Finance & economics | Reclaiming the booty

Countries are seeking help to deal with corporate tax avoidance

Avoidance hits poorer countries particularly hard

|KINGSTON, JAMAICA

PORT ROYAL, at the mouth of Kingston harbour, was once the largest city in the Caribbean, its population swollen by privateers paid by the English and the Dutch to attack Spanish ships. When the practice of issuing such “letters of marque” faded in the 17th century, crews went rogue. As pirates, they continued to use the Jamaican port as their base and to spend their loot there, earning it a reputation for unparalleled debauchery.

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Jamaica still has a piracy problem, but today’s buccaneers are in surrounding territories. Unenamoured by Jamaica’s 25% corporate income-tax rate, some international firms with operations there find ways to shelter profits using the British Virgin Islands and other nearby tax havens.

The scale of this plunder is unclear—Jamaica publishes no estimate of its corporate-tax gap. But the problem is serious enough to lead the government to seek outside help. Since 2017, auditors from Tax Administration Jamaica (TAJ), the national tax authority, have received training to help them identify and challenge the tax planning of large firms. The assistance is offered by Tax Inspectors Without Borders (TIWB), a programme backed by the OECD and the UN.

Jamaica is not alone in suffering leakage. Estimates of uncollected revenues vary. The OECD reckons that exchequers worldwide lose $100bn-240bn a year to corporate tax avoidance. An IMF study in 2016 suggested that the total could be over $600bn—equivalent to a quarter of all corporate tax collected globally. Avoidance has grown in line with intangible assets, such as intellectual property, which are easier to shift to tax havens than physical assets. An analysis of American multinationals and their international subsidiaries in 2017 found that the share of profits declared elsewhere for tax purposes had risen from 5-10% in the 1990s to 25%. Poor countries are hit hardest because they rely more on corporate tax revenues than rich countries, and because international tax rules, originally crafted to suit advanced economies, are stacked against them.

In Jamaica international investors are particularly active in tourism, mining and food and drink. As the economy has recovered from a debt crisis, so have profits. Transactions that move income offshore—for instance via a travel group’s online-booking portal, charging a local affiliate for its services—can be perfectly legal. But international rules, overseen by the OECD, state that such “transfer pricing” should be at an arm’s-length, market rate. There is room for subjectivity—and gaming.

In the past the TAJ was outgunned, its auditors struggling to master the complexities of cross-border transfer pricing. Change came in 2015. A new law required large taxpayers to provide more information on transactions, placed more onus on companies to show pricing was justified, and introduced bigger fines and even prison terms for transfer-pricing breaches. In 2017 TIWB parachuted in Steffen Scholze, a veteran auditor from Germany’s federal tax office, for a two-week mission, to teach his 70 counterparts at the TAJ the tricks of the trade. He has since returned six times.

Irate of the Caribbean

Companies claim that the new law and TIWB’s intervention have raised compliance costs. At a recent event in Kingston, a local tax partner from EY, an advisory firm, went further, hinting at an image problem for TIWB: the average Jamaican might see it as another case of “white foreigners telling us what to do”. But Mr Scholze says audits “provide certainty, which companies need”. The extra data requirements don’t involve much extra work: “they already have more than 90% of what we’re after.”

The TAJ appears happy with the help it has received. As one auditor explains, TIWB has helped it “cut through the fluff” when companies provide documents, and to get better at negotiating with firms and their well-paid advisers when disagreements arise over the pricing of transactions.

“Recently a team came back from meeting one company so excited,” relates another TAJ auditor. For the first time ever when dealing with a large taxpayer, “our people did the talking and the other side sat dumb”, struggling to answer the questions. The hope, she says, is that when one firm receives a bill, others in the same industry take note and perhaps even ask for an audit to clarify their tax position—as happened in Liberia when the tax authority began targeting mining companies with TIWB help.

Such audits move slowly, typically taking two years including appeals. The first of those done by the TAJ under TIWB’s wing is nearing an end. (The resulting bill can be paid electronically, but the company still has to collect a paper receipt from a kiosk at the TAJ.) The sums involved are not huge: one of the bigger cases is set to bring in “potentially” J$350m ($2.6m), says an official. But TIWB is lean. For every dollar spent, over $100 of extra revenue is collected, says James Karanja, who heads its secretariat.

Having answered 52 calls for help in Africa, Asia, Latin America, the Caribbean and eastern Europe since 2015, the programme is set to reach 100 by 2020. A recent addition is Papua New Guinea, which wants help unravelling logging groups’ tax affairs. It is also helping Indonesia decipher the reams of data received under global tax-information-exchange initiatives.

TIWB will need to evolve as it grows, not least because international corporate-tax rules are in flux. These are no longer up to the job. Multinationals can too easily exploit mismatches between national laws to divert taxable profits or even make them vanish. But rewriting the rules is proving tricky. A first stab, led by the OECD in 2015, dealt with some of the most aggressive types of avoidance but failed to secure global agreement on taxing the digital economy. It also ducked a big structural question: why continue to base the rules on the arm’s-length principle, when multinationals exist precisely so that market prices need not apply in intragroup transactions?

The digital impasse has forced a rethink. After consulting the 127 countries in its “Inclusive Framework”, the OECD last month floated the idea of “reconsidering” transfer-pricing rules and “go[ing] beyond” the arm’s-length concept. This marks a shift, says Alex Cobham of Tax Justice Network, an NGO. America long defended the transfer-pricing status quo. But since its big domestic tax reform under President Donald Trump, it has shifted its position on the international rules. The final destination is unclear, but the direction is towards better alignment of where tax is levied with where economic activity takes place. That could mean greater taxing rights for “source” and “market” countries (ie, where firms produce things and the home of their customers and digital users); fewer taxing rights for countries where parent firms are domiciled, often rich ones; and less scope for profits to be booked in tax havens with flimsy justification, says Pascal Saint-Amans, the OECD’s tax chief.

He is hoping for a global solution by the end of 2020. Mr Cobham believes “we’re closer now than ever before to the kind of open, global discussion of tax rules that could finally redress some of the glaring inequalities in the distribution of taxing rights that lower-income countries face.” But better-off OECD countries are unlikely to cede their outsize rule-setting power and taxing rights without a fight. The situation is “unstable”, admits Mr Saint-Amans.

Radical reform is far enough away as to be of no immediate concern to the team tutored by Mr Scholze. The TAJ auditors are bracing for more transfer-pricing tussles. There is talk of bringing in another international expert to beef up expertise in banking and telecoms, two industries with which the German number-cruncher is less familiar. But, as auditors’ confidence grows, so do worries about talent being lured away. Multinationals and tax-advisory firms have reportedly been circling the team. Anyone for privateering?

This article appeared in the Finance & economics section of the print edition under the headline "Reclaiming the booty"

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