Simpler solutions for taxing digital firms should be possible

Oct 18, 2020
Originally posted on Business Post 18 October 2020.

Last Tuesday, Paschal Donohoe and Michael McGrath were able to present a budget against a much better backdrop than exists for many of their counterparts in the developed world. True, the national pandemic response had knocked Vat receipts and income tax receipts, but the shortfall was cushioned by a surge in corporation tax receipts.

Here, corporation tax makes up almost €1 out of every €5 collected in tax. That’s an unusually high ratio by international standards, and anything which might threaten this yield is a concern.

The OECD's latest blueprints to modernise the way taxes are collected from multinationals was published the day before the budget, and this timing diluted the attention they might otherwise have received. The blueprints are part of the second instalment of efforts which commenced seven years ago to generate more tax from multinational companies.

The first instalment, Base Erosion and Profit Shifting (or BEPS as it came to be known), was a child of the great recession. Public unease led to political unease at global corporations seeming not to be paying their fair share of tax.

The project started in Ireland at a G8 meeting at the Lough Erne resort in Co Fermanagh. The OECD was given a mandate to figure out how best to tackle tax avoidance strategies that relied on mismatches of rules across borders.

The OECD did this with some success – many of the proposals under the first BEPS package were adopted by most countries. The EU responded particularly enthusiastically, issuing directives reflecting BEPS principles which member countries were obliged to apply.

Financial engineering techniques involving things like tax deductions for interest payments and so-called “hybrid” cross-border payments were rendered inefficient for tax purposes. Developments in policing and information-sharing among revenue authorities drove multinational profits out of zero tax jurisdictions.

Arguably the single change which had the most effect on restricting cross border tax planning, even though it fell outside the BEPS plan, was the US Tax Cuts and Jobs Act of 2017. While best known for reducing the US corporate tax rate from 35 per cent down to 21 per cent, it was the less heralded elements of the legislation, such as denying US companies the capacity to defer tax indefinitely using European subsidiaries, that tightened the international tax regime.

The US may have been reluctant about implementing some of the BEPS proposals. Yet, in the round, the US Tax Cuts and Jobs Act of 2017 completed a significant part of the OECD’s work for them.

If BEPS was about “fair tax”, some have described the proposals released on Monday as being about “where” tax. BEPS levelled the playing pitch when it came to the existing tax rules, but failed to establish new tax rules to address the market forces of globalisation and the digital economy.

Monday’s announcements attempt to do that by offering taxing rights to countries where multinationals with an online presence (as distinct from operations) have large markets, and by applying a minimum effective rate of corporation tax across a corporate group worldwide.

No multinational tax reform can take place without American cooperation. The US approach to the current plans has been lukewarm in some respects for the excellent reason that its major digital multinationals like Google, Amazon and Netflix might end up paying more tax to other countries.

In particular, the US seems to want the application of tax in market countries to be optional, which is a guaranteed way of reducing the total overseas yield. Offer any business taxpayer a choice of tax rules and they will take the cheapest option.

None of the options are easy. French proposals on a digital tax withered last year under the threat of US trade sanctions. A storm against digital tax rules is also bubbling in the UK. There, the penny has dropped that the UK's digital taxation rules might apply more to indigenous British industry than to a major multinational such as Amazon because the UK's digital tax system doesn't apply to agency profits.

On the other hand, less wealthy countries are growing frustrated at the slow rate of change, pointing out that Covid-19 accelerated the growth of digital economy companies.

The African Tax Administration Forum, a think tank for 37 revenue authorities on that continent, has put forward its own solutions to the digital tax conundrum. Closer to home, the EU is getting increasingly interested in a digital levy to fund the cost of borrowings in its coronavirus recovery efforts.

A recurring problem for the OECD‘s tax work is that the pace of its technical work tended to outstrip the pace of reaching political agreement. In recent years there has been a drift away from international consensus of any type.

When the principles behind the first BEPS phase were being formulated, international trade wars were a minority sport. Now they are mainstream, with the US, the EU and China revenge-swapping tariffs. Given that there is a lack of international consensus on the best approach to tackle coronavirus, what chance is there of international consensus on an item of tax policy?

Consensus, though, is needed. As the OECD rarely tires pointing out, the downside of not applying an international consensus on new tax rules is that countries may unilaterally create their own taxing rights over multinationals selling in their domestic markets.

That has its own risks. As the Minister for Finance put it in his Budget speech on Tuesday, failure to reach agreement at the OECD would have “negative consequences” for Irish yields. Better the devil you know than a pandemonium.

Some change in the way digital companies are taxed is inevitable, but the OECD blueprint solutions published on Monday do seem overcomplicated for a less collaborative, protectionist world. Simpler solutions should be possible.

The EU, for example, tackled the comparable problem of where Vat on digital services is collected by allowing businesses anywhere in the EU to deal with just one Revenue authority under “one stop shop” rules. There may also be lessons from the oldest and most effective tax for cross border trade, which is excise duty.

That duty is charged when a product is released into a country for consumption, without reference either to the profits or even to the origins of the producer. These precedents may provide models for easier ways to achieve more acceptable tax contributions from multinationals by reference to their market presence than the labyrinthine attempts currently underway.

For now, the two ministers got a lot of things right on budget day. Among them was that they did not overly emphasize an imminent disruption to Ireland's corporation tax base because of international rule changes.

As things stand at present, there is no prospect of meaningful multinational consensus emerging to disrupt corporation tax yields here during 2021. The biggest risk to corporation tax yield here next year is a collapse in corporate profits, not a collapse in corporate tax rules.

Dr Brian Keegan is Director of Public Policy at Chartered Accountants Ireland.