Getting a grasp on the size of multinational tax avoidance is a substantial challenge and depends heavily on your definition. After all, corporate tax avoidance is entirely legal (and arguably a responsibility of management to shareholders); tax evasion is a crime, but the line that separates them can depend on how good your legal representatives are or how indulgent governments are in letting a company get away with minimising its tax obligations.
But some figures can give us a sense of scale. A recent report by the Tax Justice Network and the United Voice union claimed corporate tax avoidance by both local and transnational companies costs Australia $8.4 billion a year in lost revenue — though the biggest offenders were transnationals 21st Century Fox (the standout tax dodger), SingTel, BHP Billiton, Rio Tinto and Westfield. A 2010 United States study suggested the US government lost US$37 billion a year to tax havens. Tax havens were also estimated to cost the Brits 840 million pounds a year. German studies estimated a gap of 60-100 billion euros a year between what companies reported in profits and what broader economic conditions suggested they had earned.
Another way to understand the extent of multinational tax avoidance is to look at the extent of intra-firm trade — that is, international trade between different arms of the same company. Plainly, not all intra-firm trade is for tax purposes — an iPad designed in California, assembled in China and sold in Australia can’t get here any other way. But intra-firm trade is critical to transfer pricing, overwhelmingly the largest mechanism for multinational profit shifting, and it makes up an estimated one-third of all international trade (currently around US$18 trillion dollars a year, excluding services). In some countries, over half of all international trade is intra-firm in nature.
Transfer pricing is at the core of multinational tax avoidance: at its simplest, a subsidiary sells a product produced in a higher-tax jurisdiction to a parent company in a lower-tax jurisdiction for less than market price. Traditionally, extractive industries have been very good at transfer pricing, often because they’re able to exploit the poor tax and regulatory frameworks of developing countries, which according to one estimate were losing around $100 billion a year in foregone revenue a decade ago through transfer pricing. The most notorious recent example relates to the Glencore-controlled Mopani Copper company in Zambia, which was accused of selling copper to Glencore at artificially low prices and inflating its own costs. Glencore rejected the claims, but a European Investment Bank report into the claims has been withheld for several years.
“The problem is, in the absence of effective reform, the blatant tax dodging engaged in by the likes of Glencore and Rupert Murdoch corrodes public trust in governments and, ultimately, the domestic tax base itself.”
Transfer pricing doesn’t need to apply to physical goods — it’s even easier for intangibles like intellectual property. Apple, for example, is able to avoid billions in taxes in countries like Australia and even its home in the United States by basing its intellectual property in the tax haven of Ireland, from where it charges other arms of Apple inflated prices to use it. IKEA shops around the world pay royalties to a holding company based in another tax haven, the Netherlands. And it’s easier still for intra-firm financial transactions — a low tax-based arm charging another arm in a high-tax jurisdiction a higher interest rate, for example. Glencore has been accused of using intra-firm derivatives trading to reduce its British tax liabilities by tens of millions of pounds.
Many countries, including Australia, try to block transfer pricing with tax rules based on “arm’s length pricing” principles, which form a key part of the OECD’s Model Tax Convention, but that’s no panacea. Establishing comparable market prices for all transactions is resource-intensive for governments, and difficult or impossible for intangibles like IP, which form a growing proportion of world trade.
Transfer pricing does rely on tax differentials between jurisdictions, and the ability of multinationals to locate an arm in tax havens, where profits can be maximised. But what exactly is a tax haven isn’t clearly defined, and attempts by the G20 and the OECD to blacklist countries as tax havens have foundered — the current OECD tax haven blacklist is literally empty. Nor are they confined to Caribbean islands or European principalities: Ireland’s entire economic model relies on offering very low corporate tax rates, the Netherlands also offers low tax rates and exemptions, which can interact with other jurisdictions’ systems to produce even lower tax rates (thus, the “Double Irish With a Dutch Sandwich” arrangement, although Ireland has belatedly now closed the Double Irish loophole). And the world’s biggest tax haven is Switzerland, where many tax dodgers, including Glencore, are based — although so notorious is Glencore for its tax practices that even its neighbours have taken to sending Glencore’s local tax contributions to African and South American charities.
The current G20 strategy, agreed last month at the finance ministers’ meeting in Cairns chaired by Treasurer Joe Hockey, focuses on putting in place automatic exchange of tax information — which sounds wishy-washy but is intended to prevent companies from exploiting jurisdictions’ ignorance of what companies are telling them about where profits are earnt, another useful avoidance technique. The G20 and the OECD also have a joint “Action Plan on Base Erosion and Profit Shifting”, which inter alia specifically targets the use of related-party interest payments to avoid tax and the need to tighten tax treaties that can be abused by multinationals.
The biggest impediment, however, remains the reluctance of some large jurisdictions, including the UK, to sacrifice what they regard as aspects of genuine international tax competition rather than tax dodging. The challenges of making international taxation work better are complex, but political will is the greater challenge.
The problem is, in the absence of effective reform, the blatant tax dodging engaged in by the likes of Glencore and Rupert Murdoch corrodes public trust in governments and, ultimately, the domestic tax base itself. Why should the rest of us pay our fair share of tax when multinational corporations are getting away with paying a small fraction of what they should be giving tax authorities?