As much as 40 per cent of multinational profits are shifted to low-tax countries each year according to an estimate in a working paper published recently by economists from Berkeley and the University of Copenhagen. The paper states that profit shifting is highest among US multinationals and that tax revenue losses are largest for the European Union (EU) and developing countries. The paper estimates that EU countries are deprived of 20 per cent of their tax revenues.
One of the main problems society faces is that tax authorities in high-tax countries are not doing enough to combat profit shifting to tax havens, according to Gabriel Zucman, Ludvig Wier and Thomas Tørsløv, authors of paper, The Missing Profits of Nations. The authors suggest that imposing economic sanctions on countries with low taxation rates would be one way to address the flow of capital into tax havens.
Dispelling the competition myth
In the 33-year period from 1985 to 2018, the global average statutory corporate tax rate has fallen from 49 per cent to 24 per cent, write the authors. They argue that this astonishing 50 per cent decline in the corporate tax rate is not a necessary by-product of globalisation and increased competition, but is the result of policies in high-tax countries and their failure so far to address profit-shifting and tax avoidance.
In a nutshell, the paper points out that globalisation and competition are often cited as the drivers behind the falling corporate tax rate, the logic being that countries compete to attract business operations in order to boost domestic employment and the economy. However, there is not much evidence for this, as countries that are considered tax havens don't have normal competitive motivations for their zero or near-zero corporate tax rates, and many of the multinationals that declare profits in those countries have very few employees and often no operations at all in those jurisdictions.
Google in Bermuda
The paper gives the example of Google's (Alphabet's) revenues declared in Bermuda ($19.2 billion in 2016), although the tech giant has hardly any employees and no tangible assets in Bermuda. The authors write: “Contrary to the central postulate of the tax competition model, Bermuda does not have much to gain from attracting paper profits that don’t improve wages for the population and that it taxes at 0 per cent. Despite this, the standard view of tax competition between nations continues to permeate much of the discussion about tax policy.”
The paper's authors have produced new estimates of the size of global profit-shifting using the macroeconomic data of tax havens, which they say is the first time that tax haven macro data have been used to estimate the amount of profits shifted to low-tax places, providing a 'comprehensive map of where profits are booked globally'.
CTMfile take: This working paper is a must-read for all corporate and tax professionals interested in the profit-shifting debate. The paper also contains some interesting graphs showing pre-tax corporate profits as a percentage of employee wages in different countries and the difference between profits of local and foreign firms in different jurisdictions.
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