Some voices are already shouting "revolution!" In January, what is commonly called the Inclusive Framework of the OECD (Organisation for Economic Cooperation and Development) published proposals for further comprehensive reform of the way multinational corporations are taxed. Ostensibly it is mainly about ensuring the taxation of corporations with a highly digitalized value creation chain: in other words, corporations like Google, Amazon, Apple, Spotify or Facebook. This is an attempt by the OECD to put into practice measures already decided by its member countries in 2015 under the Base Erosion and Profit Shifting (BEPS) project, with a view to countering profit reduction and profit shifting.
The taxation of highly digitalized corporations is a tricky undertaking for the international community, as their business model poses fundamental challenges to the system hitherto in place: its architecture is now 100 years old and based on two pillars. First, companies should be taxed in the places where they create value – in other words, at the place where production takes place. Second, only firms with a permanent establishment (PE) in a country or a regional or local territorial entity are liable for taxation – in other words, those officially registered in a country.
Facebook should pay its fair share
Without exception, US tech giants are undermining both these principles, in that their value creation takes place primarily in virtual space and their workers are very often also their consumers. Let us take Facebook. The company's digital platform is to an extent also its factory. It is not located in a place that exists in real-life but in the borderless digital cloud of the Internet. Facebook can therefore have millions of users in a country, who produce millions of items of content and thereby generate countless millions in advertising revenue for the social network. And this without Facebook hiring so much as a single worker locally, let alone operating a "factory" as a registered permanent establishment. The company can therefore conceivably create enormous value in a country without paying a single dollar in taxes.
It is these practices (see box) by the digital giants that the OECD is no longer prepared to accept. But the relevant tax reform proposals now under discussion concern not just the tech giants but could, if ever consistently implemented, trigger the restructuring of the entire global corporate taxation system. There are two reasons for this. First, these OECD negotiations no longer involve just the 36 OECD member countries comprising mainly the old industrialized West, but under the Inclusive Framework, there are now many Asian, African and Latin American countries also present for the first time. There are currently 128 countries altogether. The chances that ultimately the new reforms will also accommodate the fiscal interests of developing countries are therefore better than in past reform processes, in which OECD members alone would set the pace. Second, today it is not only companies that sell purely digital goods such as social network services that are digitalized. Naturally, digitalization also plays a major role in the case of all other companies. Many industries are witnessing strong growth in the trade of so-called intangible – i.e. almost invariably digital – goods.
Abandoning the arm’s length principle?
Under the existing system, corporate profits are taxed at source, in other words, where companies produce. If a company has permanent establishments in several countries, profits are currently distributed each year according to a key whereby individual locations – places where the company maintains permanent establishments – are assigned a level of profit that would accrue to independent firms in a comparable value chain. This key is known as the arm's-length principle. This system had already become dysfunctional even before the digital giants from the USA began their worldwide conquest. Because some 60 to 80 per cent of world trade currently takes place within corporations, with the result that a substantial proportion of global trade no longer occurs between independent companies but within a few hundred major corporations, there is a dearth of real possibilities of comparison for the purposes of the arm’s length principle. This lack of real markets creates considerable leeway for transfer price manipulation, through which companies determine the prices of goods and services that are traded between their subsidiaries. Owing to profit shifting from one country to another, the countries in the South alone forgo tax revenues in the three-digit billions each year. Nowhere else under the present tax system is the bottom line as negative as in the developing world. If this catastrophic shortcoming could now be removed from the international tax system through better digital taxation, it would be an opportunity for greater global justice in taxation and distribution.
The reform proposals currently being discussed under the Inclusive Framework are highly multifaceted. It is difficult to estimate how many of them will be approved by the participating countries. Because decisions can only be made by consensus, "revolutions" are a rarity at the OECD; rather, the countries that tend to get their way are those with an interest in ensuring that international rules are the least binding possible. These countries therefore aim for the lowest common denominator in negotiations. In the OECD, those countries traditionally include Switzerland, whose low-tax jurisdictions with their corporate headquarters and subsidiaries, especially in Basel City, Vaud or in the Canton of Zug, benefit handsomely from profits shifted by multinationals from other countries.
Various proposals on the table
The idea currently with the best prospects of success comprises what are known as the “controlled foreign corporation (CFC) rules”. This would render profit shifting within one and the same corporation from a high-tax jurisdiction (country A) to a low tax jurisdiction (country B) unattractive, because country A would then have the possibility of adding to the taxable profits of the corporation in country A the profit that has flowed out to country B, thereby offsetting the fiscal shortfall. Profit shifting would lose its appeal to multinational corporations. However, this would work only if the cheated high-tax country is one with the relevant laws and fiscal authorities capable of ascertaining the outflow of profits within a particular corporation. And it would work for developing countries only if the relevant rules of transparency are implemented worldwide – for example through public country-by-country reporting. But the CFC rules alone would not be enough to put a stop to the deleterious practice by commodity-trading companies of shifting profits from African countries to Switzerland.
Also under discussion is a globally binding minimum tax, which would be instituted through a similar procedure to be applied under the CFC rules. France and Germany support this possibility. Colombia, India and Nigeria wish to go even further. They recently came out in favour of completely abolishing the arm's length principle and replacing it with a unitary taxation system under which a corporation's cumulative worldwide profit would be taxed. The proceeds would then be divided up among the various countries where the company maintains operations, in accordance with value creation in each one. Alliance Sud too favours this paradigm shift.
Switzerland under renewed pressure
As things stand, the irony of the story is that irrespective of whether the pragmatists obtain the lowest common denominator or a true revolution occurs in the global tax system – the business model of Swiss corporate taxation could in any case come under challenge. The Tax Reform and AHV Financing (TRAF) proposal and the replacement of old tax dumping vehicles with new ones continues to build on the ability of multinational corporations to pay tax on profits from abroad in individual cantons. This strategy would be significantly impacted not only by unitary taxation but also by the CFC rules or the global minimum tax. Accordingly, the State Secretariat for International Finance (SIF), which negotiates on Switzerland's behalf, has already spoken out against the latter. Yet again therefore, the Federal Council is attempting to impede meaningful progress in the international taxation system. But it is highly doubtful that this would place Switzerland among the winners in this round of reforms. The Trump regime in the USA has already taken unilateral action to halt profit outflows from the United States, and many influential countries are now looking at new and effective multilateral measures. They are keen to avoid a "tax war" among individual countries, similar to the trade war currently raging between the USA and China.
For the new rules to become reality under the TRAF, the Federal Council and Parliament expended great effort and exhausted all the available economic and social policy space. Despite all this, these new rules could well turn out to be no more than waste paper by the summer of 2020, when the States in the Inclusive Framework plan to reveal the outcome of their negotiations.
The Facebook system
Facebook does not pay taxes where it ought to under the rules of the international tax system, instead it pays them where it chooses. In other words, where the company will pay the least. According to The Guardian, Facebook thus made sales worth £1.3 billion in the UK in 2017, on which it paid a mere £15.8 million in taxes or on a mere 0.62 per cent. While Facebook converted 50 per cent of its worldwide sales into taxable profit, the rate for the United Kingdom was just five per cent. There is reason to suspect that this rather low productivity by Facebook UK compared to other countries is attributable to profit shifting and that Facebook therefore declared a much smaller profit to the British fiscal authorities than it in fact made. It could reasonably be presumed that the missing profits were declared in British overseas territories, in Ireland or Luxembourg, where the effective profit tax rate is extremely low or even very close to zero.