The simplest way to pay less tax is to earn less, but if you’re a multinational enterprise, there are other options, including double deductions – pay your tax in one country then deduct that sum in two or more other ones. You can also make your income disappear for tax purposes by getting a deduction in one country that isn’t included in the calculation anywhere else. If you’re really smart you can even generate foreign tax credits for taxes you didn’t actually pay at all. The exception proves the rule, and while most OECD documents contain some warning about there being “no magic/silver bullets”, that doesn’t apply to international taxation.
The bullets are “hybrid mismatch arrangements”, hybrids for short, and although they cost the rest of us billions of dollars a year, they’re perfectly legal, for the time being anyway. The OECD’s Centre for Tax Policy and Administration and the Canada Revenue Agency have just organised a meeting with senior tax officials from OECD countries to discuss the issues raised, following the publication of an OECD study Hybrid Mismatch Arrangements: Tax Policy and Compliance Issues.
Hybrids exploit the fact that although the economy is increasingly globalised and integrated, corporate tax systems are still running on principles established around a hundred years ago for firms operating mainly in one country, with little need to consider how different systems affected each other. International tax expert Professor Reuven S. Avi-Yonah put it like this when testifying to the US Congress Ways and Means Committee: “corporate residence is not a particularly meaningful concept, it makes little sense to base the entire US international tax regime on it.” Multinationals certainly don’t base their tax strategies on it and take advantage of mismatches between national legislations via aggressive tax planning.
The basic idea behind hybrids is to have the same money or transaction treated differently by different countries to avoid paying tax. One common feature of hybrids is dual residence, companies that are residents of two countries for tax purposes. Speaking during the debate on the UK budget earlier this year, Conservative MP Charlie Elphicke denounced the “magic roundabout” that allowed companies like Google to avoid tax, pointing out that the company “took about £2.15 billion in revenue from the UK in 2010, making an estimated £700 million profit, yet it did not pay any tax. In fact, it declared a loss of £22 million”.
Amazon is another case in point. If you look at their accounts, you’ll find that they may not actually trade in a country they do business in, since they only have a delivery company there. In Europe, the main business is based in Luxembourg, and the billions of euros in sales income generated elsewhere is not taxed in those countries.
Apart from dual residence, the other most common elements that hybrids exploit are entities, instruments and transfers. The details are complex and vary from place to place, but one firm offering to help companies avoid tax through hybrid entities, in this case limited liability companies, sums up the approach in the clearest of terms: “The [entity] allows for a real presence [in the host country], with all the normal benefits of [that country’s] legal structure and bank accounts… but reap the profits – tax free!”
A typical hybrid instrument would allow a company to treat something as debt in one country and equity in another, while hybrid transfers are arrangements that are treated as transfer of ownership or an asset in one country but only as a loan with collateral in another.
By playing off one country’s tax system against another, the most successful hybrids achieve double non-taxation – the company doesn’t pay tax anywhere, an unintended consequence if ever there was one of the tax laws of the countries concerned. It’s worth repeating that none of this is illegal. Replying to criticisms of its low tax bill, a spokesperson for Google said: “We have an obligation to our shareholders to set up a tax efficient structure, and our present structure is compliant with the tax rules in all the countries where we operate.”
That may be true, but it raises a number of issues. Obviously companies act like this to reduce the revenue tax authorities receive. The total sum isn’t known and a few jurisdictions may benefit at the expense of the rest, but some figures are available. In 2009 New Zealand settled cases involving four banks for a combined sum exceeding NZ$2.2 billion (€1.3 billion); Italy has settled a dozen cases involving hybrids for around €1.5 billion; while in the US the amount of tax at stake in 11 foreign tax credit generator transactions has been estimated at $3.5 billion.
Then there’s the issue of fairness and trust in the tax system. A new OECD study, Taxing Wages shows that the tax burden on earnings is continuing to rise in OECD countries. Governments trying to convince workers that they have to pay for austerity measures would have a better chance of convincing them if capital income was seen to be taxed fairly. Local businesses that don’t have the multinationals’ means to use hybrids and other means of paying less tax may feel they’re being treated unfairly too, and they are at a competitive disadvantage.
What can be done? A number of countries have introduced rules which specifically deny benefits arising from hybrids by linking the domestic tax treatment of an entity, instrument or transfer involving a foreign country with the tax treatment in that foreign country. The OECD recommends such initiatives, along with two others: sharing intelligence and experience on tackling hybrid; and consider introducing or revising disclosure initiatives targeted at certain hybrids.
Tax Inspectors Without Borders/Inspecteurs des impôts sans frontières The OECD’s Task Force on Tax and Development has launched an initiative to help developing countries bolster their domestic revenues by making their tax systems fairer and more effective. The OECD will establish an independent foundation, to be up and running by the end of 2013, that will provide international auditing expertise and advice to help developing countries better address tax base erosion, including tax evasion and avoidance.