After years of watching with helplessness how large companies and estates reduced their tax bill by exploiting inconsistencies between tax codes and sheltering in low tax jurisdictions, in recent weeks there have been giant steps towards tackling the problem with a large tax agreement. reform of international taxation. The agreement, signed on July 1 by 130 countries of the inclusive framework of the OECD and ratified by the G-20 last week, seeks to update the notion of tax nexus and establish an effective minimum in corporate tax to achieve a more taxation. fair in a deeply globalized, financialized and digitized world. If until now, taxation has been a national competence in principle and each jurisdiction decided its tax code, the interdependencies generated by economic integration have led to unsustainable downward tax competition to face inequality and the challenges of the Welfare State.
A multinational combines production processes from different jurisdictions to potentially sell all over the world and revert the profits to its shareholders. In this process, at least three taxable events occur: production, consumption, and profit distribution. When economic flows cross borders or assets are owned abroad, states have established an amalgam of bilateral and multilateral agreements in order to avoid double taxation (that the same flow is taxed twice in two different jurisdictions for the same concept) . Until now, the principles of international taxation granted tax rights to two jurisdictions: at the source, where production (and not sale) takes place, active income, that is, profits, is taxed. The physical presence of productive factors such as capital and labor are indicative that a company has a permanent establishment in a certain jurisdiction, and therefore is subject to tax there. In the jurisdiction of residence of the owners, passive income is taxed, that is, that derived from the ownership of assets, such as dividends, interest, royalties or capital gains.
The principles of international taxation also establish that the different subsidiaries and affiliates of a multinational must maintain separate accounts, valuing intra-group trade in goods and services under the commercial conditions that would have prevailed if they had not been related. This principle of free concurrence, or arm’s length principle, It is difficult to apply in practice and facilitates the manipulation of transfer prices, allowing multinationals to transfer profits by exporting at exorbitant prices to subsidiaries in jurisdictions with high taxation, eroding their tax bases. On the one hand, in many cases there are no comparable commercial conditions to objectively judge whether the value is well set. On the other hand, the principle of free competition makes little economic sense, as it is contradictory to the nature of multinationals, which should be more profitable than the sum of their parts, precisely because vertical integration is produced seeking efficiency gains and horizontal integration scale economics. The different subsidiaries of a multinational internalize the impact they have on the rest, pool risks and exploit their complementarity.
Furthermore, these principles of international taxation were established a century ago in the context of a less globalized and more analog economy. The deep economic integration of the last decades has geographically separated the production, distribution and consumption processes, involving multiple jurisdictions, facilitating regulatory arbitration that allows the exploitation of inconsistencies in tax codes through double taxation treaties to end up achieving double taxation. not imposition. Globalization increases the mobility of capital and the proliferation of financial instruments and corporate cross-border asset management frameworks make it difficult to apply due diligence and the verification of the ultimate beneficiaries of economic transactions, generating de facto stateless and ownerless income. More than 20% of foreign direct investment is not owned by an identifiable natural person. In countries such as Luxembourg, Cyprus, Malta, Holland or Ireland the stocks of direct foreign investment represent several multiples of its GDP, which do not correspond to real economic activity but to flows in transit in search of fiscal savings (the case of Luxembourg is paradigmatic, in 2017 its stock direct foreign investment was 6,749 times its GDP).
At the same time, the digitization of production processes has facilitated the remote provision of services, so that companies with a high commercial presence in certain jurisdictions can avoid being considered a permanent establishment. For digital platforms, whose users and their data and content are a main source of value, it is difficult to argue that part of the production does not take place in market jurisdictions. The increased importance of intangible assets allows companies to strategically place them in jurisdictions with low tax pressure, in addition to being such a specific capital that it makes it very difficult to apply the principle of competition, giving rise to transfer pricing abuses. The intensive use of data and algorithms in production generates strong economies of scale and scope and network externalities, and has led to the emergence of companies with great market power, precisely those incomes that we would like to value more.
It is not surprising, then, that the principles of international taxation have been a drain for abuses of the law that allow large multinational corporations to reduce their tax bill through a multiplicity of techniques, such as the abuse of transfer prices, localization intangible capital strategy, intra-group indebtedness, regulatory arbitrage or the avoidance of permanent residence status. Differentials in the tax rate, in the definition of the tax base and in the status of residence between countries generate strong incentives to try to transfer the benefits where they are less taxed. The states know this and act accordingly, lowering their tax rates to attract them, eroding the tax bases of their neighbors, who react in the same way. In recent years there has been downward tax competition that has lowered corporate tax around the world. As the graph shows, in Europe, the unweighted average of the statutory type of companies has fallen from 35% in 1995 to 21% in 2021.
In a globalized world, regulatory systems are interdependent and that calls into question the idea of absolute fiscal sovereignty, especially when the lack of coordination leads to a balance that is harmful to all. Downward tax competition has consequences on how pre-tax income is distributed and the possibility of achieving a fairer distribution due to the action of our tax system. In the first place, the most mobile tax bases manage to reduce their tax burden, making the system more regressive, because the greatest weight of the collection tends to fall on consumption more than income, on the labor factor more than the capital factor, and on geographically located SMEs, more than multinationals. This distorts fair and neutral competition between companies (more than once European Competition Commissioner Margrethe Vestager has tried to pursue tax concessions to large companies on these terms, with relative success). In the country-by-country report published by the Tax Agency with data from 112 multinational companies with a Spanish parent company that invoice more than 750 billion euros globally, 22 of them, which represent 18.5% of the turnover and almost 26.6 % of profit, they barely contribute 2.1% of tax revenue.
The agreement reached in recent weeks is an attempt to break with these dynamics through two pillars. The first redefines the tax nexus by attributing tax rights to market jurisdictions. While this recognizes the new nature of digital production processes, it is also true that global production, consumption, and ownership are not evenly distributed across jurisdictions. While production is mostly located in developing countries, consumption is predominantly located in rich countries, and ownership is much more concentrated. The second pillar demolishes the myth of double taxation by proposing an effective global minimum in corporate tax through withholdings at source and correcting the tax differential in residence. Although it is a first step, an effective minimum of 15% is low to be restrictive in many cases, and if certain countries, such as Ireland, refuse to cooperate, there will still be loopholes of tax avoidance for companies. The definitive solution is to harmonize corporate taxation and bet on the unitary taxation of multinationals, distributing their benefits based on rules that ensure an equitable distribution of tax rights between different jurisdictions.