The only thing I’m not sure is the transformation from what to what? Is this going to transform a tax system that was designed at the start of the 20th century and is simply not fit for the purpose of the 21st? Or will it transform tax evasion techniques and give birth to a whole new set of tax evasion schemes? My intuition is the last.
I don’t seem to be alone in this case. Stock markets around the world have accepted the deal without hesitation, barely registering what is supposed to be the biggest transformation in corporate taxation in the past 100 years. This seems to tell us that after-tax corporate profits are unlikely to change much, if at all.
How tax evasion works
The international business tax regime that emerged in the early part of the 20th century provided that the income of an active business would be taxed where the business is located. But there was an inherent loophole in this, as much of world trade takes place in the form of intra-firm trade between affiliates within a single firm.
Companies often transfer a large part of their profitable activities to subsidiaries located in low tax jurisdictions, i.e. tax havens, so the income appears to come from these countries. As a result, they are taxed at very low levels.
Regulators are all too familiar with these tax evasion techniques, called transfer pricing. They have put in place a whole series of regulations to put an end to these practices, but it does not seem to have had the desired effect. Instead, it gave rise to a different kind of tax evasion scheme called jurisdictional arbitration.
Such systems take advantage of loopholes, loopholes or omissions in the laws of one country to play against the rules of another. Apple, for example, took advantage of the difference between the rules in Ireland and the United States regarding the place of taxation of business income (known as tax residency) to create two subsidiaries in Ireland that had no tax residency anywhere.
Apple has transferred the majority of its sales outside the United States to these two subsidiaries. And since these subsidiaries were not tax residents anywhere, they could not pay tax anywhere. It is currently the subject of a lawsuit brought against Apple by the European Commission.
Amazon, on the other hand, has developed a system of internal transfers that takes advantage of the generous U.S. tax credit system. By shifting losses from its international segment to the United States, it ends up paying little or no tax.
Moreover, judicial arbitration is just the beginning. Sophisticated companies – notably Amazon – are also taking advantage of accounting rules associated with financial instruments such as derivatives and swaps to modify the very accounting data used in the tax calculation. They can change the location, timing or even accounting categories of income, turnover, etc., to shift profits either from one place to another, or often to a future that never comes.
The new system agreed in London covers some of these techniques. First, it proposes to impose an overall minimum of 15% corporate tax. Now let’s be clear. It is unlikely that a single legal person located in a 0% tax jurisdiction such as Cayman Islands or Bermuda will be used for tax evasion these days, as there are enough anti-avoidance rules to ensure that they do not. assure that this is not the case.
Nevertheless, subsidiaries in Cayman, Bermuda – or indeed the Netherlands, Luxembourg, Switzerland, Ireland or Singapore – are often used as components in complex jurisdictional arbitration schemes. Zero taxation plays an important role in these regimes.
Nonetheless, it is difficult to say whether an overall minimum rate could affect programs such as Apple’s Irish “resident nowhere” setup. Likewise, at this point, it’s a mystery to me how Amzaon’s fiscal position might be affected. Therefore, the G7 proposed a second element to the new rules: the tax must be paid where the sales take place, not where the transaction is recorded. If adopted, the Apple system would no longer work because Apple’s subsidiaries would pay the tax where they sell their products. .
We can already anticipate at this stage new ways to get around the rules. The agreement only concerns very large companies (although what “very large” implies is still unknown). It will also only affect companies with an annual profit margin of 10% and above.
I suspect that if the new regime is robust enough, the “very large” rule could lead to the dissolution of larger companies. Instead, we might see groups of technically independent companies acting in alliance to ensure that the whole deal is below the threshold. We saw something similar with the rise of the so-called ‘shadow banking’ industry, where onerous banking regulations gave rise to sets of seemingly independent companies acting together as banks to avoid the need for bankruptcy. ‘a banking license.
Alternatively, the deal may further encourage techniques perfected by the Amazons of this world, using sophisticated bookkeeping to grow fat under the guise of losing money.
The deal, in other words, can be transformational, but whether or not it will affect the amount of tax paid by the corporate sector is a whole other question.
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