Date Posted
3 April 2024 12:04 BST
Article Author
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A UN convention is a big deal for tax justice

The US-backed overthrow of Chile’s elected president, Salvador Allende, on 11th September 1973 led to decades of bloody oppression and neoliberal experimentation as the Pinochet dictatorship worked hand in hand with US multinationals and extreme right-wing US economists.   

But it was the role of multinationals in an earlier coup attempt against Allende which had triggered the first serious attempt at their global regulation. Chile proposed more active oversight of these major corporate actors and this led to the creation of the UN Commission for Transnational Corporations (UNCTC).

This agenda of reform via the UN was ultimately blocked by powerful private interests. Half a century later, the negotiation of a UN tax convention provides the opportunity, finally, to deliver on that agenda.

Countries are estimated to lose some US$480 billion each year to tax abuses by multinationals and wealthy individuals with assets and income streams hidden offshore. The UN tax convention has the potential to curb tax abuses drastically, with benefits on all sides. The largest dollar gains would accrue to higher-income countries and the largest relative gains to lower-income countries, which lose an average 49 per cent of their public health spending every year.

 

The roots of corporate tax abuse

To understand the failure of today’s tax rules, and the power dynamics that are ultimately to blame, we must go back to the late 1920s and 1930s when the League of Nations – the club of imperial powers – took decisions over international tax rules that still reverberate today.

In particular, the League agreed that each subsidiary within a multinational group could be treated separately for accounting purposes. “Transfer prices” would be used to ensure that transactions between these subsidiaries were valued “at arm’s length” – as if they were not jointly owned but operating independently in the open market.

This principle is still the basis for taxing multinationals, but it has shown itself unfit for purpose. For one thing, multinational groups exist partly because it can be more efficient to internalise various transactions and so to outcompete unrelated companies that might be carrying out the same activities. By definition, then, multinationals do not operate with arm’s length prices.

By manipulating the stated prices for intragroup transactions, it is possible to change the location in which profits appear to arise – for example, to shift them from the location of real economic activity to a lower-tax jurisdiction. This has led to an explosion in profit-shifting by multinationals since the 1990s.

 

How profit-shifting exploded

In the early 1990s, the data reveal, US-headquartered multinationals declared around five per cent of their global profits in jurisdictions other than where their real activity took place. By the late 1990s, that figure had doubled. And by the early 2010s, it had surpassed 25 per cent.

This explosion of profit shifting followed three main shifts in the regulatory context.

First, the UN had lost the fight to set tax rules. As successor to the League of Nations, the UN was supposed to inheritthis role. But as more newly-independent countries joined the UN – former colonies which were overwhelmingly host countries for multinationals, not headquarters countries – the imperial powers saw a threat to their dominance.

In 1960, they created the Organisation for Economic Cooperation and Development with members drawn from western Europe and north American countries. The OECD was swiftly given the role of setting tax rules and the UN was sidelined entirely.

Despite its narrow membership, the OECD has retained this role ever since. As academics and UN experts have increasingly pointed out, this appropriation of international tax rule-setting powers by predominantly white, current or former imperial powers has both a racist and a colonial character.

Second, the post-1972 push for UN regulation of multinationals failed. The Group of Experts on International Standards of Accounting and Reporting (GEISAR), which came under the UNCTC, had recommended financial transparency,  including publication of financial reports for entities in each country within each multinational and details of intra-group trade. This provoked a backlash that ultimately ended the entire project.

Lower-income countries had a majority of votes on the UNTC and fully supported the GEISAR recommendations. Representatives of OECD countries threatened to leave the UNCTC, not to implement its recommendations and to withdraw financial support if unanimous decision-making (‘consensus’) was not adopted instead of majority voting.

Perhaps ill-advisedly, the group of lower-income countries accepted this rule change and sealed the fate of the reforms. GEISAR was stripped of its political power and the UNCTC was ultimately shut down in 1992, just as profit shifting began to explode.

Standard-setting was captured by the International Accounting Standards Board in the UK and the Federal Accounting Standards Board in the US. Both were largely controlled by the major accounting firms and their clients, and neither was inclined to support country-level transparency.

The third key driver of the explosion in profit shifting was deliberate manipulation by leading players. It could be said in defence of the League of Nations’ original decision in favour of transfer pricing that back in the 1920s, most intragroup trade had involved raw commodities and most multinationals had only a couple or a handful of entities.

By the 1990s, multinationals had become far more complex. This was compounded by the recognition – multiplied by the major accounting and law firms that sell tax advice to multinationals – that it was possible to take advantage of the hard-to-value nature of intangible assets in order to shift profits.

The arm’s length or market price of a kilogram of a particular quality of copper from Chile, for example, can be observed if the authorities so desire. The price for using the brand and intellectual property of a multinational may not be observable, however, simply because there may be no such open market transaction. Thus the ability of tax authorities to challenge the transfer prices declared by multinationals is gravely weakened.

By the 2000s, even the limited standards for aggregate geographic or business segment reporting were being eroded, so that the period of most aggressive profit shifting was also becoming one of most committed opacity.

 

Civil society is slowly winning the debate

It was at this time and in this context that the Tax Justice Network was crystallising. Even before its formal establishment in 2003, leading members had discussed and published a country by country reporting standard to require minimum transparency from multinationals.

Ten years later, following civil society mobilisation and high-level advocacy, the G20 group of countries had mandated the OECD to introduce a standard which came into force in 2016. The fiscal pressures of the international financial crisis that began in 2008, coupled with political pressure due to the mistaken austerity policies that many OECD member governments adopted afterwards, led to public anger over unfair taxation.

Leveraging a strong base of research and communications, civil society was quickly able to build powerful support for specific measures to curb corporate tax abuse in particular, including country by country reporting. But while the OECD standard closely tracked the original Tax Justice Network proposal, in key details it was narrower and significantly weaker.

Most damagingly, the OECD rejected publication of the data and instead introduced complex arrangements for the non-public exchange of information between countries which – to few observers’ surprise – have systematically excluded lower-income countries.

Since then, some OECD countries have moved slowly towards transparency in the face of opposition, including from the OECD itself. In July 2023 the Financial Times exposed (paywall) the OECD’s active lobbying of Australia against the very tax transparency which, in theory at least, is part of the OECD’s mission.Nonetheless, in both the European Union and Australia data will be made public from 2024 onwards; although in each case it will exclude data for many individual countries, including most lower-income countries and many profit shifting jurisdictions which are also OECD members. 

 

The historic opportunity of a UN tax convention

This needlessly slow progress on transparency since 2013 still compares well with the OECD’s wider responsibility to improve international tax rules. The OECD’s Base Erosion and Profit Shifting (BEPS) project failed before it began in 2013, in particular by acquiescing to US pressure not to go beyond the arm’s length principle. The best that could be delivered by 2015 was a set of piecemeal fixes to the existing system.

Sure enough, negotiations were back on in 2019, with a commitment to go beyond the arm’s length principle. But even as the OECD’s ‘two pillar’ proposals crawl towards completion, it is well understood that this time the OECD has also not provided the solution.

The technical work has been done to introduce a ‘unitary’ approach: that is, treating each multinational group as a single, profit-making unit, which is the alternative that the League of Nations dismissed a century ago in favour of transfer pricing. However, the proposal (‘Pillar One’) leaves the arm’s length principle in place for almost all multinational profits and lacks the political support to go forward even in its highly diluted and complex form.

While Pillar One is unlikely ever to be ratified, Pillar Two – the proposal for a global minimum tax– is going into law in the European Union, and a range of profit-shifting jurisdictions. But independent research now shows clearly that the complexity and deliberate loopholes of the proposal will result in precisely those profit-shifting jurisdictions gaining the lion’s share of any additional revenues, which will in any case be much smaller than the OECD has claimed. Countries are increasingly weighing unilateral measures, while still looking for better global agreement.

And so momentum has built for a UN framework convention on international tax cooperation (UN FCITC), which would supplant the OECD as the world’s primary source of international tax rules. With the continuing leadership of African countries which have piloted the initiative, strong support across the Group of 77 countries and – little by little – the engagement of OECD members, the prospects look cautiously positive.

UN member states are meeting over the next few months to develop terms of reference for the negotiations and it is already clear that early protocols could include an agreement to require public country by country reporting.

More fundamentally, the convention will create a globally inclusive framework body like the UNFCCC on climate change, which will set the standards and rules for all aspects of international tax. That would, finally, bring significant elements of the regulation and taxation of multinational companies into a UN forum.

For civil society actors in the global North especially, the most important message that can be sent right now is to our governments. They need to know they are being watched, for every step of the process is being livestreamed, in stark contrast to the closed-doors opacity of the OECD. Our governments need to know that their people expect them not just to stop blocking, but to get fully engaged in support of an ambitious outcome which can finally curb the injustice of tax abuse.

Alex Cobham is chief executive of the Tax Justice Network.

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