ON THE MONEY: Profit shifting is all about the people

IT IS easy to forget how fast the world has changed. The iPad is only five years old. Facebook has been with us for just a decade. Skype has just had its 11th birthday. Those have resulted in big changes to the ways we interact, but they are in turn the result of a fundamental technological revolution.

This revolution has allowed highly skilled workers to escape their geographical roots. For much of what we do now there is no difference between being on the other side of the world and being in the room next door. That has huge implications for one thing in particular: how to raise tax. The Davis tax committee is pondering this question in SA.

The 20th-century economic model depended on geography. Production and consumption were never far apart as most of what we consumed were physical goods. Transport costs meant manufacturing occurred either near customers or near the needed raw materials. Multinational corporations typically had a head office and series of country-level subsidiaries, all of which operated as economically independent units. Workers were located where the companies were. That made life simple for governments — it was easy to see where value was added and profits generated, and therefore how to tax them.

Multinational companies now tend to structure themselves around service lines instead of geographies. One team can be spread among several countries and still work as a coherent unit in real time.

Banks are an obvious example. Country-level operations no longer have retail banking, investment banking, asset finance and other units in country. Rather, all those units will have global reporting lines and teams spread around the world. Where the actual legal entity is positioned is another matter.

Individuals are also globally mobile. Hedge-fund managers and computer programmers can put themselves anywhere in the world. How many would rather be operating from an island in the Caribbean a la Richard Branson than a pokey office in a congested world city, especially if the island offers a much lower tax rate?

So far this problem has been framed in terms of profit shifting. In the UK companies such as Google and Starbucks have been flayed for paying almost no tax in the country, with profits instead accumulating in low-tax environments. Profit shifting is a problem because the economic activity takes place in one country, but the profits end up in a different jurisdiction, outside the tax net.

But this is generally just a tax deferral strategy — profits usually find their way to shareholders via some taxable listed entity. The bigger problem is not the shifting of profits, but the shifting of economic activity.

The Davis tax  committee released a report on how to deal with profit shifting just before Christmas. It is not a very convincing document. It is stuck in a 1980s view of the world, where the key question is how to stop South Africans from shifting profits abroad, ignoring the fact that it has never been easier for South Africans to shift themselves abroad. So the question we need to answer is: what will make South Africans choose to operate from SA, rather than the narrow question of how to make sure their profits stay in SA?

As things stand, about R50bn is paid by South African companies for foreign-based services per year, according to the committee. That number can only grow as technology allows for services to increasingly be provided from anywhere in the world. In the four years from 2008 to 2011, which are the latest data the committee has, the amount paid for legal, accounting and management consulting services increased 32.6%.

My contention is that this increase reflects the ease with which technology has made it possible to supply such services from anywhere. Of course, this works both ways, though the committee does not mention it. South Africans are able to supply services to the rest of the world, too. We should aim to improve the net flow into SA, rather than fret about the outflow alone.

The Davis tax committee is one of many around the world applying fingernails to scalps on these issues. Part of the solution is undoubtedly improved tax co-operation among countries. Multinational corporations are still subject to government authority where their consumers are.

It is not yet clear how governments are going to respond to these seismic shifts in technology and their ability to raise tax. What we do know is that our own government is eager to find ways to raise the tax take to deal with the rapidly ballooning fiscal deficit. Expect to hear more about that in February’s budget speech.