3 October 2022
Last year, academics from the University at Albany and the University of Missouri published a research paper arguing that company taxes should be abolished. Part of their argument was that transfer pricing by multinationals has become so widespread that policymakers should give up on corporate taxation altogether.
It’s a stark reminder that when it comes to multinational tax reform, what’s at stake is nothing less than the future of the corporate tax itself. I believe it is good economics to save corporate tax, but it will take deft policymaking and proper tax administration to do so.
Company taxes go back a over a century. The US introduced a corporate tax in 1898, but it was over-ruled by their Supreme Court a year later. In 1913, after they had sorted out their constitutional issues, the US company tax rate was set at a measly 1 percent.
Australia introduced our company tax in 1915. Then Attorney General and future Prime Minister Billy Hughes told parliament that it was “necessary to meet the great and growing liabilities created by the war”. Hughes put the issue bluntly: “I know of no other means whereby we could raise the necessary revenue.”
Today, while the essential purpose of corporate income tax remains the same, the challenges of collecting corporate taxes have grown enormously. Part of that arises because company taxes are simpler in an economy that makes physical products. Agriculture, mining and manufacturing have clear locations of production. But if a company’s output is digital, then it’s easier to artificially shift the location of production to the place with the lowest tax rate.
The estimates of the amount of corporate tax revenue lost annually due to big multinational firms minimising tax through low or no tax jurisdictions range from $500 billion to $600 billion. A race to the bottom between nation states has seen average corporate tax rates fall from 49% in 1985 to 24% in 2019.
Australia relies more heavily on company tax relative to other OECD countries even though Australia’s aggregate tax burden across all levels of government is lower than the OECD average. Since company taxes comprise 19 percent of Australia’s revenue base, to accept the accounting tricks and dodgy behaviour that multinational firms engage in would have a massive impact on Australia.
Among the shenanigans we’ve seen are shell companies created in low or no tax jurisdictions, allowing multinationals to funnel huge profits into secret locations where they have zero employees and no physical office.
We’ve seen one part of a company purporting to owe another part of the same company a huge amount of debt, shifting profits by paying large amounts of interest to itself in another country and deducting these payments from their tax bill.
The accounting details may be complex, but the principle is simple: all companies, large or small, should pay their fair share.
These examples of companies exploiting tax lurks are only possible for companies with cross border operations. This gives them an unfair advantage over local firms and comes at a cost to other participants in the economy. This unfair advantage ultimately weighs on the broader health of the economy, limiting productivity, economic growth and wages.
The Australian Taxation Office has tackled some of these issues, including through its Tax Avoidance Taskforce. But the tax office is only as good as the laws they administer.
It threatens to disturb the economic equilibrium of our society when multinationals refuse to pay their share. That is why the Australian Government will introduce new rules to tackle the issue of multinationals artificially inflating the amount and cost of debt they hold in Australia to claim higher deductions and reduce the amount of tax they pay.
Additionally, we will stop multinationals from claiming tax deductions where they are exploiting payments for royalties and intangibles to funnel profits to low or no tax jurisdictions.
Intangible assets, such as brand names, patents and copyrights are valuable and mobile. Their exploitation can generate both high returns (if you’re the entity that owns them) and high expenditures (if you’re the entity that must pay royalties for their use). These intangibles have been exploited by multinationals in tax minimisation and tax avoidance arrangements.
Multinationals can locate their profit-generating intangibles in jurisdictions with a lower tax rate, and charge fees to the Australian entity for the use of such intangibles in Australia. Current tax laws allow the Australian entity to claim an income tax deduction for the cost of these payments to minimise the tax they pay even further.
We will stop the Australian entity from claiming a tax deduction for the cost of accessing intangibles in arrangements that result in too little tax being paid.
Australia is also working internationally to support the OECD/G20 Two Pillar Solution. The Pillar One allocation of taxing rights to market jurisdictions, and Pillar Two global minimum tax of 15% on corporate profits aim to ensure multinationals pay their fair share of tax in the countries where they operate.
Lastly, we are changing the rules to ensure greater tax transparency for multinationals and large corporates. Public scrutiny of tax information will help provide the community with a better understanding of how much tax multinationals pay. Our measures will provide more transparency among significant global entities, listed companies and firms tendering for large government contracts.
Reforming multinational tax isn’t just about securing much-needed revenue. It’s also about fairness. A small company operating in suburban Australia isn’t conniving to cut their tax bill by using a Cayman Islands subsidiary. Suburban firms shouldn’t have to compete with tax-dodging multinationals. They should be on a level playing field. That’s precisely what we’re aiming to deliver.
Andrew Leigh is the Assistant Minister for Treasury. This is an edited extract of a speech delivered to the OECD Forum on Tax Administration.
Originally published in the Australian on Monday, the 3rd of October 2022.