Archives For BEPS

Brian Cox has got it easy…

accapr —  19 September 2014 — Leave a comment

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By Jason Piper, manager for tax and business law, ACCA

The recent launch of the OECD’s proposals for the BEPS project resulted in a deluge of response, commentary and reaction.

Too much is ill, mis or uninformed, and often from people who ought to know better. There’s a rush to present simplified answers, to try to clear everything up with a couple of soundbites and a nod to popular opinion.

But it’s not simple.

People say “oh, it’s not rocket science”. As these things go, rocket science is actually a comparatively simple bunch of equations. Rocket engineering on the other hand, now that’s difficult. Any 6th form physics student can (or at least, should be able to) do the theoretical calculations on how much fuel you need to get a given payload to escape velocity. But actually designing the pumps, tanks & nozzles to get the stuff to burn, let alone actually building them (hands up anyone with the knowledge of metallurgy to understand precisely which alloys you should be using where?) is a different matter, and only the most gifted and dedicated of amateurs have even a hope of getting a rocket to actually work (and even then they’d be the first to admit their debt to the professionals who build the parts).

Tax is much the same. Should everyone pay a fair amount of tax? Well that’s so trite it barely even deserves to be a question.

What is a fair amount of tax? You might as well ask what’s the right shade of blue, or how tall should a politician be.

Laws are the next best proxy we have to fairness when it comes to tax. But then the laws are (to put it mildly) complicated. And Brian Cox can point to planetary movements, reel off the equations, and explain what’s happened. When someone asks why a baseball pitch doesn’t work the same way, that’s easy – baseballs are operating in an atmosphere, and under another heavy gravitational field. And there’s no real mileage in trying to establish the physics of what would happen to a baseball in space, or a planet in the earth’s atmosphere and gravity, because the two scenarios are implausible. And there’s no need to worry about how a watermelon would operate at high altitude, or a whale sized object on the edge of the atmosphere, because such things don’t exist. There is no gentle graded curve between the tiny everyday objects that we all handle and work with and the vast numbers and forces which operate in astronomical models. There’s a clear break between them; no need for complex transitional calculations.

But tax isn’t like that. There’s no legal difference between the structure your window cleaner can set up to run his business and the one that a multinational might use to handle its international treasury function. There’s no difference in principle between the calculations that a business handling nuclear waste reprocessing does to work out its tax liability and those that a corner shop might do. And the tax system isn’t just trying to run one set of equations at once; it’s got two or three sets to cope with (companies, partnerships, limited vs unlimited liability variants, sole traders – they’re all valid forms of business, and it’s open to business to mix and match the legal forms to get itself the best result.) So it’s a bit like having planets that can behave like baseballs if they want to.

And the best bit is that the tax system isn’t like physics, which gets done to us and we just have to try to work it out from the evidence. The international tax system is something we’ve done to ourselves (albeit perhaps indirectly, in that it’s actually the work of elected politicians).

Now, I have to say that if we were in a position to be able to revise the equations that govern the temperature that the sun burns at, or the force exerted by gravity, I’d probably advise caution in the choice of those writing the new rules. I’d certainly want them to have a pretty firm grasp of astrophysics; a background in marketing or even an advanced degree in economics just wouldn’t quite be what I was hoping for.

But when it comes to the tax rules, there is a nasty tendency for the value of knowledge and experience to be ignored. I’m sure it would be terribly helpful to have the sun coming out at night instead, when the light would be more useful. Clearly weakening the force of gravity would make us all lighter and put diet clubs out of business overnight. Spinning the planet’s axis of rotation through 90 degrees would put London in the tropics and make for much warmer winters; bound to be a good thing.

It’s fairly obvious that actually none of those would be terribly good ideas, and no half-sane scientist would ever fall for them. But of course that’s another advantage the physicists have; they can be reasonably certain that their system works and they’re not at serious risk of breaking it. Tax systems aren’t like that. The British one was described this week as “complex, confused, irrational, punitive and in urgent need of root and branch reform”. And that got it a rating of 21st out of 34; quite what they’d have to say about the US system (33) or the French (34) is anybody’s guess. And yet unsound proposals get put forward for tax all the time in the comments columns of the internet, and explaining why they won’t work can require a degree of engagement and willingness to learn that all too few seem prepared to put in. I’d love to help more people understand the basics of tax system design, it’s really important stuff. I’ve tried to do some of it here: http://bit.ly/TaxSimplicity

But please, don’t ask me to condense 746 pages of BEPS documentation into 140 characters. It’d be about as much use as posting  and if you know what that means, you don’t need me to explain it.

(It’s the Tsiolkivsky Rocket equation, for which I must thank Randall Munroe, of XKCD – see http://what-if.xkcd.com/7/ )

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By Jason Piper, tax and business law manager, ACCA

Among the themes covered in the ongoing debates around BEPS and international tax, there’s been a strand of discussion around “tax competition” – the practice by governments of attempting to make their jurisdiction look more attractive than others by reducing the tax burden on businesses.

The argument runs that by encouraging a move away from taxation of business, tax havens and rich countries are imperilling developing countries who need tax revenues.

But if making your tax system “competitive” costs you money, why would anyone bother? Perhaps because the indirect consequence is that you make more out of the VAT, PAYE and simple GDP effects of inward investment than you lose by reducing the tax due on any profits that the company may book in your jurisdiction.

For that to work though, you need a number of conditions to be true. In particular, you need to have effective collection mechanisms for VAT, and a secure taxpaying base of employees. You need to be comfortable that you have the economic capacity to service the increased production and demand for the GDP growth to have value.

For most developed countries that is very much the case. They typically collect 30-40% of GDP in taxes, and less than 10% of that comes from corporation tax – so 3-4% of GDP is collected as corporation taxes. But in developing countries, the level of GDP collected as tax falls to 10-20%, while the proportion of overall taxes attributable to corporation tax rises to nearer 20%. So we’re still looking at around 2-4% of GDP collected as corporation tax.

And that means that the economics of “tax competition” doesn’t work for a developing country; it would need to have twice the GDP impact per pound of corporate profit untaxed to get in the same level of VAT or employee income tax as recompense – yet proportionally the amount of tax that developing countries should typically be able to extract from the international businesses who might invest in them should be far higher. The reason that big business goes to developing countries is typically natural resources – and those resources are not typically mobile. If business wants them, there’s only the one jurisdiction they’ll be coming from, so the local government should have business in a firm grip when it comes to extracting tax revenues.

And there’s another twist. Remember those percentages of GDP collected as tax? Well, it’s generally reckoned that a nation needs to devote around 15% of its GDP to government in order for government to be stable. Or in other words, if you as a business are looking at investing into a market where less than 15% of GDP gets collected as tax, then you’ve got more to worry about than just business rates and form filling; there’s a good chance that the whole infrastructure will be unstable. Whether that’s political instability, or a lack of roads on which to transport your produce, there’s going to be additional risk factors to play into your analysis of whether the investment is sound.

And therein lies the challenge for a business decision maker. In a developed country, with a high level of maintained infrastructure and political stability, corporate tax is a pure cost to be managed down. The net marginal benefits accruing from payment are nil, while the government may even be prepared to forego those taxes in order to attract your business; official resistance to corporate tax minimisation is likely to be low.

In a developing country, taxes paid to central government may have a very real benefit to business, for the simple reason that without them the whole investment may become worthless in very short order. Tax is not so much a deduction from profits as a cost of sales; it’s an essential element in allowing those profits to be earned in the first place.

To be fair, this probably isn’t something that big business needs to be told. They know full well that however valuable the resource in a mine might be on paper, it’s worthless if they can’t safely extract and process it. Political stability is a key element of their risk analysis. If the people at the top of multinationals weren’t smart enough to have worked this stuff out for themselves, they wouldn’t be there.

But there’s a lot of other people who haven’t spent a lifetime making difficult decisions based on complex yet incomplete information. And if they end up running tax administrations, then there’s a risk that they might consider tax holidays for big business to be a good way forward to attract international investment – when in fact, it may be the very last thing they need, and the very last thing that a rational business would ask for. What’s sauce for the goose may not be sauce for the gander, or indeed the value burger of your choice. When it comes to domestic tax policies in respect of international investment, it most definitely is horses for courses.