Double taxation risk in chasing multinational companies
A call to tax technology companies such as Apple and Google in the countries where they have substantial activities has re-ignited concerns companies may be taxed twice and stop business altogether.
The Organisation for Economic Co-operation and Development, which is working on a global plan to prevent companies from avoiding paying tax on profits, wants to end structures used by companies such as the “double Irish” which exploit differences between tax codes to move profits from Ireland to zero tax countries like Bermuda.
The OECD in a discussion paper on the digital economy released on Monday night notes that “structures aimed at artificially shifting profits to locations where they are taxed at more favourable rates, or not taxed at all, will be rendered ineffective”.
It wants the taxes paid by multinationals to align with where “economic activities takes place”.
“This will restore taxing rights”, with the “aim to put an end to the phenomenon of so-called stateless income”, the paper said.
Tax experts said if companies like Apple are stopped from shifting profits through Bermuda, the next question is, which country has the taxing rights.
Governments could be in dispute about it , and companies may decide to pull out if more than one country taxes.
‘Toll road problem’
“It’s the classic toll road problem,” said Grattan Institute chief executive John Daley.
“People start putting up toll roads everywhere, and eventually no one uses the toll road. If there’s multiple countries wanting to tax the same activity, then companies may not bother with that activity.”
“If every country the iPhone passes through wants to levy a 20 per cent tax on profit – let’s say America charges 20 per cent because that’s where the product is designed, then China charges 20 per cent because that’s where it’s manufactured and Australia charges 20 per cent because that’s where they sold it – it’s no longer worth making an Apple iPhone.”
To collect more tax, the OECD is examining how tax authorities can rework the old concept of “permanent establishment” – a rule that says a company must have a physical presence to be charged tax.
In the modern digital economy, many multinationals don’t have a physical location in some countries and avoid paying tax.
This was how Google’s Australian arm paid just $74,000 in tax in 2011, despite generating billions in sales revenue.
“It is increasingly possible for a business’s personnel, IT infrastructure and customers each to be spread among multiple jurisdictions, away from the market jurisdiction,” the OECD says.
While the problem is not unique to digital businesses, it was “available at a greater scale in the digital economy than was previously the case”.
“A non-resident company may interact with customers in a country remotely through a website or other digital means – for example an application on a mobile device -without maintaining a physical presence in the country,” the paper said. “Accordingly, such non-resident company may not be subject to tax in the country in which it has customers.”
The OECD suggests looking at where businesses were conducted “wholly digitally”.
A company would have a permanent establishment if it maintained a “significant digital presence” in the economy of another country.
The test would be that the core business “relies completely or in a considerable part on digital goods or digital services” and that “no physical elements or activities are involved in the value chain”.
Internet contracts only
Contracts would need to be “concluded exclusively remotely via the internet or by telephone”, payments would have to be made “solely through credit cards or other electronic payments using on-line forms or platforms linked or integrated to the relative websites”, and the websites would be the only means used to enter into a relationship with the enterprise.
“No physical stores or agencies exist for the performance of the core activities other than offices located in the parent company or operating company countries,” the paper said.
The paper also notes the need to review transfer pricing guidelines and not allow governments to take unilateral action. Australia already has given theTax Commissioner sweeping powers to “reconstruct” commercial transactions as he wants.
The OECD said its work, due by September, would “provide clearer guidance on the difference between appropriately identifying the specific nature of transactions undertaken based both on actual conduct and contracts, on the one hand, and disregarding or recharacterising a transaction on the other hand”.
“An unlimited authority in the hands of tax authorities to recharacterise transactions may lead to unwanted double taxation and increased levels of controversy, guidance will make clear that understanding precisely what business activities individual entities undertake is a critical element in the process of analysing transfer pricing matters.”
The OECD’s latest paper notes that “excessive cross-border payments to related parties in low tax jurisdictions can erode the tax base of the countries from which such payments are made”.
It said that while transfer pricing rules- based on the arm’s length principle – are “theoretically equipped to address the proper amount of such payments”, in reality sometimes payments are not subjected to tax either in the low-tax recipient country or the home country of the multinational.
It said “certain targeted measures could potentially be helpful in addressing this type of BEPS – depending on the way they are designed, such measures could preserve a measure of reliance on the arm’s length approach but depart from a strict adherence to the arm’s length principle in targeted circumstances.
Examples of such approaches would include caps on certain payments, or formula based allocations.
The OECD plans to examine these types of provisions, and how they might be applied, as well as “mechanisms that could be used to avoid or relieve double taxation in situations where it might otherwise arise”.