Tax and Investment: UNCTAD's contribution to the ongoing BEPS debate
In June 2015, UNCTAD released its annual World Investment Report on “Reforming International Investment Governance”. The report provides an impressive range of statistics on global investment trends. A special chapter (on which I was the Senior Advisor) deals with taxation. This blog first reviews the broader environment within which tax and investment issues have to be examined, and then looks at the main tax relevant conclusions from the UNCTAD study.
International Tax and Investment Policy Coherence
There is an intense current debate on whether MNEs pay their fair share of taxes. The focus is predominantly on the G20 project on base erosion and profit shifting (BEPS). The policy imperative is to take action against BEPS to support domestic resource mobilization, particularly in LDCs, and at the same time to avoid creating barriers for productive investment.
UNCTAD estimates the contribution of MNE foreign affiliates to government budgets in developing countries at approximately $730 billion annually. The relative size (and composition) of this contribution varies by country and region. It is higher in developing countries than in developed countries, underlining the exposure and dependence of developing countries on corporate contributions. On average, the governments of African countries depend on foreign corporate payments for 14 per cent of their budgets.
Furthermore, the lower a country is on the development ladder, the greater is its dependence on non-tax revenue streams contributed by firms. In developing countries, foreign affiliates, on average, contribute more than twice as much to government revenues through royalties on natural resources, tariffs, payroll taxes and social contributions, and other types of taxes and levies, than through corporate income taxes.
UNCTAD's Offshore Investment Matrix shows how much investment comes from, goes to, and is routed through tax havens and so-called Special Purpose Entities (SPEs) in other countries (figure V.11). Together, these can be considered "offshore investment hubs" in a hub-and-spoke system of international investment. Some 30 per cent of cross-border corporate investment stocks have been routed through offshore hubs before reaching their destination as productive assets (figure V.10), largely due to tax planning, although other factors can play a supporting role.
UNCTAD estimates that such practices are responsible for $100 billion of annual tax revenue losses for developing countries related to inward investment stocks. Developing countries with limited tax collection capabilities, greater reliance on tax revenues from corporate investors, and growing exposure to offshore investments are particularly vulnerable.
UNCTAD proposes a set of guidelines for coherent international tax and investment policies that could help realize the synergies between investment policy and initiatives to counter tax avoidance (figure V.20). Key objectives include removing aggressive tax planning opportunities as investment promotion levers; considering the potential impact on investment of anti-avoidance measures; taking a partnership approach in recognition of shared responsibilities between host, home and conduit countries; managing the interaction between international investment and tax agreements; and strengthening the role of both investment and fiscal revenues in sustainable development as well as the capabilities of developing countries to address tax avoidance issues.
The Fair Tax Debate and Tax Competition
At the center of the BEPS project is what has come to be referred to as the “Fair Tax Debate”: are MNEs paying their fair share of taxes? Fairness is a difficult concept to apply, but this is the test that politicians and civil society are now applying and concluding that it is not plausible that a company that has billions of dollars in sales and a significant physical footprint in a country pays little corporate income tax. As a tax expert, my definition of fairness is that a MNE must pay the right amount of tax, at the right time in the right place. Of course, the question raises the issue of what is right: clearly right must depend on the legislation and the international tax norms in force. But to answer this question, we need to go beyond a strict legal interpretation and have to ask whether a tax scheme is consistent with the spirit and the letter of the law.
Of relevance to this debate is the question "does tax influence the location of investment?" The traditional view was that tax was not a key factor: rather it was factors which influence pre-tax profits (e.g. access to markets, supply of labour etc.), which were the main drivers. Nevertheless, as non-tax barriers have largely been removed; new communication technology has become available; a shift has taken place in international production from goods to services (almost two thirds of FDI now involves services); intangibles have increased in importance (50-70% of the wealth of MNEs); and more sophisticated financing options have become available; tax has become much more important.
This is why governments are increasingly using their tax systems to attract FDI through Special Economic Zones and Tax Incentives. The message that comes out from the UNCTAD report is that the priority should be to get the economic fundamentals right, to have a reasonable tax system and a tax administration that is business friendly.
Tax competition is not only pushing countries to use tax incentives but is forcing down tax rates. In the OECD, in the 1980s, Corporate Income Taxes rates were rarely less than 45%; today the average is just over 25%. Governments are also looking at how to attract highly mobile activities such as intangibles (the spread of patent boxes, with nominal rates of 10% or less). Many commentators are asking "will downward pressure on rates continue? Will the outcome be zero or the Irish 12.5%?" My expectation is that rates will level out around 20%.
The tax world is at a tipping point. Governments and citizens now have zero tolerance of aggressive tax planning that wipes out the tax base (whether by MNEs or "high-net-worth individuals"). The imperative to mobilize domestic resources will offer the international community a unique opportunity to put tax back at the center of the debate on sustainable development. The G20 leaders at their meeting in Turkey in November can give their political support to these goals.
Finally, the next two to three years are going to be interesting as governments and business begin to see that investment and tax treaties offer alternative ways to resolve tax disputes and as, respectively, the OECD moves forward with its work on a multilateral framework for disputes, and UNCTAD with its work on investment policies. All of this is against the backdrop of developments in the Trans-Pacific Partnership (TPP) and the European Union-United States Trade and Investment Partnership (TTIP).
The WIR15 chapter on International Tax and Investment Policy Coherence and related technical annexes can be downloaded here.