Focus on private sector: An end to tech tax dodging

Blog Tax and State

Although the problem of tax avoidance by multinationals is faced by both developed and developing country governments alike, the burden falls heaviest on developing countries. Closing loopholes that enable corporations to manipulate transfer pricing will require significant inter-governmental cooperation. However, revenues from improved enforcement could be reinvested in local economies to generate tangible benefits to foreign investment and trade.

Google and the UK government recently announced an agreement for the technology giant to pay back £130 million (US$181 million) in taxes owed over the past ten years. Activists say the deal is too lenient, and an inquiry by a UK parliamentary committee reported this week that the government could have done more. [1] But it is nevertheless a step forward that governments are beginning to act on tax avoidance.

As damaging as tax avoidance can be to wealthy governments such as the United Kingdom’s, it is devastating for developing countries, which lose as much as US$100 billion a year in revenues due to the failure to collect taxes from foreign corporations, according to the UN. [2, 3]

Developing country tax revenue makes up only ten to 15 per cent of GDP (gross domestic product), compared with 35 per cent in the developed world, yet developing countries depend more on taxes for their budgets than rich countries do.

“Tax avoidance is devastating for developing countries, which lose as much as US$100 billion a year in revenues due to the failure to collect taxes from foreign corporations”

Maha Rafi Atal

This limits the ability of developing country governments to deliver essential public services such as health or education, which are not only humanitarian necessities, but critical ingredients for driving economic growth.

Corporate tax avoidance often takes the form of transfer mispricing. If, for example, a US company sells mobile phones in Europe that are assembled in China using chips made from metals collected in Zambia, the company will have subsidiaries in each country and each subsidiary will be taxed locally. For accounting purposes, the subsidiaries are independent companies trading with each other. The Zambian subsidiary spends money to mine the minerals, and puts down in its accounts that it has ‘sold’ these to the Chinese subsidiary, which writes in its accounts that it has ‘sold’ the finished phones to the sales subsidiary in Europe, which puts down in its accounts the price for which it sold the phones to consumers, and either takes this as profit, or ‘sells’ its revenue up the chain to the parent company.

Because no cash actually moves between a multinational’s divisions in such internal transactions, companies have leeway in what ‘prices’ they put down for the internal trades. By manipulating these prices, companies can choose which subsidiaries look to local tax authorities as though they have turned a profit.

In effect, the single profit that comes from phone sales is distributed across the subsidiaries. By declaring most of that profit in nations where taxes are lowest and declaring losses in countries where taxes are high, multinational corporations reduce their tax burden. These manipulations deprive high tax-rate countries of both tax revenue and earnings that can be reinvested in businesses locally rather than further up the chain, at the parent company level.

Business - Pakistan (12)

Tax avoidance by multinationals means that, while developing country governments adopt neoliberal policies — like privatisation of state-owned businesses — to court foreign investment, their citizens don’t see the benefit of the investment when it arrives. Tax avoidance thus helps stoke public opposition to foreign investment and international trade, and spark protests pushing governments towards protectionist policies that further restrict growth.

What can be done? First, developing and developed countries must work together. In 2014, the OECD (Organisation for Economic Co-operation and Development) recommended an international tax enforcement system. The OECD proposal particularly considers the challenges posed by digital companies, whose value chains include many intangible components that are hard to assign to a particular geographic subsidiary. [4]

Second, developed countries can negotiate for trade and investment deals with developing nations to incorporate stronger, coordinated tax enforcement.

Third, technology — the very systems companies use to track internal supply chain logistics — can help governments track where profits are generated and therefore where tax ought to be paid. [5] Organizations like SourceMap can help governments by tracing the flow of component parts and raw materials in the supply chain, and the real world prices of these goods.



[1] Corporate tax settlements (UK Public Accounts Committee, 23 February 2016)
[2] World investment report 2015: Reforming international investment governance (UN Conference on Trade and Development, 2015)
[3] Ernesto Crivelli and others Base erosion, profit shifting and developing countries (International Monetary Fund, May 2015)
[4] Addressing the tax challenges of the digital economy (OECD, 16 September 2014)
[5] Vikas Kumar and Jakob Svensson (editors) Promoting social change and democracy through information technology (IGI Global, 30 July 2015)


This article was originally published on SciDev.Net. Read the original article.