Tax avoidance: three things G20 governments can do

The ability of multinational companies to shift profits into low-tax jurisdictions is undermining governments’ ability to raise revenue. But the cross-border policy solutions are complex.

Curbing international tax avoidance has become a focus of G20 discussion this week, after last week’s revelation that major companies including Ikea, AMP and Pepsi are paying very low tax rates in Australia. But against a background of a growing number of multinational companies with complicated, cross-border supply chains — and competition among nations to attract investment — the policy challenge is significant.

A global problem will require the type of international co-operation offered by groupings like the G20. The way John Freebairn of Melbourne University’s Department of Economics sees it, there are three main options for governments.

“The smartest one,” he explained to The Mandarin, “would be to raise the lower tax rates — if you could bribe low-taxing countries like the Bahamas, the Cayman Islands, Ireland or Luxembourg to move their rates up a bit. High tax rate countries like the United States or Australia might move theirs down a bit, so standardising the tax rates.”

These “bribes” would likely mean large countries transferring money to tax haven-supporting governments, set at an amount that would still see the higher taxing jurisdictions receiving a net benefit.

Countries like the US, UK and Germany have already been leaning on tax havens to play ball, including reaching agreements with Switzerland and other countries to ensure money held in banks there is taxed.

“Second,” said Freebairn, “is to at least define how you measure taxable income similarly across countries and share that information.” He cites as a model the way income taxes are divided between the states in the US and provinces in Canada based on sales or employment. Each state still sets its own tax rate.

“You’d have to go much further than we go with the World Trade Organisation, you’d have to get some sort of move towards a global agreement on how you measure company income and a principle on how to apportion that. That model works reasonably well in the US,” he said.

The third option is for countries to share information with each other so that each jurisdiction can work out from a company’s global revenues what it should be paying. Under that model, “each country would have different rules still, so that’s a halfway house” compared to an agreed set of rules, argues Freebairn.

Several countries have signed agreements forcing companies and states to share information on entities legally based within their borders. Australia signed a revised tax treaty with Switzerland in 2013 to share data and reduce tax evasion.

Even with an international agreement, however, “you’re always going to be stuck with the problem of how to measure overhead costs”, Freebairn adds. There are many companies where it is difficult to work out a unit cost price, such as medicines where most costs lie in research and development, or software where spending is largely on product development and administration.

Differentiated products also make it difficult to establish what is a fair transfer price. Transfer pricing can be used to sell products between national branches of the same company to incur losses in high-tax areas and profits in low-tax countries, and is common in tax avoidance schemes.

“Even iron ore is not iron ore, it depends on the number of impurities.”

“Even iron ore is not iron ore, it depends on the number of impurities. Google’s software is different to another company’s, and so on,” Freebairn said. This means tax agencies can struggle to determine how much companies should be paying to transfer products.

“Those companies will always argue that the management of that process is being done in Australia, while moving as much of the revenue as they can to Ireland, so they’re declaring most income at the 15% rate, and moving their costs to where there is the 25% rate,” he explained.

The Organisation for Economic Co-operation and Development has done a lot of work exploring solutions to what it calls Base Erosion and Profit Shifting over the past few years; The Australian is reporting G20 member states are expected to sign off on a BEPS plan this weekend.

Sharing information would be a great help to the Australian Tax Office, but tracking down all that money requires sufficient resources, Freebairn points out.

“Data sharing would give a big bang to the ATO’s efforts, if they could just go to the computer and check what companies are doing in the Bahamas or Ireland,” he said. “It clearly takes a lot of skilled people to chase all this stuff down, and it’s very difficult to do this unilaterally.”

While he doubts much will come out of the upcoming G20 meeting, Freebairn sees it all as part of a gradual build-up of strategies to deal with a complex issue.

“This is a problem that’s going to get bigger and bigger. It’s not going to be solved overnight. If this helps build pressure to getting a better solution, then it’s a step along a long road,” he said.