Monday, July 22, 2013

22/7/2013: G20 Spells Out a Squeeze on Tax Arbitrage

Last week we saw the conclusion of the G20 Finance Ministers and Central Bank Governors meeting in Moscow. The meeting covered, in part, financial regulation and international taxation issues, aimed at addressing, as the IMF put it, "international spillovers of national tax policies".

Here's what the basic set of the proposals discussed implies for Ireland - a country at the centre of these spillovers in the euro area and largest per-capita beneficiary of the international tax arbitrage after Luxembourg.

The OECD-prepared, G20 discussed 'Action Plan' on Base Erosion and Profit Shifting (BEPS) covers loads of technical ground. The main points of relevance to Ireland's real economy are:

  1. Tax issues relating to the Digital Economy - including coverage of tax application to services, geographic distribution of tax revenues etc. In the nutshell, the G20 will aim to adapt international direct and indirect taxation rules to the digital economy, including attribution of profit 'together with the character and source of income'. In simple terms, aggressive tax base shifting from, say the UK-sold advertising revenues to, say Ireland-based pro forma sales centre. In other words, the rules will challenge the system on which much of the Ireland's comparative advantage in ICT and financial services currently rests. The threat is more genuine in my view in the case of ICT services than in the case of financial services.
  2. Tighter controls over Controlled Foreign Company rules - a relatively minor issue from the point of view of Irish real economy, but having a potential to impose small adjustment on our official GDP.
  3. Reduce artificial avoidance of tax application, presumably including by schemes such as Double Irish. This has potentially strong adverse impact on Irish economy.
  4. Intangibles transfers within the company group are to be tightened, to reduce effectiveness of transfer pricing. Once again, this suggests pressures on IP tax arbitrage and licenses arbitrage - a core competitive point for Ireland.
  5. The Plan also aims to (explicitly) develop rules to align profits with value creation. Bad news for major MNCs operations here.
  6. Beefing up of data, tax and transfer pricing documentation, and reporting compliance in line with BEPS proposals - an additional significant cost for Irish companies and MNCs, although this is symmetric for all other jurisdictions, so not an issue from comparative advantage of Ireland point of view.

In effect, many proposals link directly into CCCTB structure (see my analysis of this in the G8 context here):

  • Reporting on tax matters re-aligned to cover business activities and capital bases
  • Focusing on documentation of the location where key business risks and business processes are located
  • A country-specific breakdown of group profits and revenues
  • Common anti-avoidance regime
  • Services delivered on-line will migrate toward effective tax rates based on location of end-user of services
  • As KPMG analysis statesd: "Change in effective rate of tax on group profits where change in transfer pricing basis for profit attribution alters the mix of profits attributable to group members". Or in other words: kiss goodbye the key pillar of tax arbitrage in Ireland via consolidation of the tax base.
  • Tax base will migrate to the locations "of key functions and management and oversight of key risks"

So good luck eating that 'breakfast of champions' of the claims that the G20 proposals present no threat to Ireland's economic model. They might not spell a full-scale closure of the tax 'haven' we run, but they do present a significant costs and risks threat to our model, where it is reliant heavily on tax arbitrage. Not a catastrophe, but...

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