Tax Justice Australia Network
I have made revenue collection a frontline institution because it is the one which can emancipate us from begging. If we can get about 22 per cent of GDP we should not need to disturb anybody asking for aid; instead of coming here to bother you, give me this, give me this, I shall come here to greet you, to trade with you. - President Yoweri Museveni of Uganda, that currently collects around 11 per cent of its GDP in tax.
Tax provides the money for services that we all need, like health care, education, aged care, clean water and roads. However, some wealthy individuals and multinational companies engage in large scale tax dodging, avoiding paying hundreds of billions of dollars in taxes globally. This means everyone else has to pay more tax or go without essential services. The impact on developing countries is devastating, denying them the money they need to be self-sufficient and making them dependent on aid and debt.
Tax, not aid, is the most sustainable source of finance for development. Tax can help make governments accountable to their citizens, while aid can make them accountable to the interests of foreign donors. As put by South Africa’s Finance Minister, Trevor Manuel, “It is a contradiction to support increased development assistance yet turn a blind eye to actions by multinationals and others that undermine the tax base of a developing country”.
In contrast, tax havens facilitate corruption globally and as such are an impediment to addressing global poverty and achieving the Millennium Development Goals. They force developing countries to lower tax rates to compete with the havens in order to attract foreign capital. Tax havens actively assist multinational companies and wealthy individuals in being able to engage in tax evasion and tax avoidance, cheating other governments out of much needed revenue. It is estimated that half of all global trade now takes place through tax havens, helping companies to avoid contributing their fair share of tax.
The money lost by developing countries from ‘illicit financial flows’ is vast, mainly through tax evasion and tax avoidance but including other forms of corruption and crime. Anti-corruption non-government organisation, Global Financial Integrity, estimated that in 2008 alone, Africa lost US$64 billion in illicit flows, while the Philippines lost US$16.4 billion, India US$21.5 billion and Indonesia US$16.5 billion. Globally, overseas aid in 2009 was only US$120 billion.
Christian Aid estimated that, through tax evasion and tax avoidance by transfer mispricing and false invoicing, in 2008 developing countries lost an estimated US$160 billion in tax. They estimated that, if this money was used in the same way as the taxes actually collected, it would have saved the lives of 350,000 children.
The Tax Justice Network has recently released research that estimated the amount of unreported private financial wealth owned by wealthy individuals held in tax havens was between $21 trillion and $32 trillion. This is at least the size of the US and Japanese economies combined. The lost tax revenue on this hidden wealth is estimated to be between $190 billion and $280 billion.
Where are tax havens?
Tax havens are all over the world. Many havens are small islands states such as Jersey, Cyprus and Malta in Europe; Labuan and Singapore in Asia, the Seychelles and Mauritius that serve India and Southern Africa, and Cayman Island and Bermuda in the Caribbean. Additional tax havens in our region include the Cook Islands, Marshall Islands, Samoa, Tonga and Vanuatu.
There are also a significant number of onshore havens that serve particular aspects of the global market. The City of London is a Corporation within wider London that hosts the offshore Eurobond market, whilst Switzerland, Austria and Luxembourg have insisted on their right to provide secret banking facilities. The Netherlands is home to almost 20,000 ‘mailbox companies, corporate shells set up by foreign companies and wealthy individuals who use them to reduce taxes on royalties, dividends and interest payments. Globally some 1,165 companies use Dutch tax shelters to reduce or eliminate taxes on royalties and patents. A number of states in the US act as tax havens, with Delaware being a key example. An office at 1209 North Orange Street, Wilmington, Delaware is host to over 200,000 companies including Ford, General Motors, Coca Cola, KFC, Intel, Google and Hewlett Packard. Only about 80 people work in the building.
How do tax havens facilitate corruption?
In the view of the Tax Justice Network: '..banking secrecy and trust services provided by global financial institutions operating offshore provide a secure cover for laundering the proceeds of political corruption, fraud, embezzlement, illicit arms trading and the global drug trade. The lack of transparency in international financial markets contributes to the spread of globalised crime, terrorism, bribery of under-paid officials by western businesses, and the plunder of resources by business and political elites. Corruption clearly threatens development, and it is tax havens that facilitate the money laundering of the proceeds of corruption and all types of illicit commercial transactions.'
The Tax Justice Network concludes 'In combination, tax competition, aggressive tax avoidance, tax evasion and the associated illicit capital flight to offshore finance centres imposes a massive cost on developing countries. This cost exceeds aid flows by a considerable order of magnitude and also distorts investment patterns to the extent that it undermines growth in developing countries whilst also stimulating asset market bubbles in developed and developing countries.'
Transfer (mis)pricing as a funnel for tax dodging
One of the main ways tax evasion occurs globally is through transfer pricing within multinational companies. This covers the sale between subsidiaries of the same parent company of goods. It also includes intangibles for which a price is levied, such as intellectual property rights, management services, branding and insurance.
As long as the subsidiaries of the same multinational company charge each other a fair market price – known in regulatory circles as an ‘arms length’ price – such transactions are perfectly legitimate. Tax is paid where it should be on the profits that are made in that location. But by artificially altering the price or cost of a good or service, a multinational company can increase its costs artificially in a location with higher taxes and transfer revenue to a location with lower taxes (often a secrecy jurisdiction or tax haven).
With 60 per cent of world trade now taking place within, rather than between, multinational corporations, there are substantial opportunities to manipulate transactions to reduce tax. This is especially the case for things like brands and management services. While it is easier to detect if a company is distorting the price of a particular good (by comparison with the normal price of the good traded between two unrelated companies), when it comes to charges for things like branding rights and management services, it is much harder to determine if the price being charged is a ‘fair’ price. There has been significant growth in relation to intra-firm trade with regards to interest and insurance, and service components, both of which have more than doubled over the period 2002 – 2009. The Australian Taxation Office Compliance Plan for 2010-11 notes this concern.
In 2009, Christian Aid commissioned international transfer pricing expert, Associate Professor Simon Pak, President of the Trade Research Institute and an academic at Penn State University in the US, to analyse EU and US trade data, and to estimate the amount of capital shifted from non-EU countries into the EU and the US through bilateral trade mispricing. Professor Pak, who has advised US Congress on this issue, analysed bilateral trade in every product between 2005 and 2007. He calculated the flow of capital from non-EU countries to the EU and US through trade mispricing over that period was in the order of US$1.1 trillion, resulting in lost tax revenues to non-EU governments of US$365 billion. Amongst low-income countries, the biggest tax losses were from Nigeria (£502 million), Pakistan (£305 million), Vietnam (£251 million) and Bangladesh (£ 186 million). In addition Cambodia lost £31 million between 2005-07. Nigeria’s loss was from its mineral fuel and oil industry, which it exports. The money was lost through the artificial lowering of the final sale price in order to minimise tax liability in Nigeria.
The calculations also found that Australia lost 1.1 billion euros in tax revenue through transfer mispricing to the EU in the period 2005-07 and US$1.5 billion in tax revenue through transfer mispricing to the US in the same period.
There are a steady stream of allegations of well known multinational companies being engaged in tax dodging. For example, the Bureau of Investigative Journalism has aired footage of a meeting with Vodafone’s Swiss branch manager in which they allege he admitted Vodafone takes up takes up less than 5 per cent of his time and that Vodafone has a dedicated room in his office but it is almost always unoccupied. One of Vodafone’s subsidiaries with profits worth US$2.5 billion is alleged to have been taxed at less than 1 per cent in 2011. It was further alleged Vodafone did not respond to questions of how it allocates its profits between Switzerland and Luxembourg and why it maintains a Swiss bookkeeping office when it has so few business activities there.
Media reports also indicate Google is under investigation by the US Internal Revenue Service and French tax authorities. It is alleged to have avoided paying more than US$4.6 billion in tax in Britain and other countries over the last five years. It is further alleged to have an elaborate network of companies spanning at least five countries, including Ireland, the Netherlands and Bermuda, allowing it to minimise its tax bill. Profits are legally shifted between Google subsidiaries that ultimately lead to Bermuda. It is claimed Google’s tax rate on overall foreign earnings worked out at just 3 per cent. Despite handling billions in revenue, Google Ireland Ltd’s accounts for 2009 show a profit of £41 million and a tax bill of £15 million. It paid more than £3.7 billion in royalties back to Google Ireland Holdings via an Amsterdam subsidiary. It is further alleged Google cut its tax bill by about US$1 billion a year using a technique that allocates profits to a unit managed out of a law firm in Bermuda. In 2009, this subsidiary collected around US$6.1 billion in royalties from a Google unit in the Netherlands, according to a Dutch corporate filing.
It is alleged Apple paid just £10.3 million in taxes for its three main British subsidiaries despite making an estimated £6 billion worth of sales in Britain. It is alleged to have avoided paying higher taxes by using foreign subsidiaries, such as those in Ireland and the British Virgin Islands.
Amazon is reported to be under investigation by UK tax authorities after paying no corporation tax on any of its profits from the sale of more than £3.3 billion in the UK in the last year. Regulatory filings by parent company Amazon.com with the US Securities and Exchange Commission show the tax inquiry into the UK operation focuses on a period when ownership of the British business was transferred to a Luxembourg company. Amazon’s tax affairs are also reported to be under investigation in the US, China, Germany, France, Japan and Luxembourg. The latest 2010 accounts for Amazon EU Sarl show the Luxembourg office employed 134 people, but generated turnover of €7.5 billion. In the same year, the UK operation employed 2,265 people and reported a turnover of £147 million. Amazon is currently disputing a tax bill of nearly £1 billion imposed by US authorities related to transfer pricing.
Recent inadequate action on addressing tax havens
The initial global response to tax havens in recent years has been to pressure them to sign Tax Information Exchange Agreements with other countries. These allow a country to request information about particular citizens, but only after the requesting country can provide sufficient evidence the citizen in question might be engaged in illegal activity. This is highly resource intensive, and so few requests are made and most of those engaged in tax evasion and other illicit activities go undetected.
This system of information on request particularly disadvantages developing countries. A tax haven comes up with a new abusive product to assist multinational companies and wealthy individuals to avoid and evade tax, wealthy countries construct defences against it as best they can. But developing countries, without the relevant expertise, are left wide open to be drained further of their tax revenue.
Under the current system, Switzerland has managed to get itself off the OECD list of tax havens by signing tax agreements with over two dozen countries, but only four of them are developing countries; Kazakhstan, Qatar, Mexico and India. The poorest developing countries are entirely absent from the list of countries that Switzerland has been willing to sign agreements with to help track down money hidden by tax evaders and corrupt government officials. Further, Switzerland is expecting that developing countries to waive taxes on earnings from Swiss foreign investments in exchange for signing a tax agreement, costing the developing countries revenue. For Switzerland to give up the information under these tax agreements the requesting government has to have the name of the person the request is being made about and the details of their Swiss bank account. It is highly unlikely tax authorities in a developing country would be able to obtain details of Swiss bank accounts, meaning that Switzerland’s banks are likely to continue assisting foreigners in tax evasion and in hiding money obtained through corruption and other criminal activity.
There are a number of things that can be done to tackle the tax dodging practices of some of the super wealthy and multinational companies. Some of these are slowly being implemented by governments and others are under serious consideration.
One thing that is needed is an international agreement that would require tax authorities to share information about each other’s citizens. Say a business man from India opens a bank account in Australia and starts to deposit large sums of money in it, then the Australian Taxation Office would report this to the Indian tax authorities, with appropriate safeguards, allowing the Indian tax authorities to investigate if the person is legally paying tax. Such a system already exists in Europe, and is reported to work well in reducing tax evasion by European citizens. The recently developed Convention on Mutual Administrative Assistance in Tax Matters includes steps towards automatic information exchange between tax authorities. Australia is in the process of becoming a party to the Convention.
In the wake of the global financial crisis, the US government introduced the Dodd-Frank Wall Street Reform Act, which requires companies in the oil, gas and mining sector listed on the US Securities and Exchange Commission to have to report on their revenues, profits and taxes and royalties paid to governments on a country-by-country basis. This is a small step towards reducing tax evasion and other forms of corruption by making it harder for companies to shift their revenues to tax havens unseen. It also increases the ability of citizens of developing countries to hold their own governments to account for the tax revenue they receive from natural resources. The oil, gas and mining sector in developing countries has often been associated with grand levels of corruption and lost revenue for the ordinary people of the country.
There have been moves at the international level towards requiring countries to have laws that would require the public disclosure of the real and ultimate owners of companies and trusts, to deny tax evaders the ability to hide behind shell companies in the control of nominees.
The Australian government should also support the development of a new international norm to replace the OECD rules on transfer pricing that would tax the economic substance of a multinational and its transactions, instead of prioritising the legal form in which a multinational organises itself and its transactions.
One example of such a method is unitary taxation, which originated in the US over a century ago, as a response to the difficulties US states were having in taxing railroads. Over 20 states inside the US, notably California, have set up a system where they treat a corporate group as a unit, then the corporate group’s income is 'apportioned' out to the different states according to an agreed formula. Then each state can apply its own state income tax rate to whatever portion of the overall unit’s income was apportioned to it. Such a formula allocates profits to a jurisdiction based upon real factors such as total third-party sales; total employment (either calculated by headcount or by salaries) and the value of physical assets actually located in each territory where the multinational operates. It has been suggested a formula based only on sales would be least subject to manipulation and the most simple to administer, as sales are far easier to observe and quantify than are production factors and income streams. Limited forms of unitary taxation have been shown to work well in practice.
The aim of unitary taxation is to tax portions of a multinational company’s income without reference to how that enterprise is organised internally. Multinational companies would have far less need to set themselves up as highly complex, tax-driven multi-jurisdictional structures and are likely to simplify their corporate structures, creating efficiencies. The big losers are those consultants who derive substantial income from setting up and servicing complex tax-driven corporate structures. By using worldwide rather than origin-based income, formulary apportionment eliminates any need for geographic income and expenses accounting. In doing so, it largely eliminates the possibility of transfer price manipulation and several other tax avoidance techniques created by tax rate variation between geographic jurisdictions.
Suggested citation Tax Justice Australia Network, 'Tackling tax-havens', Evatt Journal, Vol. 11, No. 1, August 2012<https://evatt.org.au/tackling-tax-havens>