The international tax evolution and fractional taxation
By Prof Robert Anthony, Anthony & Cie
BEPS (Base erosion and profit shifting) has become the in word following on from transfer pricing. It is on the tip of every tax professional’s tongue While international prosperity reigned, governments were not so concerned about losing tax revenue. However, premeditated aggressive tax planning triggered famous tax cases as well as new domestic anti-avoidance legislation. This was because of the industrialised use of famous high profile tax planners charging percentage fees for finding loopholes in legislation.
Treaty shopping has caused new clauses in tax conventions. In the past, people changed tax domiciles to reduce their taxation. This was often to the consternation of their spouses. Artificial divorces created separate tax residencies in order not to be caught by family ties. This often ended in real separation and the denunciation of the divorced partner for tax evasion. All these strategies lead to the question of whether the international legislators have lost the plot themselves!
Today, the Organisation for Economic Co-operation and Development (OECD) talks of coherence, substance and transparency. For sure, in the digital age it is easier than ever to trace transactions and people. Thin capitalization, hybrid companies and transfer pricing to name a just a few examples, all created legislation to control tax payers from manipulating their taxable profits. Implantation in practice is another story. I do feel, however, that the tax legislators need to take a step back and ask what they are trying to achieve. It is quite clear that governments will compete for tax revenue. Unlike the US, the EU does not have federal tax or state tax. The disparity between countries’ corporate tax rates and income tax creates automatic fiscal conflictual challenges. Exit taxes become irrelevant, when the revenue source doesn’t exit.
Up to now, a company’s accounts and expenses were taxed on a permanent establishment basis. International groups took advantage of low tax jurisdictions to pay little or no tax. Personally, I see a solution which would resolve considerable conflicts of interest. For example, when a company sells its good or services, there is an ultimate end user. This end user will reside in a country fiscally that receives the services or goods. Looking at the entire process to the ultimate sale, BEPS or transfer pricing evaluations are no longer needed. If the total costs are then consolidated, the real cost of the sale can be established. The sale will represent a percentage of overall turnover. This percentage can be applied to establish the amount of costs. The profit on the sale can be identified. Rather than apply tax in the country of permanent establishment, it can be taxed at the rates of the country of sale. This would give an average tax rate where the permanent establishment is based.
This might beg the question, what happens if you buy in services etc.? This is a real cost, so it is not an issue. There is also the issue of what happens if you sell to low tax jurisdictions? There, a party will pay less tax quite legally. What happens if a company manufactures abroad? This might represent a saving, but it is a real cost. The delocalisation of the company would make no difference, as it would be taxed at the average rate applying at its sales location. In practical terms, there is a question as to how practical this is to implement? On the basis that laws are passed domestically, there would be a neutral effect internationally.
A European directive could endorse this legislation. Countries like Malta and Estonia would find new tax revenues and multinationals would pay to offshore jurisdictions without the need for BEPS and transfer pricing. Obviously, there is always abuse of every system and careful analysis of connected parties and barter trading would be needed. If a property is considered as an immovable asset and therefore revenue and gains are normally taxed where the property located, why can’t trading companies be taxed on the same basis, as per their sales?
I would welcome the thoughts of fellow professors and legislators as to how this idea could be practically implemented. I think the time has come to simplify our tax systems as opposed to accumulating more and more legislation. This idea would go a long way to modernise tax systems in a changing world. Letterbox companies would become irrelevant and also mail order and software companies would be taxed where the clients were based. After all, it is the revenue source that creates profits, not the expenses, as they dictate the margin. The movement of profits to take advantage of the conditions in different jurisdictions is the main issue that hides profits. Go back to the source and work from the final transaction to resolve all tax avoidance issues. I agree that the practical detail needs to be carefully defined, but I think fractional taxation as indicated is the way forward. Lastly, the same principal can apply to direct taxation such as VAT. Rather than the witch hunt to chase hidden tax liabilities, tax where the revenue is generated and the problem no longer exists.
How does this work in practice? Expenses in one country are revenue in another. If an expense is paid, it is identifiable. This puts the obligation on the buying client to declare purchases on an allocated data base. This is similar to a European VAT number, but instead, being the corporation reference number. With the exchange of information, the data would be transmitted to the domestic country which can then ensure that the tax treatment on a revenue basis coincides with the company’s tax return. With Visa payment systems that involve customers paying their bills from all parts of the world, it is not difficult to implement automated sales allocations in the same way.
Published: September 2016 l Photo: Colourbox.de - Sasin Tipchai