Canada is one of over 100 other countries that are in intense discussions and negotiations in Paris about how to fundamentally reform the international corporate tax system. While other major nations have taken a prominent role in the talks, the Canadian government has been almost silent, even though there’s a unique contribution Canada could make.
It has become increasing clear that our international corporate tax system no longer works effectively or fairly. Under existing rules, large multinational corporations can relatively easily avoid paying corporate taxes by shifting profits through low-tax jurisdictions using a variety of techniques. There are frequent headlines about Apple, Google, Amazon and others paying very low rates of tax, but the problem isn’t limited to these mega-corporations in the digital economy. For instance, last fall Saskatoon-based uranium producer Cameco Inc. won its latest round at the Tax Court of Canada against the Canada Revenue Agency (CRA) over $2 billion in taxes it avoided by shifting profits to a subsidiary in Switzerland, where it had one employee.
Christine Lagarde, head of the IMF — not an organization given to radical hyperbole — recently wrote that “the current international corporate tax architecture is fundamentally out of date.” The ease with which multinational corporations avoid taxes has undermined faith in the overall tax system, she said, adding that “we clearly need a fundamental rethink of international taxation.”
The IMF estimates that revenue losses for governments from profit-shifting by multinational corporations averaged about 1 percent of GDP for OECD countries in 2013, with more – nearly 1.4 percent of GDP – for non-OECD countries, amounting to over US$600 billion worldwide. Today it would be close to $1 trillion Canadian annually. Even at the lower end of estimates, this translates to revenue losses of at least $8 billion annually for federal and provincial governments in Canada. With that amount of money at play, it’s understandable why finance ministers around the world are now considering taking serious action.
The revenue losses are even more damaging, and often a matter of life and death for people in developing countries. These populations depend on corporate taxes for public revenues more than do wealthier countries, and they have a pressing need for publicly funded basic infrastructure, health, education and other public services. It’s estimated that African countries lose more in tax revenues to profit-shifting and tax havens than they receive in international development assistance.
Massive loss of revenues isn’t the only problem. There is also the issue of tax fairness, and of promoting competition and economic growth. It is easy for large global corporations to gain an unfair tax advantage over smaller and medium-sized businesses. This has increased corporate concentration across many industries, and reduced competition and dynamism in economies.
At the direction of the G20 leaders, around five years ago the OECD initiated the Base Erosion and Profit Shifting (BEPS) action plan. There were positive aspects of the plan, such as the exchange of tax information and country-by-country reporting by multinationals, but it hasn’t fundamentally reformed the international tax system. Large multinationals can still avoid paying their fair share of taxes, and this continues to fuel popular frustration. In Canada, a survey found that a large majority of Canadians — 80 percent — and an even larger majority of professionals from the CRA — 90 percent — believe that it is easier for corporations and wealthy individuals to avoid their tax responsibilities.
A number of major nations have introduced tax measures to make large multinationals in various sectors pay more taxes, including the UK’s Digital Services Tax, Australia’s Diverted Profits Tax, France’s GAFA tax, Spain’s “Google Tax,” and the measures with the best acronyms, introduced in the US last year, the Global Intangible Low Taxed Income (GILTI) and Base Erosion Anti-Abuse Tax (BEAT). Individually these are positive measures, but the international corporate tax environment has now become a complex, balkanized, less coherent patchwork.
This is why discussions about fundamental reforms have gone into overdrive in the past few months through the OECD’s Inclusive Framework, involving 129 nations. G20 finance ministers considered various proposals at their meeting in early June, and they directed officials to redouble efforts to reach a consensus solution by next year. There were proposals for minimum international corporate tax rates and for increasing the taxing powers of countries where the ultimate customers of multinational corporations reside. While they do patch holes, some of these proposals would further complicate things, without fixing the system.
One proposal from the G24 group of countries – summarized in this OECD document – would vastly simplify the international tax structure. It would allocate taxable income of multinational enterprises between countries using a formula that reflects real economic activities in each country, as measured by sales, employment, capital assets, and other factors.
This would be radically different from the transfer pricing system that’s been at the heart of the international corporate tax system since it was established a century ago, but it wouldn’t be a completely novel or revolutionary approach.
In fact, the system is very similar to the one Canada has operated successfully for over 50 years to allocate the taxable income of corporations between provinces for tax purposes, using just payroll and gross revenues. It’s been so uncontroversial that few people are aware of it, and some provinces, for example, Quebec and Alberta, which collect their own corporate income tax, use the same formula. US states have also used a formula apportionment system, but with more variables and variation, for many decades, and the European Union is moving toward a similar system with its Common Consolidated Corporate Tax Base.
This OECD proposal has the support of independent experts and would be combined with a system of unitary taxation, so multinational enterprises can’t use subsidiaries and affiliated companies to avoid taxes. Also on the table is a system for minimum international corporate tax rates to prevent a race to the bottom.
India is also now seriously considering using this approach to force multinationals selling there to pay corporate tax, whether or not they have a permanent establishment, effectively doing an end-run around existing rules. Other countries might join India if discussions through the OECD don’t make enough progress, putting pressure on these negotiations.
Canada’s Finance Minister Bill Morneau and his officials could play a constructive role in this process by supporting the proposal (and considering similar unilateral measures) in the negotiations, highlighting the positive experiences we’ve had with the system.
There are numerous details to be hashed out and negotiated, like the formulas to use, the establishment of a common tax base, separate rules for specific industries. But it would be much fairer and simpler system, and national revenue agencies could administer and enforce it more effectively than is the case with the current system.
This is an historic opportunity for the world to finally achieve substantial progressive reform of the international tax system, to ensure that multinational enterprises are taxed fairly and that all countries receive their fair share of the revenues. At stake are not only billions of dollars annually for Canada and hundreds of billions worldwide, but also the fundamental faith of the public in the fairness of our overall tax system.