The European Commission’s new proposals for legislation against corporate tax avoidance, released today, are meant to curb the egregious tax dodging by big companies that has caused scandal across Europe.
Unfortunately, the proposals bear out our warning last month that efforts to tackle tax avoidance could end up worsening competition between Member States to attract companies with super-low tax rates if they don’t address this problem as well. The result could be that big-name multinationals which currently pay little tax on their profits may not end up paying much more in future.
The legislative proposals include some good principles, but so weak and timid in detail that they may well fail to achieve their objectives and could even incentivise some Member States to lower their corporate tax rates still further. This is a serious problem for developing countries because they depend more on corporate taxes and, according to research from the IMF, they lose out disproportionately from tax competition.
The Commission has at least recognized that developing countries can suffer harm from the effects of tax policies in Europe. It calls, for example, for Member States to reconsider their bilateral tax treaties with developing countries, which often limit the rights of the latter to tax multinationals’ income. But the proposals do not add up to a concrete package of reforms that can be relied on to stop European companies from shifting profits out of developing countries. Worse, they invite charges of double standards: the Commission proposes to press third countries not to offer special tax deals to companies, before these problems are anywhere near being addressed within Europe itself.
Some proposals follow the generally weak tone of the OECD’s Base Erosion and Profit Shifting (BEPS) Project. Others are good in principle but very weak in practice. An example is the proposal for Controlled Foreign Company (anti-tax haven) rules. These rules deter multinationals from shifting profits out of countries where they do business and into tax havens by allowing their countries of residence to tax these shifted profits at their own, higher rates. Fewer than half of Member States have CFC rules, so it would be positive in theory if all of them did.
Unfortunately the proposal is that these rules will only apply to foreign income which has been taxed at less than 40 per cent of the effective rate in the Member State where the multinational is resident. Those Member States that already have CFC rules usually set this threshold between 50 and 75 per cent, while Germany has a fixed rate which is still higher. So this proposal, if adopted in its current form, could actually drag down standards.
A similar problem afflicts the proposal for a “switch-over clause”. This means that corporate income flowing into a Member State cannot be exempted from tax there if it has not been adequately taxed in its country of origin. This could be a deterrent against the common problem, which also afflicts developing countries, of multinationals shifting profits out of these countries and into low-tax regimes in the Netherlands, Luxembourg or other Member States.
But once again, the proposed threshold is far too low (40 per cent) to be effective. If a Member State has a tax rate of 15 per cent, then it could still offer tax exemptions on the foreign income of multinationals as long as that income has already been taxed at six per cent or more. With a 10 per cent tax rate, then the threshold falls to four per cent. This is not much more than some of the most egregious tax-dodging companies are paying at the moment.
What’s needed now is to significantly tighten up the proposals and complement them with the introduction across the EU of public country-by-country reporting by multinationals. But the Commission is clearly constrained by what it thinks Member States will accept, including those Member States which are busily trying to undercut the public revenues of other countries by luring away companies with super-low tax rates or preferential regimes and deals.
This is the nub of the problem. The recent round of tax reforms in Europe, driven by public outrage and tight national budgets, might in fact lead to fewer highly artificial and elaborate tax avoidance schemes. But they could also mean that some multinationals continue to avoid their fair share of tax, only by different means.
Until all countries recognise that tax competition is a fool’s game with no winners except the corporations themselves, the struggle for fairer taxation will go on.
For a more detailed analysis of the ATA package, please see ActionAid’s reaction here.