 to 2014, the re­search is the first to use data from a tax ad­min­is­tra­tion in a de­vel­op­ing coun­try.

Only Ger­many, Nor­way, Swe­den and the United States have pre­vi­ously granted ac­cess to tax re­turn in­for­ma­tion on multi­na­tional en­ti­ties, ac­cord­ing to the au­thors, Lud­vig Wier of the Univer­sity of Copen­hagen and South African trea­sury of­fi­cial Hay­ley Reynolds.

Some forms of profit shift­ing are le­gal, the au­thors say in a press state­ment, but some, such as trans­fer mis­pric­ing, are not. Trans­fer mis­pric­ing oc­curs when a multi­na­tional im­ports goods or ser­vices from an­other branch in a lower-tax ju­ris­dic­tion at inflated prices to in­crease its costs and re­duce tax­able prof­its in a higher-tax ju­ris­dic­tion.

In a sep­a­rate pa­per, which in­ves­ti­gated trans­fer mis­pric­ing in South Africa, Wier es­ti­mates that rev­enue losses be­cause of it equate to 2% of for­eign-owned firms’ tax pay­ments, or al­most R1-bil­lion each year.

In their joint re­search, Wier and Reynolds say, even though for­eignowned firms in South Africa make up only 2000 of the 1.2-mil­lion com­pa­nies in the coun­try, they are typ­i­cally much larger than do­mes­tic firms and ac­count for more than 30% of to­tal sales of all com­pa­nies.

Their re­search sorts for­eign-owned firms into 50 groups ac­cord­ing to size based on their wage bill and iden­ti­fies firms owned by a par­ent com­pany domi­ciled in a tax haven and the firms that are not. It finds that, de­spite sim­i­lar wage bills, fixed as­sets and turnover in both havenowned and non-haven-owned firms, ma­jor dis­crep­an­cies emerge in the fig­ures for tax­able prof­its.

They say, among the largest 2% of firms, the wage bills of haven-owned firms were 6% higher, as was turnover, and they had 22% more fixed as­sets, but their tax­able prof­its were 72% lower.

The re­search also sug­gests that the bulk of this “prof­itabil­ity gap” is driven by re­source ex­trac­tive com­pa­nies, even though they only ac­count for 2% of for­eign-owned firms. This is fol­lowed by the fi­nan­cial in­dus­try, which ac­counts for 19% of the prof­itabil­ity gap.

The ef­fects can be par­tic­u­larly per­ni­cious in de­vel­op­ing coun­tries. The re­searchers say, his­tor­i­cally, in de­vel­op­ing coun­tries, a sub­stan­tial amount of tax rev­enue has been col­lected from large cor­po­ra­tions. This is true for South Africa, where cor­po­rate tax amounts to 19% of to­tal tax re­ceipts, or twice the de­vel­ope­d­coun­try av­er­age. And, like many de­vel­op­ing na­tions, they say South Africa is fis­cally con­strained.

Global ef­forts to ad­dress these kinds of tax avoid­ance ac­tiv­i­ties have cen­tred on the Or­gan­i­sa­tion of Eco­nomic Co-op­er­a­tion and Devel­op­ment’s (OECD) Base Ero­sion and Profit Shift­ing ini­tia­tive, in which South Africa has long par­tic­i­pated.

But in­ter­na­tional tax jus­tice ad­vo­cates have ar­gued that the OECD’S ap­proach has se­ri­ous flaws.

Ac­cord­ing to Alex Cob­ham, the chief ex­ec­u­tive of the Tax Jus­tice Net­work, the OECD’S in­sis­tence on bas­ing in­ter­na­tional tax rules on the arm’s length prin­ci­ple lies at the heart of these kinds of multi­na­tional tax abuses.

This ap­proach, he says, treats multi­na­tional groups as if each cor­po­rate en­tity in the group is in­di­vid­u­ally max­imis­ing its prof­its, re­quir­ing that any trans­ac­tions be­tween group en­ti­ties take place at mar­ket prices, or “as if they were op­er­at­ing at arm’slength from each other”.

But multi­na­tional groups “ex­ist pre­cisely when it is more prof­itable to in­ter­nalise such trans­ac­tions than it would be for in­de­pen­dent en­ti­ties to op­er­ate sep­a­rately; and profit is max­imised at the global, group level”, he ar­gues.

“As such, the OECD ap­proach cre­ates clear in­cen­tives to ma­nip­u­late the prices on in­tra-group trans­ac­tions in or­der to shift profit away from the lo­ca­tion of the un­der­ly­ing eco­nomic ac­tiv­ity that gives rise to it, and in­stead to some low- or zero-tax ju­ris­dic­tion.”

Ac­cord­ing to the Tax Jus­tice Net­work’s own 2017 re­search, profit shift­ing re­sults in an es­ti­mated rev­enue loss of $500-bil­lion glob­ally.

The sys­temic fix, says Cob­ham, is to elim­i­nate arm’s-length pric­ing and to “tax multi­na­tion­als at the level of the group, with their global prof­its ap­por­tioned be­tween ju­ris­dic­tions as tax base ac­cord­ing to the share of real eco­nomic ac­tiv­ity tak­ing place in each”.

But, he says, lower-in­come coun­tries may not have the po­lit­i­cal power to ig­nore the OECD, or to take on multi­na­tion­als di­rectly.

He says there is a so­lu­tion, first pro­posed by the Tax Jus­tice Net­work and now backed by the In­de­pen­dent Com­mis­sion for the Re­form of In­ter­na­tional Cor­po­rate Tax­a­tion (ICRICT), which would leave the OECD rules in place but would cre­ate a back­stop to limit the de­gree of profit shift­ing.

In Fe­bru­ary last year, the ICRICT en­dorsed a way to im­prove the rules for tax­ing multi­na­tion­als — a uni­tary tax­a­tion ap­proach known as for­mu­lary ap­por­tion­ment. Ac­cord­ing to the United States-based Tax Pol­icy Cen­tre, this would as­sess a multi­na­tional firm’s in­come in dif­fer­ent coun­tries, us­ing a for­mula that in­cludes a com­bi­na­tion of its sales, as­sets and pay­roll in each ju­ris­dic­tion.

Al­though the OECD ef­forts are a step in the right di­rec­tion, they do not ad­dress the core de­fi­cien­cies of the ex­ist­ing sys­tem, ac­cord­ing to the ICRICT. It says the OECD pro­vides a “patch-up of ex­ist­ing failed ap­proaches and [has] failed to ad­dress the more fun­da­men­tal is­sue of profit shift­ing”.

Re­vi­sions to trans­fer pric­ing rules con­tinue to “cling to the un­der­ly­ing fic­tion that a [multi­na­tional en­ter­prise] con­sists of sep­a­rate in­de­pen­dent en­ti­ties trans­act­ing with each other at arm’s length”, but the re­al­ity is that these com­pa­nies are uni­fied firms “or­gan­ised to reap the ben­e­fits of in­te­gra­tion across ju­ris­dic­tions”, it says.

For­mu­lary ap­por­tion­ment is the best method to en­sure that the coun­tries in which the multi­na­tional firms’ prof­its are made get their fair share of tax rev­enues, the ICRICT ar­gues.

For­mu­lary ap­por­tion­ment does have chal­lenges, ac­cord­ing to the Tax Pol­icy Cen­tre, start­ing with the need for ma­jor economies to agree to scrap the cur­rent arm’s-length ap­proach and con­sen­sus on how to al­lo­cate cor­po­rate in­come among ju­ris­dic­tions.

But, the ICRICT says, with­out a global agree­ment on this ap­proach, an in­di­vid­ual coun­try or re­gion could con­sider im­ple­ment­ing it as part of an al­ter­na­tive min­i­mum tax regime. A coun­try could ap­ply a mul­ti­fac­tor for­mula to a multi­na­tional firm’s global in­come and com­pute the min­i­mum tax payable on the ap­por­tioned in­come, for ex­am­ple at 80% of the reg­u­lar cor­po­ra­tion tax rate.

“The min­i­mum tax would be payable if it ex­ceeds the ju­ris­dic­tion’s reg­u­lar cor­po­ra­tion tax payable com­puted on the [multi­na­tional en­ter­prise’s] lo­cal in­come as de­ter­mined un­der con­ven­tional arm’s-length trans­fer pric­ing meth­ods,” the ICRIT says.

A coun­try could do this with­out reneg­ing on ex­ist­ing mul­ti­lat­eral agree­ments or com­mit­ments to the arm’s-length prin­ci­ple and the OECD trans­fer pric­ing guide­lines.

The Euro­pean Union is con­tem­plat­ing leg­is­la­tion that would tax firms on a for­mu­lary ap­por­tion­ment ba­sis but only in the EU. But, Cob­ham and other aca­demics, who un­der­took work for a left-lean­ing coali­tion of Euro­pean par­lia­men­tary mem­bers, iden­ti­fied risks with this ap­proach, not least of which is that com­pa­nies will sim­ply shift prof­its to ju­ris­dic­tions out­side the EU.

The ICRICT stresses the need to adopt an ap­proach that pre­vents this.

The trea­sury did not re­spond to re­quests for com­ment.

Re­search sug­gests that the top 10% of firms ac­count for the lion’s share of profit shift­ing

Sit­ting pretty in Geneva: Re­searchers have found that about half the prof­its moved out of South Africa by multi­na­tion­als cor­po­ra­tions end up in Switzer­land. Photo: Gilles Lansard

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