The Great Multinational Tax Rort: how we’re all being robbed

The Great Multinational Tax Rort

Martin Feil was born in 1947 in Sydney. While attending university for 13 years (10 years part-time) on a scholarship, he got his first job in the Customs department, and then became the Tarriff Board’s youngest project director at the age of 26.

He was eventually responsible for 11 major industry inquiries, before striking out on his own and working as an industry-policy consultant for the next 30 years. During that time he also owned trucks, warehouses, customs bonds-stores and container yards, and worked for the Australian Taxation Office as one of the few Australian independent experts on transfer pricing and profit repatriation by multinationals. He has been chairman of the Institute of Chartered Accountants’ customs committee, and the institute’s representative on the tax office’s transfer-pricing subcommittee.

Feil has written many op-ed pieces over the years for The Age, accompanied by illustrations by John Spooner, warning of the dangers of free-trade ideology. He is also the author of The Failure of Free-Market Economics (Scribe, 2010).

Scribe Publications

18–20 Edward St, Brunswick, Victoria 3056, Australia

2 John St, Clerkenwell, London, WC1N 2ES, United Kingdom

First published by Scribe 2016

Copyright © Martin Feil 2016

All rights reserved. Without limiting the rights under copyright reserved above, no part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted, in any form or by any means (electronic, mechanical, photocopying, recording or otherwise) without the prior written permission of the publishers of this book.

9781925321647 (Australian edition)

9781925228908 (UK edition)

9781925307856 (e-book)

CiP records for this title are available from the National Library of Australia and the British Library.

scribepublications.com.au

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To John Spooner, a longtime true believer and supporter

Contents

Preface

Introduction

Part I: Setting the Scene

One/What’s the trouble with multinationals?

Two/The games the Big Four play

Three/Base erosion and profit shifting

Four/Treaties and havens

Five/Time is not of the essence

Part II: Multinational Domination

Introduction

Six/Shearers and diggers, 1890 to 1990

Seven/The containerisation revolution

Eight/Unforeseen consequences

Nine/The multinationals’ market strategy

Ten/Transfer-pricing strategies

Eleven/Transfer-pricing methodologies

Twelve/The OECD Action Plan, and the Big Four’s responses

Conclusion

Part III: Australia: a case study

Introduction

Thirteen/Is Australia history?

Fourteen/The end of distance

Fifteen/Reinventing Australia

Conclusion

Postscript

Appendices

B/The golden age of tax planning

C/Recent Australian court cases

D/A partial list of tax havens

E/Transfer-pricing legislation in Australia

F/Treasury scoping-paper comments

G/The UK parliamentary report on the Big Four

H/The OECD

Glossary

Preface

This book is not about the Panama Papers. The 11.5 million pages released in the first tranche of those documents revealed truly shocking global tax avoidance and tax evasion — but they dealt with the behaviour of wealthy individuals and their tax advisers. They did not deal with similar behaviour by multinational corporations and their very highly paid tax advisers. The latter is a much bigger problem, and it is what this book is concerned with.

Panama has been known as a tax haven for more than half a century — one of at least 70 tax havens throughout the world, including the British Virgin Islands, Gibraltar, Jersey, the Seychelles, the Isle of Man, a number of ex-British Commonwealth countries, and Delaware in the United States.

The total number of tax havens isn’t known, but it is estimated they are holding between $21 and $70 trillion on behalf of high-wealth individuals. In his 2015 book, The Hidden Wealth of Nations, the economist Gabriel Zucman calculated that 8 per cent of the financial wealth of households, or $7.6 trillion, is held in tax havens, and that the money hidden in those havens causes a loss to global tax revenues of US$200 billion a year — including $35 billion in the US and $78 billion in Europe.

A large number of such havens have existed for at least 100 years. Until the Panama Papers, governments had turned a blind eye to their existence and function, taking care not to press the havens to obtain information about the identity of account-holders. The one possible exception to this behaviour was the Nazis, in the course of their theft of massive amounts of artefacts, art, gold, and other treasures of Europe during World War II. It is likely that some of that treasure is still held in the tax havens, if only because the passwords that would enable their withdrawal have been lost.

The Panama Papers. were exposed by an unprecedented leak from an unknown source to the German newspaper Süddeutsche Zeitung, which went on to share them with the International Consortium of Investigative Journalists. The documents came from the database of the world’s fourth biggest offshore law firm, Mossack Fonseca, which acts for 300,000 companies — more than half of which are registered in British tax havens, as well as in the United Kingdom. It is the worldwide revelation of the beneficial owners of those offshore companies — including many wealthy and highly placed people in a number of countries — that has led governments to start working out what actions they can or should take against their citizens and the tax havens they use.

Transfer pricing is a completely different matter. This technique, developed by multinational corporations, has been out in the open for at least the last 25 years, with more and more devastating consequences for governments and their citizens around the world. The multinationals have perfected the practice of selling to their global affiliates at prices that would send the affiliates bankrupt if they were left on their own, trying to recover their inflated import costs in the marketplace. The affiliates survive only because the banks of the world lend them money based on surety letters from their parent companies or regional head offices.

This process has allowed multinational firms to dominate the markets for goods and services in around 180 countries, or to operate without permanent establishments and to have no tax obligations anywhere. This trick relates principally to internet operators such as Google, Amazon, Apple, etc, and to ‘sharing-economy’ companies such as Uber and Airbnb.

There are approximately 500 multinational companies in existence, who control about 60 per cent of world trade, and whose brand names are familiar to the media and the population. Most of the world’s major economies are members of the Organisation for Economic Cooperation and Development, and have participated in its major meetings in Paris over the last two years, where the core problems caused by transfer pricing have been clearly expressed and discussed. As a result, the governments of many major economies have recently subscribed to a level of mutual tax cooperation that has never been previously known.

In 2013, the powerful UK House of Commons Committee of Public Accounts received evidence from the Big Four accounting firms’ subsidiaries in the UK. The report it issued, Tax Avoidance: the role of large accountancy firms, was damning:

HM Revenue & Customs (HMRC) appears to be fighting a battle it cannot win in tackling tax avoidance. Companies can devote considerable resources to ensure that they minimise their tax liability. There is a large market for advising companies on how to take advantage of international tax law, and on the tax implications of different global structures. The four firms employ nearly 9,000 people and earn £2 billion from their tax work in the UK, and earn around $US25 billion from this work globally. HMRC has far fewer resources. In the area of transfer pricing alone there are four times as many staff working for the four firms than for HMRC.

The parliamentary report effectively expresses the UK government’s position on transfer pricing, and is discussed at length in Appendix F. Their estimate of lost revenue is immense. Partly as a result of this, the HMRC is consulting on a set of draft rules to ban tax-avoiding businesses from being awarded government contracts. That would be devastating for the companies, but hasn’t even been raised as an issue in Australia.

The quantity of the tax revenues being denied to governments around the world by transfer pricing is unknown, but occasionally snippets of information emerge that hint at the enormous size of the losses. For example, the UK pharmaceutical firm AstraZeneca was found in 2015 to have paid no tax on £3 billion of profits, after having channelled funds through a subsidiary in the Netherlands. And a recent report from the UN Conference on Trade and Development has revealed that, in 2015, multinationals funnelled £221 billion through low-tax jurisdiction such as The Netherlands, and through tax havens in the Caribbean.

To some extent, the Panama Papers. have been a distraction. Outing high-wealth individuals may create an interesting circus, but it is not really the main game.

Introduction

International trade began over 2,000 years ago, and is the oldest element of the global economy. In many ways it has been responsible for the prosperity, security, and happiness of the vast number of people lucky enough to be living in the developed world.

In the twenty-first century, international trade has metastasised, and now reaches a global population of many billions of customers, including impoverished people in the most isolated and undeveloped of countries. The dominant suppliers are multinational corporations that have few competitors other than each other.

Until the end of the twentieth century, most manufacturing nations created barriers regulating the entry of imports. The barriers included customs duties, quotas, import restrictions, and non-tariff measures. The ‘Protection Wars’ ended in the last decade of the twentieth century.

The modification of national border protections has created a global trade environment misnamed ‘free trade’. Together with free-trade agreements (which are not free, either) governments have completed a series of bilateral and multilateral agreements that provide a measure of entry into markets (though only for some goods) that were previously impenetrable. So far, no major national market is completely free of either tariff or non-tariff protections.

These political moves have had little impact on the strategies that multinationals use to penetrate and dominate virtually every national market of substance.

The weakening of border protection resulted in another kind of foreign invasion. When ad valorem tariffs (based on percentages of import value) were reduced, import prices rose. High customs duties had previously been a deterrent for multinational parent companies charging prices that, together with duties and marketing on-costs, could not be recovered in the consumer market by their subsidiaries.

The multinationals’ light-bulb moment was to recognise that subsidiaries did not need to make a profit in every national market. In fact, foreign governments would want to collect taxes on any such profits. The multinationals’ solution was to impose charges on their subsidiaries for royalties, manufacturing knowhow, and technical-service fees. There were no taxes on charges for intangible services. These parent-company imposts ensured that the subsidiaries never made a profit and so never paid company tax. In some cases, the subsidiaries incurred losses for decades.

The almost meaningless expression ‘transfer pricing’ is used to describe the pricing mechanisms that multinationals employ to charge their subsidiaries in overseas markets for the subsidiaries’ purchases of goods and services, intellectual property, interest on loans, and much else. These charges, usually excessive, are imposed where the parties to the transaction are related by common ownership: that is, where it is a parent–subsidiary relationship. The subsidiaries have no choice in the transactions. Those prices would not be acceptable (they would, indeed, be ruinous) to an arm’s-length purchaser, as they do not enable the purchaser to on-sell the goods, intellectual property, or services at a profit.

Years (or even decades) of continual losses by a multinational marketing affiliate, for instance, indicate that the parent company is not charging an arm’s-length price for goods, services, and intellectual property. Some subsidiaries of multinationals have not made a profit in over 20 years of operation in Australia. No business operating on its own behalf continues in business if it makes a loss year after year, unless it is contributing to an international profit across borders. Banks do not lend to independent companies that make such losses.

Generally, the purchaser is wholly owned by the parent, though it may simply be controlled by a much lower level of external ownership. This level of ‘controlling’ ownership varies from market to market. And although the ATO accepts that start-ups will often make losses for two or three years, losses over any longer period are a clear indication that a multinational affiliate is not acting at arms’ length.

Multinational ownership and control does not rely on a single shareholder owning 51 per cent of a company’s shares. A 10 per cent ownership can be enough to control a company, through disciplined voting of the bloc of shares on major issues, and the broad distribution of remaining shares to a large number of shareholders.

Governments need tax. The decline in income tax, company tax and, in Australia’s case, a stubborn bipartisan political refusal to increase the GST to the levels that are common in Europe, will ultimately mean that national governments will not be able to meet the social and infrastructure-development obligations that they were elected to deliver. The problem is the mismatch between the demand for government services and the supply of tax revenue. Demands upon the public purses of all government authorities are increasing, while tax collections are falling relative to the increasing size of national populations.

Although the full-blown blight of transfer pricing has been with us for 25 years, it has been a known and growing threat for much longer. In a special message on taxation to the US congress in April 1961, President John F Kennedy said:

Recently more and more enterprises organised abroad by American firms have arranged their corporate structures aided by artificial arrangements between parents and subsidiaries regarding intercompany pricing, the transfer of patent licensing rights, the shifting of management fees and similar practices … in order to reduce sharply or eliminate completely their tax liabilities both at home and abroad.

We don’t often think much about tax. It is one of those subjects that you know has an impact on your life but you are not really interested in. Maybe you don’t want to know. Tax usually gets taken out of your wages or salary, and you get what is left.

Alternatively, you may own a small business and have to pay a number of different taxes, including company tax. You either struggle with the end-of-year return to the Australian Tax Office, or get an accountant to help you. Either way, it costs you time and money.

This book explains how multinational corporations have avoided trillions of dollars of tax over the past 25 years. That number is not an exaggeration. They don’t ‘evade’ tax; they ‘avoid’ it. Tax ‘avoidance’ is legal, but tax authorities will try to collect the additional tax and impose a charge for the period of time they are out of their money. Tax ‘evasion’ is illegal and, if the case is serious, the tax office may try to send the offenders to jail.

Multinational corporations generate profits in around 180 countries around the world. They work hard to avoid, reduce, or delay their tax obligations for as long as possible, and they generally succeed. Sometimes they pay nothing or, at best, the percentage of their multibillion-dollar incomes they pay in tax is a lot less than the percentage an individual worker pays.

Four accounting firms — PricewaterhouseCoopers, Ernst & Young, KPMG, and Deloitte — are the global accountants and tax advisers for the multinationals. They have been paid over $500 billion in the past 25 years to prepare annual accounts and to manage the multinationals’ tax affairs. The favourite tool of the ‘Big Four’ accountancies to minimise tax for their multinational clients is transfer pricing: a complex and confusing array of methodologies and strategies that works to reduce tax or even avoid tax payments altogether.

This book explains how transfer pricing developed, and describes the strategies and tactics that the Big Four global accounting firms use.

The negative financial and economic impact of this behaviour on the nations of the world is about a lot more than just money. It strikes at the heart of how governments obtain the financial resources they need collectively to make global society function efficiently and compassionately. That goal demands a fair taxation system in which everyone contributes according to their ability, and receives support from government according to their needs.

Governments need taxes to pay pensions, build infrastructure, and provide services, and help those who can’t help themselves. In particular, most people do not believe in ignoring the poor, the old, the helpless, and the underprivileged.

According to a report issued by Oxfam in April 2016, tax dodging by multinational corporations costs the United States approximately US$111 billion each year. A follow-up report in June 2016 by Oxfam Australia found that, in 2014, an estimated $638 billion worth of multinationals’ profits had been shifted to tax havens, resulting in $172 billion of tax revenues being denied to 110 developing countries, preventing crucial investments in education, healthcare, infrastructure, and other forms of poverty reduction.

The French-born economist Gabriel Zucman calculates that more than half of the foreign profits of US firms are booked in tax havens. Zucman puts the annual tax-revenue losses of this practice at $130 billion — even more than Oxfam’s estimate. According to Zucman, the effective tax rate paid by US corporations has been reduced by one-third since the late 1990s. Other reports indicate that Apple, for example, had an effective tax rate of 1.9 per cent on its US$36 billion of international earnings in 2012.

The Organisation for Economic Cooperation and Development (OECD) is the peak tax and economic advisory body for most major countries. The good news is that it is at last slowly coming to accept that it must act to put a stop to multinational tax abuse. At the G20 conference in Lima, Peru, held in October 2015, OECD secretary-general Angel Guerra said: ‘The G20 has recognised that BEPS [base erosion and price shifting] is eroding