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End of the line for multinational tax abuse?

December 10th, 2012

flickr / soumit

Is it inevitable that multinational companies pay pitifully small sums in tax relative to huge profits? Not necessarily because amid growing political and public outrage at how multinationals organise their tax affairs, a new report today suggests there could be an alternative.

Towards Unitary Taxation of Transnational Corporations by Sol Picciotto, emeritus professor at Lancaster University, presents a blueprint for a complete overhaul of international corporate tax rules.

Today multinationals are able to avoid tax because global protocols, known as the Arm’s Length Principle (ALP), treat their extensive networks of subsidiaries as separate businesses. Under ALP, businesses can structure their operations using low tax jurisdictions to help reduce their tax exposure.

It is why, ‘consumer-facing’ companies like Amazon, according to Picciotto, classes its UK consumer operation as a logistics centre fulfilling orders that is supplied by a related, but legally separate Luxembourg ‘sales’ company.

And it is how Amazon, completely legally, last year paid no corporation tax on its £2.9bn net UK sales. Amazon’s profits from its UK online shoppers were funnelled into Luxembourg – widely considered to have an extremely opaque financial and tax system.

Draining profits

Multinationals repeat the same trick with intellectual property (IP). Global businesses establish subsidiaries tasked with the job of owning IP in places like Switzerland. The IP subsidiary charges operating companies belonging to the same company for the privilege of using IP. The effect is the same: a draining of taxable profits.

Earlier this week, the EU suggested tax abuse cost the European economy €1 trillion. And Picciotto pins the blame on the Arm’s Length method, which has dominated global business for 80 years. He argue it is broken and a new way of looking at multinationals is required.

Rather than separate business entities, multinationals should be seen as a single unit with profits ‘apportioned’ in the country where they accrue, subject to legitimate costs, he argues.

Unitary taxation would require a company to publish a global consolidated set of accounts so a true picture of its performance could be established. In this way, tax authorities would be better placed to understand the extent of a company’s economic presence in any one country.

It is a simple concept. But it is not new. In the 1920s, the state of California used a form of Unitary Taxation with profit apportionment to bring to heel rogue film studios in the 1920s who siphoned their profits through neighbouring Nevada.

Only little people pay tax

Last week, respected finance thinker John Kay, in the Financial Times, commented: ‘The repeated revelations that many major companies pay little or no tax, even if they do so by legal means, fuels a public sense that tax is mainly for little people. We need only look at Greece to see how socially, politically and economically corrosive that perception can be. . . . Well conceived apportionment is the best – perhaps only – answer to the problem presented by multiple company tax jurisdictions.’

It is now up to the Paris-based OECD, which is the ultimate global tax authority, to decide whether there is a more effective model of taxation than the current discredited system.

Given how easily big business can downsize profits, at the very least the OECD should consider commissioning studies to establish whether it has something to offer.

Historically, the OECD, encouraged by the UK, has resisted all calls to explore unitary taxation. But it surely cannot ignore a shifting public mood that is demanding change?

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Written by Nick Mathiason

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