A misguided approach to multinational tax avoidance

The OECD, the organisation that does research for developed countries, has just released its recommendations on how countries should address tax avoidance by multinationals. It comes under the inspirational name of “Base Erosion and Profit Shifting” or BEPS — which suggests the OECD needs to spend more on marketing.

But clumsy acronyms aside, we need to question why BEPS is under the spotlight.

Tax minimisation and avoidance has been around for millennia. But with globalisation, it is becoming simpler for multinationals to minimise tax by shifting profits from high taxing countries (such as Australia) to tax havens. A multinational company can do this by loading up its Australian subsidiary with lots of debt, or overcharging the Australian arm for goods and services. But the general approach is pretty simple (not often what you can say for tax): increase taxable income in a tax haven, and reduce it, or eliminate it, in Australia. The OECD goes into more detail, particularly on the BEPS issue, on their website.

This practice isn’t particularly fair to local companies. Your corner store (probably) doesn’t have a parent company in the Cayman Islands.

But is BEPS a real problem? There is of course anecdotal evidence; for example, some are suspicious that Apple in 2013-14 reportedly paid $80 million in tax in Australia on revenue of more than $6 billion, below what many other retailers pay. However, Apple, Microsoft, Google and other companies strenuously deny that they actually engage in minimisation of Australian tax.

In fact, it is hard to say where the real truth lies. Maybe Apple did genuinely make only a small profit in Australia from its products, with most of its global profits generated from research conducted in other countries. Outside observers can’t make judgements on this issue without all the facts. As a result of this uncertainty, the OECD estimates that revenue foregone could be anywhere from $US 100bn to $US240bn. Similarly, the Australian government has indicted it is ‘almost impossible’ to verify how much revenue is being lost through BEPS.

Despite this uncertainty, our government sees potential for big revenue gains and has taken early action to address multinational tax avoidance. The ATO is planning to hit multinationals with a penalty if they avoid Australian tax by selling products directly to Australians rather than through the multinationals’ local subsidiary (which pays tax here).

Concerns have been raised that this plan pre-empts the OECD, and that the number of companies affected has dramatically increased from the original estimate of 30 to the current estimate of 1000. The government has also sent mixed messages about the revenue impact of the proposal: the legislation says the revenue raised is unquantifiable, but the ATO separately said it expects revenue of hundreds of millions of dollars. In addition, the proposal seems somewhat inconsistent with overall government rhetoric about having lower taxes, not tax increases, and it does nothing to fix our increasingly uncompetitive tax system.

However, the more important concern is that the planned change, a fuzzy anti-avoidance provision, is uncertain in its impact: an anathema to investment and economic activity. Companies won’t know if the provision will hit them, and if so what the cost will be, until the provision is tested in court — and a battle over the provision could go all the way to the High Court before certainty is attained. The uncertainty for business also means the impact of the provision on jobs, growth, investment and productivity is unknown — but could be substantial.

We do know the provision is targeted at getting businesses to change their behaviour. The government wants multinationals to pay more tax. But there is always a risk of other changes to their behaviour: they might engage in much more complicated procedures to avoid tax; they might hike prices; or they might cut back on their activity in Australia. A multinational might, for example, completely remove its physical presence in Australia and conduct all Australian-related activity from offshore. It would be almost impossible for Apple to do this, but it would be easier for other technology companies. Again, these impacts are unknown and unmeasurable.

There still remains to be rigorous analysis of the costs of the policy and the benefits. Nevertheless, the government has felt free to argue that the ALP’s proposals for addressing multinational tax avoidance will cost investment and jobs. This seems somewhat inconsistent.

Instead of a general anti-avoidance provision, a rule targeting the problem more directly will dramatically cut back on uncertainty. It might be the case that some multinational companies would prefer such an approach, even if they pay more tax in the end. It might also have a smaller impact on jobs and growth. It is an option worth exploring.

Regardless, the government should be acting speedily to reduce tax, consistent with its rhetoric, instead of acting speedily to increase tax.

Michael Potter is a Research Fellow at the Centre for Independent Studies