Those for whom the term 'world trade' immediately evokes exports and imports between independent enterprises are finding themselves ever further off the mark. OECD estimates are that today more than half of international trade takes place between companies belonging to the same group.
This poses enormous challenges when it comes to levying corporate taxes. Multinational corporations are able to use intra-corporation trade to accumulate their worldwide profits in a place where the lowest taxes are levied. Earnings are therefore not reported where they are generated, but are transferred to tax havens. The corporations themselves colourfully describe such profit transfers as tax optimization. Non-governmental organizations prefer to speak of aggressive tax avoidance.
Who is being harmed?
The victims of this practice are the countries in which production actually takes place: they provide the companies with labour and the necessary infrastructure, they allow them to exploit mineral deposits, but go away empty-handed when it comes to tax revenues. They must fill the financial deficits by cutting back on public services or by taxing small companies and employees more heavily.
Developing countries too are being particularly affected. For years British brewery SAP Miller made millions in turnover in Ghana, but officially garnered hardly any profits and therefore, according to research by the Action Aid development organization, paid as good as no corporate taxes. The branch in Ghana allegedly used up all profits to settle internal company debts, license fees were paid to a Dutch sister company and costly intra-company services were contracted in Switzerland. The group's public justification was that it had acted strictly in accordance with the law.
Immoral, but legal
The fact is that most of the practices whereby companies transfer their profits to low-tax countries such as Switzerland are perfectly legal. Only the so-called arm's length principle applies. It holds that internal corporate transactions should be conducted at the normal market prices that would apply to transactions with unrelated parties. Nevertheless, the responsible tax authorities often find it difficult to monitor compliance with this rule at a reasonable cost. In developing countries for the most part, the authorities often lack the human resources needed and at times even the requisite legal bases.
Added to this is the fact that the arm's length principle allows considerable leeway. There are really no free markets for patents, trademark rights and internal company loans for example, and hence also no straightforward possibilities for comparison. Corporate groups can therefore set prices for intra-company transactions more or less freely.
This is one of the reasons why intra-company royalty payments are becoming an ever more frequently used vehicle for aggressive tax avoidance. It suffices to hold expensive patents and trademark rights in a country that hardly taxes the corresponding revenues, and the result is that almost no more taxable profits are generated in the actual country of production.
Switzerland is a favourite destination for fiscally motivated profit transfers. This is down to the tax privileges for so-called special status companies (holding companies, mixed companies and management companies above all). They bring about unequal treatment of domestic and foreign profits, they boost the foreign business of firms headquartered in Switzerland and secure an unfair competitive advantage for the country in the international competition to attract companies. Profits from abroad are often largely tax-free. This has long angered countries where the profits originate and has also been a source of growing annoyance for the OECD.
But this should end soon. The Federal Council has launched expert consultations on the so-called Corporate Tax Reform III. To put an end to the protracted row with the EU, the Federal Council wishes at long last to eliminate the existing tax privileges for special status companies. At the same time, however, it wants to ensure that Switzerland does not lose market share in the competition amongst tax havens. Alongside other measures, the planned reform therefore envisages replacing exceptional taxation of special status companies with fiscal privileges for income from royalties (the so-called license boxes). Moreover, the cantons are to receive support in drastically lowering their corporate taxes yet again.
Of course it makes sense to abolish cantonal tax privileges for special status companies. The planned replacement measures (license boxes and other corporate tax cuts) are highly questionable from a developmental standpoint. They would continue to represent a powerful incentive for multinational corporations to transfer their profits from developing countries to Switzerland via internal company transactions, thereby depriving the country concerned of urgently needed government revenues. This would clearly contradict the aims (and successes) of Switzerland's development policy.
The fact is, however, that the gloves are already off in the international tax competition. License boxes, for example, already exist in several European countries. Switzerland's renunciation of such boxes would be of rather limited benefit to developing countries. More corporate profits from poor countries would simply flow into Holland or the United Kingdom instead of Switzerland.
But in the competition between business locations, Switzerland has more to offer than tax dumping. Rather than further stoking the tax competition, it would do better to actively combat tax dumping by other countries and advocate for fairer corporate taxation internationally.