Global tax avoidance and its effects on Australia’s economic prosperity
Mark Konza, Deputy Commissioner - International, Public Groups and International
Presented to Committee for Economic Development of Australia
Tuesday 26 August 2014
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End of attention
I’ve been asked to make some brief comments on the topic of global tax avoidance and its effects on Australia’s economic prosperity.
It is important to start by recognising the mutual dependency of taxation and business activity. Thinking tax people want business to be successful so we have something to tax. They know that reducing compliance costs, increasing certainty of tax treatment and, in an international context, avoiding double taxation are important to business success. Thinking business people recognise that tax needs to be collected to maintain and develop the society in which they trade and the infrastructure upon which they rely. To be successful, however, they cannot have cost structures that are more expensive than their competitors. Uncompetitive tax arrangements increases the incentive for multinational enterprises to seek tax avoidance opportunities.
Before I talk about the effect on economic prosperity, I think it important to note the impact that tax avoidance can have on trust in the legitimacy of the tax system. The great majority of taxpayers, individual and corporate, pay their taxes voluntarily and in accord with the law. They do so partly because they believe that others are doing the same. If tax avoidance is left unchecked, the perception of unfairness has the potential to undermine the voluntary ethic in the broader tax system.
Global tax avoidance can take different forms. It includes:
- Profit shifting – where the prices paid between related parties for goods, services or use of assets are inflated above their true economic value so that profits are artificially moved between different jurisdictions;
- Treaty shopping – where transactions are organised through intermediaries located in particular jurisdictions in order to obtain different treaty benefits without those intermediaries materially contributing to the transaction; and
- Residency manipulation – where individuals and legal entities attempt to present themselves as residents of a low tax jurisdiction, or of nowhere;
- Global tax evasion can also occur through the use of secrecy jurisdictions to hide or wash money or other assets.
The 2013 OECD Base Erosion and Profit Shifting (BEPS) Action Plan highlighted that greater economic integration across borders, improvements in communications technology, reduced barriers to international trade, and the increasing value of intellectual property have fundamentally changed the way businesses operate. These factors have allowed some taxpayers to exploit existing weaknesses in the law to concentrate trading profit into particular economic factors of production and then move those factors into favourable jurisdictions.
The 15 point plan envisages the discussion and resolution of identified problem areas over the course of 2014 and 2015.
Australia is involved in these discussions through Treasury and Tax Office representatives. We need to be involved because these discussions have the potential to impact Australia’s economic prosperity.
This impact could manifest in several ways.
Firstly, the G20 has recognised that global tax planning can affect Government revenues and that this tax planning can be facilitated by both domestic and international tax law. Part of the G20’s concern is the maintenance of government revenues needed to maintain the societal infrastructure. That infrastructure is also instrumental to business success.
However, the first challenge is to properly understand the extent to which these laws are used in tax planning or are ineffective in preventing tax avoidance. As a tax administrator, the ATO’s first concern is whether Australian taxes have been properly paid under the existing law. We do provide guidance to business on how we see the law operating and we provide the ability for business to get advanced pricing agreements which gives the taxpayer the opportunity to work with the Commissioner and to make sure their arrangements are compliant. There are 171 agreements currently in operation.
Nevertheless, we do have concerns in other cases that, in the desire to concentrate profits into the moveable or ‘footloose’ assets, income from Australian economic activity is not properly returned in Australia. We also have concerns in some cases that, in the desire to locate those profits in the most favourable location, business actually being conducted in our country is not being accounted for here.
The ATO is examining these issues through a program of reviews of companies that have internationally restructured or that have significant related party transactions. It also has a group focussed on closely examining the arrangements of some high tech taxpayers to see whether the law is being applied correctly. Australia has strong transfer pricing, general anti-avoidance, thin capitalisation and controlled foreign corporation rules that provide defences against BEPS risks. We use those rules in our review of company operations. We have received the support of successive Governments in making improvements to these integrity measures.
The ATO has broken new ground by working closely with a number of other countries’ tax administrations to pool our knowledge of the global operations of some multinational enterprises and jointly analyse whether their tax planning complies with existing laws. We see this type of joint action as being an integral part of the solution to base erosion and profit shifting – whether or not the international tax laws need to be improved.
It may be that the existing law is not sufficient to achieve the G20 goal of ensuring that ‘Profits should be taxed where the economic activities deriving the profits are performed and where value is created.'
This is why the OECD is examining the existing law to see what change is necessary. The work of the ATO and other tax administrations is important here also because such considerations need to be founded on a sound understanding of what is currently occurring – media analysis based on publicly available data is no substitute for a proper examination of the facts. Through its work, the ATO has been able to inform Treasury and the OECD about the types of arrangements it sees being put in place and the pressure points in the law. In Australia, this has been reflected in the Government seeking to tighten the thin capitalisation rules by reducing the ‘safe harbour’ debt limits and removing a flaw in the exemption for foreign non-portfolio dividends.
It has been clear from representations made here in Australia and in other countries that the advantages some companies have been able to get from structuring to minimise their tax gives them an unfair advantage over companies who cannot structure in this way. Companies who cannot structure in this way include those who operate only in the domestic market and therefore cannot claim that sales have been made in a far-off island. Small and medium enterprises, who may or may not be operating internationally, cannot afford the tax planning that is required. The presence of this advantage creates a distortion in the market and hurts local businesses looking to compete and grow.
The OECD will produce reports recommending the approaches to be taken. Some of these, such as anti-treaty shopping and permanent establishment rules, will help keep income and economic activity together. The extent to which jurisdictions take them up will depend on their own sovereign choices. Australia also will have to decide what, if any, changes are needed in our domestic law, given that our code is relatively strong. It is true that Australia relies more on corporate income tax than other countries, but it is important that Australia’s taxation system does not prevent us from being internationally competitive. This will be a major consideration for the Government in considering its response to the OECD work. Any change will need to be pragmatic, tailored and proportionate – and fit in with the Government’s commitment to deregulation overall.
The G20 has restoring world economic growth as its top priority, while ensuring all people have an opportunity to gain from that growth. It also seeks to prevent the cross border tax evasion and avoidance which undermines public finances and people’s trust in the fairness of the tax system.
The OECD is a consensus based organisation and in its BEPS considerations it has attempted to include a wider range of countries either through direct involvement in the discussions or through regional discussions. Its recommendations will reflect the agreement that can be reached between countries, balancing the growth, equity and fairness considerations.
There are two key reasons why it is important that consensus be reached. Firstly, a strong global view allows the G20 and OECD to pressure those countries who might want to continue to facilitate tax avoidance to stop that facilitation.
Secondly, reaching a global view on improvements through the G20 and OECD reduces the possibility of unilateral action being taken by countries dissatisfied with the current international tax arrangements. Unilateral action could result in multiple tax systems operating around the world, increasing the risk of double taxation, compliance costs and further tax planning.
As an open trading economy, Australia needs to be involved in these discussions to ensure we support moves towards a coherent international tax system that encourages trade, investment and growth.
Global tax evasion has historically been facilitated by secrecy jurisdictions which have allowed some people to conceal or launder their income or assets offshore. With the rise of the Foreign Account Tax Compliance Act in the USA and the Savings Directive in the EU it has become obvious that a common reporting of bank information through a global standard would make sense. As project Wickenby has demonstrated, Australia has had a problem with its citizens using secrecy jurisdictions. The rise of global financial systems has made it easier than ever before for people to seek out and use such jurisdictions. The Common Reporting Standard is an important development, not only because of its global reach but also because it extends to any form of monetary investment. We have also seen a shift in behaviour of many jurisdictions we would have previously considered to be tax havens. Numerous such jurisdictions have entered into Tax Information Exchange Agreements with Australia and have indicated that they will sign up to the standard. The era of secrecy is fast coming to an end.
Back in the Base Erosion and Profit Shifting space, transparency is being improved through reforms to transfer pricing documentation including country by country reporting by multinational enterprises of their activities, assets, income and tax. These reports should give tax administrations a better basis on which to analyse the global operations of an MNE in their country. I would expect that this documentation will usher in a new round of co-operation as revenue administrations work together to compare their interpretations of the submitted material.
Multinational enterprises need to make choices about where they will ‘put their feet down’ around the world. Tax should be a part of the bundle that companies pick up when they choose a country. A stable society and legal system, high education standards, good infrastructure, hardworking people and a tax rate that is competitive in that context should be a good offering.
The different bundles being offered by countries can amount to legitimate competition. The ability to separate income and economic activity is what gives rise to unfair tax competition – it is unfair because it attempts to delink the mutually cooperative nature of tax and the economy. Low tax jurisdictions attract the income without the economic investment and it does them little good. Productive economies lose the income and lose the ability to sustain themselves.
Australia is a good country in which to do business: limiting global tax avoidance and its impact on Australia will help us keep it that way.
Mark Konza, Deputy Commissioner - International, Public Groups and International, presented to the Committee for Economic Development of Australia on Tuesday 26 August 2014 in Sydney