Tax Analysts Blog

Global Tax Harmonization and Other Impossible Things

Posted on Jun 5, 2015

On June 2 a group called ICRICT, (the Independent Commission for the Reform of International Corporate Taxation) gathered in Trento, Italy, to release a declaration urging major changes in how governments around the world tax multinational corporations. You can find its declaration here.

In reading these documents, it occurred to me that ICRICT might have chosen Trento as its launch venue because it is literally thousands of miles away from K Street. The substance of the declaration is not exactly what corporate America, or its tax lobbyists, wants to hear.

ICRICT argues that current multilateral efforts to reform the corporate tax (read: the OECD base erosion and profit-shifting project) are “clearly insufficient” and will only serve to propagate the status quo -- which is to say our overly permissive tax regimes that facilitate stateless income aren’t going away anytime soon.

Further, ICRICT observes that this inadequacy arises from institutions promoting international tax cooperation (read: the OECD) not being “inclusive enough” -- which is to say that multinationals hold too great an influence over how their activities and profits will be taxed.

The list of ICRICT commissioners includes Nobel Prize-winning economist Joseph Stiglitz and former United Nations Undersecretary General José Antonio Ocampo. Notably missing is any representative of the business community. The omission, I suspect, is purposeful. The ICRICT declaration is precisely the type of policy report one gets by putting smart people around a table for a few of days and instructing them to fix the global tax system without regard to what business wants.

Radicalism Meets Cynicism

ICRICT’s recommendations for global tax harmonization are well intended and premised on much sound reasoning, but they also strike me as being aspirational and unrealistic.

As the declaration’s authors see it, nothing in the BEPS project will bring meaningful change. Likewise for country-by-country reporting. Ditto for tax haven blacklists and codes of conduct, and diverted profits taxes. That’s all window dressing that masks the real issue. And the root of the problem, according to ICRICT, lies in the unchallenged acceptance of separate entity accounting. The group contends that the best hope for legitimate change is to tax multinational groups as a single unitary business. Only then can transfer pricing based on the arm’s-length standard be assigned to the dustbin of history and replaced with formulary apportionment.

The declaration makes this point rather forcefully:

“[Nations] must reject the artifice that a corporation’s subsidiaries and branches are separate entities entitled to separate treatment under tax law, and instead recognize that multinational corporations act as single firms conducting business activities across international borders.”

I don’t dispute its reasoning. Multinationals themselves often don’t respect the phony contracts and sham lending agreements between their wholly owned affiliates. Separate entity accounting, however flawed, is how the world operates. I can’t see how that will change.

Formulary apportionment sounds eminently rational in an ideal world. But I don’t know how we’d get every government in the global economy to agree on the pesky details of determining the formula. I suspect we’d merely trade one set of compliance and enforcement headaches for a different set of headaches.

The declaration is full of other bright ideas, such as this one:

“All [nations] should proactively disclose to the public tax incentives, tax preferences, and income exclusions provided to multinational corporations.”

Good luck with that. I can appreciate the value in having a well-informed citizenry. But I can’t see the same politicians who approve all these incentives, preferences, and exclusions – many of them resting on dubious merits -- wanting such matters publicly scrutinized. The powers that be will fight that tooth and nail. Sorry, that’s just how it is.

There’s more. The declaration takes a dim view of the global tax treaty network. Those treaties -- at least the ones based on the OECD model -- enshrine the narrowly construed permanent establishment concept. That practice allows multinationals to extract many profits from source countries while paying them little in the way of tax. ICRICT wants the PE concept to be as broad as possible.

The declaration also encourages governments to “avoid restrictions on tax withholding.” ICRICT likes the idea of source countries imposing withholding taxes on outbound income flows. Those withholding taxes are perhaps the best means for a developing nation to tax the economic activity taking place inside its own borders, especially among the extractive industries. No argument there. But again the declaration runs counter to conventional thinking. Ask most tax attorneys and they’ll tell you that reducing (or eliminating) withholding taxes otherwise imposed by the source country is the whole point of entering into a tax treaty.

Ultimately, the ICRICT declaration is a sensible, but radical manifesto. It suffers from its own idealism in viewing corporate taxation as a revenue tool for social change to help societies in need. How quaint. Perhaps I’ve grown cynical from having spent too many years inside the Beltway. I’m inclined to view the corporate tax as a bag of commercial subsidies with a small levy attached. If you’re willing to suspend your disbelief that impossible things can happen, ICRICT’s declaration is definitely worth reading.

Read Comments (6)

edmund dantesJun 4, 2015

Too bad they failed to recommend the one change that would render the cost of
all the tax gymnastics pointless: lower the corporate tax rate to the point
that it's just a nuisance instead of a major line item. A 5% tax rate, 10%
tops, could achieve that.

emsig beobachterJun 4, 2015

Robert: BEPS is aspirational in the other direction. Monsieur Pascal Saint
Amans loses sleep when he considers that the net income of some multinational
enterprise may be slightly over-apportioned under combined reporting and
formulary apportionment. Instead, the BEPS project strains at gnats attempting
to perfectly match an arbitrary measure -- net income -- to the constituent
parts of a multinational enterprise using complex transfer pricing mechanisms,
profit sharing, and cost sharing arrangements. Now, a new method. Apportion the
net income to the constituent parts by somehow estimating the relative value
created by each unit -- sacre bleu.

Why should ICRICT invite business participation? ICRICT knows what business
wants -- a tax code chock full of special interest deductions and credits, low
marginal rates, and "loopholes" to avoid paying the minimum tax possible.
Besides, large businesses and governments get together to make the world a
better place sans taxes on corporate net income at Davos, Jackson Hole, and
other equally inhospitable venues.

As for the radical ICRICT manifesto (I love the Marxian reference) being too
idealistic' please note that this system is currently being used by 26 of
states in the U.S. There is no need to have a completely uniform system for
combined reporting and formulary apportionment to work. If it didn't work, the
multistate/multinational business community would not push for the passage of
BATSA bills every year.

Eventually, if economists such as Professor Stiglitz keep pushing for worldwide
combined reporting and formulary apportionment, it may actually come into
being. Practical people who view this as delusional now, may adopt it later
because they are in the thrall of dead academic scribblers.

herman b. boumaJun 5, 2015

It's nice to at least know what the ideal is. If you don't even know what the
ideal is, how can you ever take any steps towards it?

Michael KarlinJun 7, 2015

Emsig Beobachter's line about the system currently being used by 26 U.S. states
blithely ignores the fact that states constantly tinker with the three-factor
formula in efforts to grab revenue, as a result of which we have single factor
in some states and other variants. I would regard the U.S. experience of
formulary apportionment as a warning that unless we can get very strong
commitment from all countries to use the same rules, we'll end up with just as
big a mess as we have now with separate accounting and the arm's length
Formulary apportionment that actually works will never be accepted because it
involves too great a relinquishment of national sovereignty. Politicians won't
agree that the only thing they get to regulate is the tax rate.
Formulary apportionment has other problems. The valuation problems, especially
with respect to IP, are huge. The number of industries for which variations or
exceptions are required to reach any kind of rational result is large.
Formulary apportionment will kill off countries which compete based on cheap
labor, the very thing that makes enterprises in those countries profitable.
And on and on. Yes indeed, it's a leap from the frying pan into the fire.

emsig beobachterJun 7, 2015

Michael Karlin: A major problem with the corporate income tax is that policy
makers -- national and state/local -- try to use the that tax as a means to
coax new businesses and existing businesses to invest in their jurisdiction by
tweaking the apportionment weights as well as tax rates, investment credits,
etc. States tinker much more frequently because of the competitive pressures
they face.

One of the benefits of formulary apportionment and combined reporting is that
elected officials, frequently with the tacit approval of the electorate, are
the ones who shred the tax base. In our current "system." it is corporate
leaders who shred the tax base, frequently with the tacit approval of elected

edmund dantesJun 7, 2015

In CT we have a different philosophy. We're sharply increasing taxes on
corporations, encouraging them to exit the state as soon as practical. The
strategy is working!

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