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Richard Murphy City, University of London, U.K.
Richard Murphy is Director, Tax Research UK and Professor of Practice in International Political Economy at City, University of London
The contradictions of corporate taxation have become clear on a global scale. One possible solution, an Alternative Minimum Corporation Tax, is proposed here.
Corporation tax should be such a simple affair. After all, the aim is to tax the profits of a company once only in the place where they arise. What could be complicated about that? As we all know, quite a lot. And, much as I would like to think the BEPS project will work I cannot confess to confidence in it (country-by-country reporting excepted, of course). That, though has led me to think about what solutions there might be to the conundrums of corporation tax that might work, whilst addressing some of the essential contradictions that the tax exposes and which tax avoiders exploit.
There are, in essence, three such contradictions. The first is that companies are created nationally but can trade extraterritorially and no one sees any contradiction in this.
The second is that companies can own companies, which provides layer upon layer of removal of entities from any identifiable ownership, and again no one sees anything odd about this.
The third is that corporation tax, apparently alone among direct taxes, now has a territorial basis: the right of the state to charge a warm-blooded tax resident to tax on a source of income arising outside its jurisdiction is unquestioned almost anywhere, but when it comes to companies we now have a water's-edge concept. The paradox is all too obvious: there is implicit in this an invitation to relocate income and yet this territorial concept is another now apparently unquestioned assumption.
Add the three situations together and the problem of corporate taxation is all too clear. The law of any state can apparently permit trade elsewhere without the corollary of a right to tax the resulting income. If there is any doubt about the ability to achieve this goal then the right to incorporate elsewhere is accepted as being absolute for most corporations, even if it is constrained for individuals in many states. And the law now makes clear that as a consequence the tax base might be rightfully reduced. It is really quite a strange situation to have arisen.
The question is what might now be done to address the opportunities for abuse that this combination of accident, law and policy has given rise to. The BEPS project is obviously one answer to that, but is candidly little better than a sticking plaster on a failing system. What is more, that failure is inevitable: if the Organisation for Economic Co-operation and Development (“OECD”) persists in arguing that all companies in a group are independent of each other for tax purposes, when that is obviously untrue, then poor tax outcomes are inevitable. Good tax systems cannot be built on the basis of fairy tales.
Unitary taxation is one obvious solution to this problem. The revival of the European Union's Common Consolidated Corporate Tax Base proposals is welcome as a consequence, but I have to accept that any such solution is going to take time to deliver, not least because many of the accounting issues involved are much more complicated than most people seem to realize.
In that case an interim solution is needed, and I suggest that an Alternative Minimum Corporation Tax (“AMCT“) fits the bill.
My proposal for an AMCT is simple. In essence the AMCT would apply an agreed tax rate to the globally reported pre-tax profits of the reporting entity. This sum would be collected by the head office location of the company, unless that jurisdiction refused to cooperate in the process, in which case another country could nominate itself to undertake the task.
The sum settled would then be apportioned among all the jurisdictions in which the entity traded as indicated by its country-by-country reporting data. To minimize potential valuation disputes, I would suggest any apportionment be based only on sales and labor, with sales also being apportioned on both a source and destination basis (each being weighted equally) and labor on both a headcount and payroll cost basis (again weighted equally). I accept this would mean extending the OECD template but this information should be available to any company, so the demand is not onerous.
The tax rate to be used would be blended: I would suggest the rate be based on the headline tax rate of those most populous states representing at least 90% of the world's population, with the calculation being weighted by population. If this was thought to create bias, this sum could itself be averaged with a similar calculation based on GDP per country itself weighted by GDP.
The actual figure to be charged should, I suggest, be 80 percent of this blended sum. This would then ensure that most states would still have an additional tax charge to make, giving them a vested interest in reviewing the local affairs of the corporation. This would also mean that if some local incentives, such as accelerated capital allowances, were to be offered to encourage investment in a jurisdiction then they are likely to be effective.
There are, of course, some issues arising from basing the payment on the accounts figure for pre-tax profit. In particular this risks capital gains and unrealized profits that might be subject to lower or no tax in some cases being subject to a tax charge. If this gives rise to a review of the availability of reduced tax rates, for which there appears to be almost no economic justification in a world where there is a corporate savings glut, then this would be one advantage of the AMCT. If it also gave rise to improved profit reporting under International Financial Reporting Standards so that realized and unrealized profits were better identified and the identification of tax allowable and disallowable expenditure became more commonplace, then this would also be welcome: the development of tax reporting standards to achieve this accounting reform is long overdue. In the meantime the approximation of profit before tax will have to do.
If, as a result of this apportionment process, tax was allocated to a state that did not wish to receive it (and Ireland has recently proved that this possibility exists) then it would not be refunded but would instead be subject to a second round of apportionment to ensure it was matched against potential liabilities in other states. As such the essential goal of ensuring most group profit was taxed once only in the states where it was likely to have arisen would have been achieved by an AMCT, by design. That is more than can said of the existing global tax system.
This is not to say there would be no problems. In particular, the right of a state to collect tax as global agent for other nation states would have to be recognized. I think that the current state of cooperation between OECD member states does not make this impossible.
There are also problems with current systems of payments on account required in some countries: building credit for these into any system would be a challenge but one that is hardly insurmountable. After all, the principle that these can be refunded if a liability is not ultimately due is well recognized.
And I accept losses create an issue, but not one of significance: there is nothing to stop an allowance for losses before tax to be carried forward for offset against future profits. The issue then becomes one of whether local losses are ever meaningful in groups that are overall profit-making, or always represent some degree of artificial base shifting when engagement with a jurisdiction is ultimately a group decision. I have always tended to the latter view.
Of importance is the fact that the objection of low tax states to this system would not need to be taken into consideration: the system does not require them to accept payment they do not want.
In addition, by using a rate that is below a blended aggregate the right of states to offer tax incentives is not undermined so long as they remain proportionate, and the autonomy of local tax systems is also preserved: local tax computations and returns would still be required. The autonomy of local tax systems is not at risk unless artificially low rates are offered that are significantly different from headline offerings, and such arrangements have always, in any event, been subject to opprobrium or sanction and so are not now reason for objection to the AMCT. In this way the conundrums noted previously are resolved.
And before anyone gets too excited about a special tax role for head office locations, this is exactly what the new, BEPS endorsed, transfer pricing rules envisage.
So what's the net outcome? Several things happen. First, tax payment on profits is ensured.
Second, the objective of taxing profit once only is greatly assisted.
Third, profit shifting becomes a largely meaningless exercise.
Fourth, as a result most tax game playing will come to an end: in effect most tax haven usage will cease to be of benefit.
Fifth, certainty on taxation will increase: this is what business always says it wants.
Sixth, stakeholder confidence in business will grow.
Seventh, investor risk will fall, which is likely to improve share prices.
Eighth, the focus in business will be on the actual location of economic activity and not tax, which is likely to improve decision-making and so the rate of return on capital.
Ninth, tax administration, audit and dispute costs are likely to fall as any sums under dispute will be reduced.
Tenth, there will be a focus on improved tax and profit reporting as parallel tax books will cease to have as much relevance as they have in the past.
So is it a panacea? No, full unitary taxation based on much improved tax reporting that eliminates the anomalies of financial accounting when used for tax purposes in the accounts of multinational companies would be better than an AMCT. But for now, AMCT could pave the way to that outcome. I believe the time has come to give it serious consideration.
Richard Murphy is Director, Tax Research UK and Professor of Practice in International Political Economy at City, University of London. He may be contacted at: firstname.lastname@example.org
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