“It is easier undoubtedly for smaller offshore jurisdictions to eliminate corporation tax on the basis that the quid pro quo is full employment for the residents living there."
Contemplating a world where corporate taxes are abolished creates an interesting philosophical discussion, but at a time when cash-starved governments have never before been so aggressive in targeting corporations for tax revenues, it is unrealistic. Instead, a power struggle between many states for an increased share of the multinational ‘pie’ has arisen in recent times. The economic crisis, which started almost 10 years ago fundamentally shifted international tax policies and there is unlikely to be a shift away from many of these trends. The crisis created budgetary shortfalls which required the introduction of austerity measures, in many European countries in particular, which were greeted with an unpopular reaction from the general public. This in turn led to a populist movement in many countries, which called for increased tax revenues from corporations, rather than individuals. If corporate taxes were ever to be abolished, now seems to be the least likely time.
While it is easier for smaller economies, which are dependent on foreign investment to create employment, to lower or eliminate corporate tax, it is much more difficult for large economies to shift tax policies without rebalancing the books by introducing unpopular measures. In the US, President Trump is seeking to reduce the corporate tax rate to 15 percent and the UK is lowering its corporate tax rate to 17 percent. There has been much discussion on how difficult it would be for the US Treasury to balance the books with such a stark reduction from the current rates, which could lead to deficits amounting to trillions of dollars. Countries that have lowered their rates, Ireland being a good example, have sought to broaden the corporate tax base by attracting more foreign investment and by plugging a shortfall from corporate income tax revenues by imposing somewhat higher personal income tax rates and also, more importantly, having a value added tax (VAT). At the same time, total tax receipts from corporate tax in Ireland in 2015 accounted for 11.4 percent of total tax collected in that year, which is almost four percent more than the OECD average (7.7 percent) and a full four percent more than in the United States (7.4 percent). This illustrates that corporate taxes, even in perceived low tax jurisdictions, still form an important cornerstone of exchequer funds.
It remains to be seen whether the US can reduce the corporate tax rate to 15 percent without incurring substantial deficits. The bigger question remains whether the US should seek to introduce a federal value added tax to supplement the budgetary coffers. VAT as a concept remains very unpopular in the US and is seen as a regressive tax which is unfair and disproportionately taxes lower income families, and raising personal income tax rates is never a popular move! From a political perspective it certainly would be much more palatable to retain existing corporate taxes rather than imposing the burden of a VAT on consumers.
It is easier undoubtedly for smaller offshore jurisdictions to eliminate corporation tax on the basis that the quid pro quo is full employment for the residents living there. It is much more difficult for larger economies to migrate to such a regime without introducing some form of unpopular tax.
While I would not advocate abolishing corporation tax, I think it is open for jurisdictions to lower their rates and make their offerings more competitive for foreign investment. In the case of the US, the hope is that by lowering rates and having a more attractive regime this in turn will lead to many of its own multinationals reinvesting offshore profits and create employment in the US.
OECD BEPS Project
While the elimination of corporate tax is unlikely, creating rules which provide more certainty and some form of conformity on a principled basis as to when tax applies is achievable. Nowadays the resources required to comply with tax laws when operating in multiple jurisdictions seems to be increasing on an exponential basis with the introduction of uncertain and sometimes subjective rules.
Many zero tax jurisdictions are coming under fire, with the creation of blacklists and rules which can allow tax authorities to disregard legitimate transactions involving parties in haven jurisdictions. Perhaps the trend moving forward will be that jurisdictions that have traditionally favoured a zero rate of tax may prefer to have a regime that requires residents to at least pay some tax. It is clear from the OECD’s various BEPS (base erosion and profit shifting) reports that substance will need to be aligned with profits going forward and mere ownership of certain assets (eg intangibles) will not guarantee traditional residual profits without that party also having so-called ‘DEMPE’ functions in place. The introduction of country-by-country reporting will of course bring this into sharper focus. Creating a low tax environment will not be enough to attract investment in the future, it will also be necessary to create an ecosystem where particular industries and sectors can thrive with employees carrying out key functions. In Ireland’s case, the technology, life sciences sectors and financial services sectors are well placed to continue to attract such investment due to the developed ecosystems in those areas.
The OECD’s BEPS Project was designed to stamp out certain abusive structures which stripped value out of market jurisdictions through base-erosion and profit-shifting techniques. However, a number of measures which were advocated under the OECD BEPS Project could lead to greater uncertainty moving forward. In particular, the proposed changes to the permanent establishment rules and the introduction of different transfer pricing norms could lead to further uncertainty, controversy and ultimately increased costs for the tax payer. The likely introduction of a ‘principle purpose test’ over a ‘limitation on benefits test’ in the updated treaty, which will be agreed under the multilateral instrument, is a good example of the tendency of most OECD member states to favour subjective rules over objective criteria. This in turn will inevitably lead to more disputes and competent authority cases. Tax authorities may be emboldened to adopt conflicting interpretations of the rules, which ultimately cannot be good for tax payers as there are bound to be some nasty surprises in certain jurisdictions.
The EU has shown a growing willingness to get involved in the realm of direct corporate tax, despite the sovereignty EU member states enjoy in respect of tax matters under the Lisbon Treaty. Over the last two years there has been a proliferation in the number of EU state aid cases, which have been brought on matters that primarily concern domestic member states’ corporation tax rules. These state aid cases, which re-examine the domestic rules of member states retrospectively, have introduced uncertainty for tax payers. An authority, which was established to enforce competition law principles, is now reviewing the tax structures of multinational companies and the local domestic tax rules of member states and trying to decipher whether in their opinion a distortion of state aid rules has occurred. If they were to do so prospectively that would be one thing, but unfortunately they have looked back over a number of years and determined sizable judgments against multinational companies for historic years. While this topic is a little too complex to cover in detail, the upshot is that the EU is now interfering in domestic tax affairs of sovereign member states.
More recently, the European Commission has initiated proceedings against the Netherlands in respect of the limitation on benefits test which is set out in the bilateral tax treaty which was agreed by the Netherlands and Japan. This intrusion into how sovereign governments would like to carry out their tax affairs is another unwelcome development.
The EU’s involvement in direct tax matters does not end with the Commission and EU state aid cases. The proposed introduction of the Anti-Tax Avoidance Directive (ATAD) will also have a significant impact moving forward. The various measures proposed in the ATAD directive were unanimously agreed by member states and will only operate on a prospective basis and seem somewhat less egregious than the state aid cases brought by the EU Commission. Nevertheless there is now a further source of legislative impact on corporation tax in the EU and that trend is likely to continue moving forward. Finally, the EU has not completely given up on introducing a common consolidated corporate tax base (CCCTB), which would mandate that EU-established companies would compute their taxes in a uniform manner and set out rules for the apportionment of profits in accordance with a formula. However, the latter measure is far less likely to be agreed on unanimously by member states.
Unilateral Anti-Abuse Rules
Aside from legislative changes and cases brought by the EU, we have also a number of jurisdictions taking unilateral action to introduce measures, sometimes in defiance of the wishes of the OECD, to counter what they perceive as abusive tax planning. The UK has led the charge in this regard with the introduction of the diverted profits tax, and, more recently, an extension of its royalty withholding tax regime. Australia and other jurisdictions have inevitably followed suit and have seen an opportunity to increase tax revenues through such unilateral measures. These new measures are complex and in some cases create uncertainty as to whether tax should apply and also purport to circumvent the terms of tax treaties and can dis-apply provisions which would otherwise protect tax payers where royalty withholding tax rates could be reduced or a permanent establishment would otherwise not exist.
In conclusion, while the elimination of corporate taxes is still a utopian ideal, the reality in terms of what we are seeing in practice, is trending towards more of a dystopian vision! Tax authorities are getting more aggressive, governments are introducing new and increasingly divergent tax measures to target profits of large multinationals, and supranational bodies such as the EU Commission are also seeking to target large multinationals who have legitimately applied domestic tax laws to mitigate the amount of tax paid. While I do not expect corporate taxes to be abolished any time soon, I would be hopeful that the increased amount of uncertainty that has arisen as a result of the various measures and cases which we have seen over the last number of years will lead to some sort of consensus that there is a need to have objective rules and a mechanism to quickly and efficiently settle disputes between tax authorities.
About the Author
Mark O’Sullivan is a partner in the firm’s Tax Department and advises on all aspects of Irish corporate taxation. His primary focus is advising overseas clients establishing operations and doing business in and through Ireland. Mark also advises extensively on all aspects of international tax planning, including IP planning, cross-border reorganizations and financing transactions.
. Source: 2015 OECD Revenue Statistics.
. Development, enhancement, maintenance, protection and exploitation of intangibles (DEMPE).
. Treaty of Lisbon amending the Treaty on European Union and the Treaty establishing the European Community (2007).
. See, for example, European Commission decisions against Ireland (Apple), Netherlands (Starbucks) and Luxembourg (Fiat, McDonalds and Amazon).
. See Council Directive (EU) 2016/1164 of 12 July 2016, laying down rules against tax avoidance practices that directly affect the function of the internal market and European Commission Press Release dated 21 February 2017.
Mark O'Sullivan is a partner in the firm's Tax Department and advises on all aspects of Irish corporate taxation. His primary focus is advising overseas clients establishing operations and doing business in and through Ireland. Mark also advises extensively on all aspects of international tax planning, including IP planning, cross-border reorganizations and financing transactions.