It's time to rewrite the international tax rules

It was designed more than 80 years ago in an industrial age when multinationals operated across the world as separate legal entities and the major concern was to prevent double taxation, where the same profits ran the risk of being taxed in more than one jurisdiction.

But it cannot cope in the digital age where those multinationals are economically and operationally far more integrated, and able to use mismatches and asymmetries between the tax rules of national jurisdictions to achieve the tax planning nirvana of double non-taxation.

The ability of multinational companies to drive a coach and horses through the international tax rules — most recently highlighted in the media by the sort of perfectly legitimate profit-shifting strategies allegedly adopted by mining magnate Glencore, apparently to reduce its tax on corporate profits of over $14 billion to zero — poses a serious risk to corporate tax revenues for all countries, undermines tax sovereignty and adds to the perceptions of an unfair tax system for ordinary taxpayers. The corporate tax base, comprising about 20 per cent of all tax revenue and principally derived from the larger corporates, is particularly important in Australia. Changes to the tax mix (possibly even in the form of broadening the GST base) may be inevitable, but as a nation we should not lose the capacity to continue to derive vitally needed resources from the big end of town.

Although we can attempt to shore up existing international tax arrangements with unilateral and bilateral patchwork renovations such as revising the thin capitalisation, transfer pricing and general anti-avoidance rules, by tightening up on tax treaty provisions, or by exchanging more information across international borders, the better resources, in the form of high-quality advice available to the multinationals and the lack of access to key information about group structures and transactions, means that revenue authorities are always playing catch-up.

All too often changes to specific and general anti-avoidance provisions by governments are too late — the stable door is being closed well after the horse has bolted. A better and more imaginative process might be to tear down the existing regime and redesign and rebuild on a multilateral level.

Australia’s tax system is creaking under the strain of globalisation and we need to act radically and in concert with other countries to plug revenue holes. Australian governments shouldn’t get too distracted by a planned global crackdown on ‘‘base erosion and profit shifting’’ (BEPS) prompted by the increasing ease with which firms such as Apple and Google can shift their intellectual property and profits to the lowest-tax country. It may be high profile — but in the general scheme of things the G20 and OECD approach to tackling BEPS will not get us very far. Ultimately there is a tension between the enhanced international collaboration required by the BEPS approach and the natural urge of each country to provide a low rate and highly competitive tax environment to attract the multinationals to locate within its borders.

That tension can only lead to lowest-common-denominator compromise outcomes from the BEPS approach.

We may need to be a bit more imaginative in how we deal with the problem. For example, the problem stems from the fact that multinationals are treated as if they are a series of separate entities operating in different tax jurisdictions for tax purposes. That permits them to easily shift their expenses to high tax countries (where they are worth more to the company) and their income to tax haven jurisdictions where they will pay little or no tax. If, instead, the multinational were treated as one single global entity, and had to make a consolidated report on all its activities to all tax authorities for the countries it operates in, then it would be a relatively simple task to stop this tax arbitrage activity. A portion of those consolidated profits could be allocated to each of those countries on the basis of predetermined factors, such as agreed weighted formulae that based upon the number of employees, amount of sales or physical assets in each of those countries. Each country could then tax their share of the profits at whatever rate they deemed appropriate and put an end to the game playing that bedevils the international tax scene.

Chris Evans is a Professor of Taxation in the Australian School of Business, UNSW.

This opinion piece was first published in The Australian.