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International Taxation Panel Presentation

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Presentation from the International Taxation session at the ICTD 7th annual meeting. The panel featured a discussion with Sol Picciotto, Alex Ezenagu, Michael Durst, Catherine Ngina Mutava, Martin Hearson, and Annet Oguttu.

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International Taxation Panel Presentation

  1. 1. International Centre for Tax and Development International Centre for Tax and Development Sol Picciotto ICTD International Taxation Research Emeritus Professor, Lancaster University Senior Fellow, ICTD ICTD Annual Meeting, Kigali, February 2019
  2. 2. International Centre for Tax and Development Questions for ICTD Research  1. How should international tax rules be reformed to benefit developing countries in the long-run?  2. What are the most cost-effective short-term measures for small developing countries to protect their corporate tax base?
  3. 3. International Centre for Tax and Development Main Areas of ICTD International Tax Work  Taxing Multinational Corporations Key part of revenues, especially for developing countries (average 15%) also for tax morale, fairness, competitive equality G20/OECD project on Base Erosion & Profit-Shifting (BEPS) 2013- comprehensive reform attempt central issue: allocation of MNC income – problems of arm’s length shift to unitary taxation of MNCs? (ICTD book) Interim measures to protect tax base (ICTD WPs) e.g. interest deduction limitations implementation of BEPS project recommendations extractive industries: e.g. price-based royalty Inclusive Framework on BEPS now open to all Tax consequences of digitalisation: radical reforms? UN Tax Committee: what role can/should it play?  Tax Treaty Policies Data-set on provisions in developing country treaties 2016 New area of work 2017-
  4. 4. International Centre for Tax and Development Allocation of MNC Income
  5. 5. International Centre for Tax and Development International Centre for Tax and Development Sol Picciotto Problems of Transfer Pricing & Current Reform Attempts Emeritus Professor, Lancaster University ICTD Senior Fellow
  6. 6. International Centre for Tax and Development Allocation of Income of MNCs  Tax Treaty Provisions: model treaties, originating 1928, 1935 Article 9: power to adjust accounts of Associated Enterprises to ensure profits are in line with those of independent enterprises Article 7: PE Profits = what would be expected if it were independent enterprise  The Arm’s Length Standard The treaty specifies comparable profit - “arm’s length” 1935-1975 = comparable profits method, or “fractional apportionment” (Carroll report 1935) 1968 US Transfer Pricing Regulations: new focus on transaction prices Rejected by OECD 1967,but accepted in 1979 OECD Report US experience shows no true comparables (Treasury 1973, GAO 1981, IRS 1984) US introduces Comparable Profits Method 1988 > conflicts in OECD 1988-1993  OECD Transfer Pricing Guidelines (TPGs) 1995 adopt 5 methods, all “transactional”: but only CUP focuses on price Cost+, Resale-, TNMM focus on profit margin – but all “one-sided” Only Profit Split Method (PSM) allocates combined profits UN Practical Manual – follows OECD, with some variations Developing Country Practices: Brazil, China, India, South Africa, Mexico
  7. 7. International Centre for Tax and Development Application of Transfer Pricing Guidelines  Ambiguous Status of OECD TPGs widely adopted 1996- , not only by OECD members, almost universal 2009- Only “soft law” in most countries, but widely applied in practice Deeply embedded in professional-technical practices, but easy to amend Ad hoc methodology & complexity allows flexibility Depoliticises issue of allocation of MNE profits Yet continual rise of conflicts & disputes: MAP & Arbitration -- in secret  Implementation in Africa Statutory power to adjust to “arm’s length” profits – almost all countries Specific Regulations based on OECD TPGs: 17 states - Egypt (2005) , Kenya (2006), Namibia (2006) , Rwanda (2007) , Senegal (2008), South Africa (2009), Malawi (2009) , Uganda (2011), Ghana (2012), Nigeria (2012), Madagascar (2014), Tanzania (2014), Seychelles (2015), Liberia (2016), Zimbabwe (2016), Mozambique (2017), Zambia (2018)
  8. 8. International Centre for Tax and Development Example: Rwanda  General Power to Adjust Accounts Income Tax Act s. 33 (enacted 2005) “Transfer pricing between related persons Related persons involved in controlled transactions must have documents justifying that their prices are applied according to arm’s length principle. Failure to do so, the Tax Administration adjusts transactions prices in accordance with general rules on transfer pricing, issued by an Order of the Minister.”  Detailed Regulations Ministerial Order 004/2007 Arm’s Length Principle – presumption Specific Methods: CUP, Cost+, Resale- Also: “any other method that the fiscal administration deems appropriate”
  9. 9. International Centre for Tax and Development Problems with the TPGs  Major practical problems Individual “facts & circumstances” functional analysis & comparables search Need for expert knowledge: asymmetry between Revenue & Taxpayer Subjective: creates uncertainty & conflict  Basic conceptual flaws Separate entity concept illusory: whole is more than sum of parts, profits from synergy Key functions centralised: Finance, R&D, Risk - major problems for ALP  BEPS project and beyond Aim to align profits & tax with real economic activity but Actions 8-10 focus on “misuse” excluded study of alternative approaches Revised TPGs 2017: start from contracts, but analyse “real deal” e.g. for intangibles DEMPE functions Result: TPGs 450 >> 600 pages, “far more complex” (Andrus & Collier 2017) Achievement: country-by-country reporting (CbCR) + Master File + Local File Continuing work 2016-18: Attribution of profits to PEs: 2018 – only for post-2010 OECD model treaties Profit Split Method – still “transactional”, some new examples  Need for Simplified Methods
  10. 10. International Centre for Tax and Development The TPGs and Simplified Methods  Compatibility of Simplification with the TPGs TPGs say aim is “reasonable estimate”, “not an exact science” but requires judgment, so individual audit, not automatic application Safe Harbours? TPGs chapter 4  Brazil: Fixed Margin System 1998 based on OECD Cost-Plus & Resale Minus methods but fixed margins (3 bands for imports used in manufacture), +/- 5% taxpayer can only choose among available methods, not e.g. TNMM right to appeal to Minister – never used Compatible with art. 9 but not TPGs Brazil candidate to join OECD, joint review 2018-9 easy to administer, few disputes, predictability for investors but one-size-fits all, fixed margin regardless of actual profitability corporate tax revenues quite high, tax/GDP ratio = average of OECD
  11. 11. International Centre for Tax and Development Tax consequences of digitalisation of the economy  BEPS Project Action 1: 2015 report not separate sector, whole economy - needs comprehensive solutions Task Force on Digital Economy work extended to 2020 possible interim measures (not recommended)  Unilateral Actions India: “equalisation levy” 2015 - advertising (Google/Facebook tax) Withholding Tax on payments to nonresident for advertising UK: Diverted Profits Tax 2014; proposed Digital Services Tax (users) 2020 EU: proposed Digital Activities Tax 2018 adverts + data sales + intermediation (e.g. Uber) not digital services (Spotify, Netflix) US: TCJA 2017: shift from (weak) worldwide to territorial-plus system CIT rate 36% >> 21% GILTI: minimum tax on foreign profits @ 10.5% on tangible assets BEAT: minimum tax on US profits @ approx. 10%
  12. 12. International Centre for Tax and Development Moves towards a Long-Term Solution  TFDE Reports to Inclusive Framework on BEPS Interim report 2018, Policy Note January 2019 proposals by US, UK, France-Germany, G24 (esp. Ghana,India, Colombia) Consultation March, Work Programme May 2019, Final Report 2020  Wider Permanent Establishment (PE) definition (taxable presence) Significant Economic Presence  Global Minimum Tax Franco-German proposal (income inclusion rule + tax on base-eroding payments)  Rules for Allocation of Profits New criteria for value creation (for “non-routine” returns): UK: user contributions US: marketing intangibles Wider Approach – shift to formulary apportionment G24: balance of production factors (workers, assets) & sales – simple rules fractional apportionment still allowed in tax treaties under UN model article 7(4) EU Commission 2018: within EU – CCCTB formula (assets-employees-sales) towards non-EU: mandatory use of profit split method (similar apportionment)
  13. 13. International Centre for Tax and Development International Centre for Tax and Development Alexander Ezenagu Safe Harbours PhD Candidate, McGill University ICTD Researcher
  14. 14. International Centre for Tax and Development Definition, Purpose and Concerns  Definition:  Administrative simplification regime for a category of taxpayers or transactions;  Election between accuracy and simplicity.  Purpose:  Administrative simplicity and efficiency; reduction of compliance cost and burden; reduction of risk of dispute and potential litigation risks; and promotion of FDI.  Securing corporate income tax revenues- guarantee of a minimum of tax revenues.  Tax certainty.  Promotes equitable treatment of taxpayers in an industry or engaged in similar transactions, unlike APAs.
  15. 15. International Centre for Tax and Development Contd.  Concerns:  1995 TPGs  Pre-determined prices or TP methodology may not comply with the arm’s length principle.  unilateral safe harbor may create room for double non-taxation.  Tax optimization opportunities for MNEs.  OECD, Multi-Country Analysis of Existing Transfer Pricing Simplification Measures, 2012. Influence on the OECD’s take on Safe Harbours.  OECD- SHs can help to relieve some of the burdens associated with administering and complying with the TP rules, while providing taxpayers with greater certainty.
  16. 16. International Centre for Tax and Development Types of Safe Harbours  Types:  Exemption from Transfer Pricing Rules: Mexico (small individual taxpayers); UK (SMES, subject to some exceptions).  Exemption from Transfer Pricing Documentation: in some jurisdictions, applied as a de minimis rule.  Prescription of pre-established transfer method and margin rates.  Exemption for SMEs: determining threshold; SMEs in Africa largely do not come under the TP rules as they do not engage in cross-border activities with related entities.  Exemption for Small Transactions: issue of threshold.
  17. 17. International Centre for Tax and Development Substantive Safe Harbours  Sectoral APAs:  What is an APA?  Difference between a sectoral APA and sectoral Safe Harbour Regime?  Sectoral Safe Harbours  Determining the sectors: EU Report (applied to large sectors of the economy).  Determining the transfer pricing method to be applied.  Examples of Sectoral Safe Harbours  Mexico: Maquiladora industry.  Dominican Republic: Hospitality industry.
  18. 18. International Centre for Tax and Development Design of Safe Harbours  Safe Harbour Transfer Pricing Methodology  A one-sided method is recommended.  Safe Harbour Price Range and Interest Rate  Approximates to the arm’s length price, else it becomes an incentive.  Participation in the Safe Harbour Regime: Opt-in or Opt-out  Safe harbour regime must be voluntary.  Acceptable alternative(s) where a taxpayer refused to opt in or opts out.  Unilateral, Bilateral or Multilateral Safe Harbours  Fear of double taxation vis-à-vis exigency and expediency.  Fear of capture by the bigger party.  Surmounting the hurdles of a multilateral agreement.
  19. 19. International Centre for Tax and Development International Centre for Tax and Development Michael C. Durst Alternative Corporate Minimum Taxes ICTD Senior Fellow
  20. 20. International Centre for Tax and Development Minimum Taxes on MNCs  US Tax Reform 2017 GILTI – minimum tax on foreign (non-US) profits BEAT – minimum tax on US profits (prevent base erosion)  Proposals to Inclusive Framework for BEPS Germany: minimum taxes on both domestic & foreign profits  Protecting Tax Base of Developing Countries Alternative Minimum Taxes – on inward investment E.g. Pakistan, Ecuador
  21. 21. International Centre for Tax and Development Minimum Tax on Inward Investment Based on Turnover  Alternative minimum tax is computed as some small percentage (for example, 1 percent) of taxpayer’s total revenue (turnover). If the alternative tax is higher than the taxpayer’s regular tax liability, minimum tax is paid.  A means of limiting base erosion and profit shifting (BEPS).  Currently, AMTs based in whole or in part on turnover are in effect in about 18 countries, especially in francophone Africa. Rates and other details of the tax, however, vary widely from country to country (with, for example, the tax subject to low maximum amounts in some countries).  Question for today: Is the turnover based AMT a promising model for further consideration?
  22. 22. International Centre for Tax and Development Example of Turnover-Based AMT at 1%  Assume local subsidiary with $100 million turnover, reporting net operating margin of 3%, yielding net operating income of $3 million. Assume also that subsidiary deducts interest at 30% of net operating income, so taxable income = $2.1 million. Assuming corporate income tax rate of 35%, “regular” tax is $735,000.  Alternative minimum tax at 1% of turnover = $1,000,000  Additional research surely should be conducted, using data from tax returns, but it seems plausible that even a 1% alternative minimum tax on based on turnover could generate better revenue results than the current BEPS-vulnerable system.
  23. 23. International Centre for Tax and Development Economic Argument Against Turnover-Based Taxes  Taxes on gross revenue subject investors to risk taxation even in absence of economic profit; therefore, they can be seen as economically inefficient.  But does the arguable economic inefficiency of, say a 1% tax on turnover outweigh the advantages of efficient and effective revenue collection? See Best, Brockmeyer, Kleven & Spinnewijn, “Production versus Revenue Efficiency with Limited Tax Capacity: Theory and Evidence from Pakistan,” 123 Journal of Political Economy 1311 (2015).
  24. 24. International Centre for Tax and Development Potential Advantages of Turnover-Based AMT  Since no deductions are allowed, a gross-based AMT is immune to avoidance through the overstatement of deductions. This includes immunity to avoidance through interest deductions, as well as deductions for management fees and the cost of goods sold.  (The turnover-based AMT would remain vulnerable to underpricing of outbound sales of goods and services, including natural resource and agricultural products -- but the quantitative effects of the underpricing should be small compared to the effects under net-income taxation.)  A turnover-based AMT should be relatively easy to administer.  Might a turnover-based AMT result in revenue collections at levels that are politically realistic given the pressures of tax competition for inbound investment?
  25. 25. International Centre for Tax and Development Suggestion  Additional research should be conducted to assess performance of turnover-based AMT in countries that have adopted it.  Given its potential utility, the possibility of more extensive use of turnover-based AMT should figure more prominently in global discussions of BEPS.
  26. 26. International Centre for Tax and Development Tax Treaties
  27. 27. International Centre for Tax and Development International Centre for Tax and Development Catherine Ngina Mutava Tax Treaty Practices & Policy in Africa Associate Director, Strathmore Tax Research Centre ICTD Researcher
  28. 28. International Centre for Tax and Development
  29. 29. International Centre for Tax and Development Current situation  Imbalance between capital exporting and capital importing countries makes negotiations lopsided.  Increasing resident centric treaties Increasing resident centric treaties – ICTD/Actionaid database  Secret and rushed conclusion of treaties – elite capture  Lack of expertise  Need for treaty policy
  30. 30. International Centre for Tax and Development Objectives of a tax treaty policy  Transparency  Protecting the tax base  Provide a framework for negotiation of tax treaties
  31. 31. International Centre for Tax and Development What should inform the treaty policy?  Economic status - country’s level of investment and trade flows  Country’s tax policy  Main corporate players  Implications on domestic tax  Other existing policies  Cost of implementation
  32. 32. International Centre for Tax and Development Content of a treaty policy  Choice of treaty partner  Choice of negotiators  Expected outcomes  Choice of Model
  33. 33. International Centre for Tax and Development Negotiations - pre-negotiation stage – determine who will be involved, carry out a study, prepare a model; - Negotiation stage – determine strategy – a. Interest vs position strategy b. Disclosure or non-disclosure c. Post negotiations
  34. 34. International Centre for Tax and Development Protecting the tax base - UN and OECD Model are the most common - OECD assumes a balance - UN though more favourable to source countries is a compromised position - Retain source taxation - Seal off loopholes
  35. 35. International Centre for Tax and Development Protection recommendations - Limit PE activity exemptions to where the activities are genuinely preparatory or auxiliary in nature. - if that enterprise or a closely related enterprise carries on a business in that place, or in any other place in that state that qualifies as a PE; or if the combination of activities between that enterprise and the related enterprise are not auxiliary or preparatory where the combined activities are complementary functions of a cohesive business operation.
  36. 36. International Centre for Tax and Development PE provisions – UN Model  Construction PE – The UN Model extends the scope of building and construction PE to include supervisory services relating to the building, construction or assembly project that continues to exist for more than 6 months;  Service PE – The UN Model widens the definition of a PE to include a PE created by performance of services by an employee or any other personnel may create a PE if the services continue for more than 183 days in any 12-month period;  Agency PE - Under the UN Model, the maintenance of stock and habitual delivery of the stock by an independent agent who does not habitually conclude contracts will create a PE; and  Specifically providing creation of a PE by a foreign insurance business unless the premiums are collected by an independent agent in ordinary course of business.  Force of attraction rule  Technical services PE
  37. 37. International Centre for Tax and Development Taxing capital gains  Seek to preserve taxation of gains from alienation of shares.  UN allows for taxation of alienation of shares from immovable properties as well as those not related to immovable properties
  38. 38. International Centre for Tax and Development International Centre for Tax and Development Annet Wanyana Oguttu Implications of the BEPS-MLI for African countries’ tax treaties Professor, Department of Taxation and African Tax Institute, University of Pretoria
  39. 39. International Centre for Tax and Development Background  2015 OECD BEPS Measures – to ensure profits are taxed where economic activities generating those profits are performed and where value is created  Measures impact on: international tax principles; domestic law & DTAs  Focus - DTA BEPS measures:  Action 2 - hybrid mismatches  Action 6 - prevent treaty abuse  Action 7 - prevent artificial avoidance of PE status  Action 14 - resolving treaty disputes - MAP  Challenges of adopting DTA measures  renegotiation of thousands of DTAs  burdensome, time consuming & expensive
  40. 40. International Centre for Tax and Development The BEPS-MLI  Action 15: MLI to implement DTA BEPS measures  Swift, coordinated & consistent implementation across existing DTA network  Simultaneous renegotiation of DTAs  Development of MLI  Ad Hoc included 23 African countries & 2 observer African organisations  24/11/2016 – MLI & Explanatory Statement text concluded  31/12/2016 – MLI opened for signature for all countries  As at 23/01/2019, 11 African countries have signed; 2 have expressed interest  Status of MLI  Self-standing convention - operates alongside existing DTAs - not a Protocol
  41. 41. International Centre for Tax and Development Impact of MLI for African countries’ tax treaties  Impact if signed  Impacts current DTA network - applies to only covered tax agreements (CTA)  Applicable provision of MLI override provision of CTA  Modifies DTAs depending on options and reservations made  Main impact is on older CTAs  Advantages of signing the MLI for African countries  DTAs restrict source taxation – MLI will strengthen source taxation  DTA BEPS concerns - priority for African countries  Developing countries prefer UN MTC - MLI can modify any DTA  Will reduce costs & time involved in re-negotiating DTAs  Improvements in existing tax treaty rules  MLI provisions – pertinent matters developing countries should consider to opt in or out of – see published paper
  42. 42. International Centre for Tax and Development MLI Challenges for African countries’ tax treaties  Administrative challenges  Lack of experience in the use of multilateral conventions  Administrative capacity to engage with and benefit from MLI  Complex reservation and option mechanism  Distinguishing between modified and unmodified provisions  Impact of MLI flexibility to its effectiveness  Non-uniform adoption - jeopardizes BEPS project  Country can opt out of some BEPS minimum standards  Uncertainties  Treaty negotiations consider interconnected articles – some not covered by MLI  Treaty negotiation, a give and take process - concessions not considered  Parliamentary approval before ratification  Explanation of BEPS measures/ MLI  Impact on bilateral trade & investment flows  Language:  MLI - so far in English and French  Many treaties concluded various languages  Global acceptance of MLI  Evolves from BEPS project - interests of developing countries?  USA, part of Ad hoc group – didn’t sign up  UK/Germany; UK/Switzerland – chose to sign protocols  Is the OECD becoming a world tax organization?  Need for representative body under UN auspices rejected  Developing countries view MLI suspiciously
  43. 43. International Centre for Tax and Development Recommendations and concluding remarks  Great care & caution before signing the MLI  Inconsistent implementation - double taxation, impact on cross-border trade  Administrative & political uncertainties: adopt wait & see approach  Consider what other countries are opting in or out of  Understand own treaty policy - make informed decisions  For countries with fewer DTAs – consider protocol  For details refer to:  Annet Wanyana Oguttu “OECD Multilateral Instrument on Treaty-related BEPS Measures: Benefits, Challenges and Recommended Options for South Africa and Other Developing Countries” South African Yearbook of International Law (2017) vol 22 pgs 220-265.
  44. 44. International Centre for Tax and Development International Centre for Tax and Development Thank You!