Panama Papers demonstrate the need for truly global tax cooperation

The publishing of the Panama Papers exposing the hidden wealth of elites has increased the recent public concerns of tax issues, including tax evasion and avoidance by companies and rich individuals.  There is an urgent need for global cooperation to act on tax issues, but discussions and decisions on these should be based in the United Nations involving all governments, and not in exclusive groups like the OECD.

By Manuel F. Montes

We live in a time of heightened mindfulness over defective governance at the international level, in general, and deeply defective governance over international tax cooperation, in particular.

The aftermath of the information explosion on hidden wealth from the “Panama Papers” is the latest scandal, based on the information leaked from the files of one law firm called Mossack Fonseca headquartered in Panama.

The exposure of some high ranking politicians triggered intense interest, even though the defects of the system go much beyond the participations of public servants.  The Prime Minister of Iceland, Sigmundur Davíð Gunnlaugsson, relinquished his post after it was revealed that he co-owned a company called Wintris Inc, set up in 2007 on the Caribbean island of Tortola in the British Virgin Islands, with his wealthy girlfriend and future wife.

An offshore fund in the Bahamas ran by Prime Minister David Cameron’s father, in which he had earlier made investments, managed to avoid paying British taxes.

Mossack Fonseca was in business of creating corporate vehicles in different tax jurisdictions by which owners could hide their wealth and identity from tax authorities.  While the revelations of politicians’ involvement elicited the greatest interest, it is important to train the spotlight on the fact that the corporation form, whether used by politicians or multinational companies, is now the weapon of choice for avoiding and evading taxes.

The ease with which corporations are created to enable their owners to place their wealth incomes beyond the tax authorities must be seen as a key pitfall of the system of international taxation.

Mossack Fonseca acted on behalf of 300,000 companies.  Multinational companies who are significant sources of tax revenues have created thousands of these companies scattered in different countries for their tax strategies.

When they found themselves desperately seeking taxpayer resources to bail out their financial sectors in the wake of the 2007-08 financial crisis, North Atlantic authorities , all responsible for the world’s leading economies,  woke up to the reality that their own corporate sectors were undermining their own tax bases.

They asked the G20 and OECD to launch the Base Erosion and Profit Shifting Project (BEPS). The outcomes of BEPS, launched in September 2015, demonstrated the existence of a need, or a set of needs, for a thoroughgoing reform of international tax cooperation.

It also demonstrated that fundamental flaws of an OECD-led process in this field.  As a secretariat accountable to its developed country membership, it has to respond to the basic interests of these set of countries in which the world’s largest and most prominent multinationals are headquartered.

For the tax planning, multinational companies have found the “separate entity” principle to be very advantageous. Otherwise the tax advantages of setting up different corporate entities in a variety of locations could be disabled.  If the separate entity principle were abandoned, companies created by multinationals would be treated as being related to its owner and can be treated together with the owner as one company.

The BEPS outcome did not respond to the most critical needs of developing countries in tax cooperation, even though the cooperation of developing countries would be required to make the BEPS proposals be effective  even in meeting the needs of developed countries.

BEPS explicitly avoided dealing with the split between residence and source taxation, despite the fact that the global community has reached agreement earlier that “all companies, including multinationals,  pay taxes to the Governments of countries where economic activity occurs and value is created, in accordance with national and international laws and policies” (Addis Ababa Action Agenda, Paragraph 23).

There is no place, for example, in the BEPS project structure for two of the most important tax issues confronting developing country officials in generating revenue from activities of foreign companies in their jurisdiction: (1) taxation of technical services and (2) the treatment of enterprises in extractive industries.

Where the OECD has proven to be bogged down or severely crippled is in making effective progress in regulating transfer pricing abuses.  The OECD is unable to abandon the basic separate entity principle in structuring the tax treatment of related companies operating transnationally.

Would a World Tax Authority or an Intergovernmental UN Committee Help Developing Countries?

From my own point of view, there are two distinct governance mechanisms posed in this question: (1) a World Tax Authority (WTA) and (2) an Intergovernmental UN Committee.  The exact nature of each of these two mechanisms is subject to more detailed conceptualization.

World Tax Authority

First, on the World Tax Authority.  It is easy to imagine, as had been imagined by the Zedillo report before the first international conference on financing for development in 2001, that WTA would have many of the functions in tax cooperation that the World Trade Organization (WTO) has in the area of trade.  (Of course, the WTO has strayed far and wide beyond trade issues, such as the international enforcement of intellectual property rights.)

For a WTA to work, it would be necessary to set out and agree upon its overall purpose, in the same way that the WTO is supposed to provide “the common institutional framework for the conduct of trade relations among its Members.”  The purpose of this framework has to be set out and it could depend on the mood of the moment.  Could it be to protect the tax bases of its members and to minimize the negative spillovers of unilateral tax policies on other member states?  This would be not in conformity with a still-dominant view in support of diminishing the role of the public sector and unleashing that of the private sector in economic activity.

A WTA could have a dispute settlement facility.  It would have to be decided whether only disputes between states will be entertained or whether disputes between taxpayers and states will be accepted.  (It is understandable that developing countries are extremely suspicious of the latter and find themselves at variance with BEPS discussions on strengthening the “mutual agreement procedures” (MAPs) in taxation treaties.)

Intergovernmental UN Tax Committee

Imagining what an intergovernmental UN committee could do is easier than imagining what a WTA could do, mainly because a UN Committee of Experts on International Cooperation in Tax Matters already exists.

The UN tax committee of experts has been engaged in updating the double tax model of the United Nations which privileges taxation of incomes at the source, instead of in the residence of the taxpayer, which is the preferred OECD approach.  In more general terms, it has been involved in the business of experts coming to an agreement on effective tax practices when individual country policies have potentially an impact on the tax performance of others.

Upgrading this body to an intergovernmental body would elevate its recommendations to a higher level than as a matter of expert suggestion.  As an intergovernmental body, its recommendations would carry the weight of a standard or norm agreed by representatives of governments.  These kinds of international norms, not just in tax policy but also in tax cooperation, are already being decided among OECD countries.  Because OECD member country representatives participate in norm-setting, member countries are morally bound to meet these norms (or have to explain transgressions or seek an exemption).  An intergovernmental UN tax body would have the ‘power’ corresponding to the norm-setting power of the UN Statistical Commission which decides on the appropriate technical procedures to estimate key economic variables such as GDP or investment in a manner that allows these estimates to be comparable with the same variables produced by other countries.

An intergovernmental UN tax body would thus do what the OECD already does, but have the moral power to demand compliance from all UN member states – both OECD and non-OECD.

(It can be assigned other responsibilities in the same way, for example, that the UN Committee for Development Policy declares which countries qualify for LDC status.  For example, it might or its appointees could arbitrate or sit in judgement of tax disputes.)

Why an Intergovernmental UN Tax Committee

My view is that when developed countries blocked the upgrading of the UN tax committee at the Addis Conference it was an exercise in refusing to cede the overwhelming power of developed countries in norm setting in international cooperation in tax matters (just as they are unwilling to cede this power in resolving sovereign external debt, in appointing heads of the WB and the IMF, in deciding on the global levels of monetary liquidity and rules governing the payments system, and so on).

It was not a question of whether or not the UN activities would cooperate with the OECD tax work.  UN tax work is already cooperating because its deliberations are open to OECD participation.  By design, in order to make developed countries feel safe in the expert tax committee, half are appointed by the UN Secretary-General from OECD countries.

It is not a question of whether a UN process would be too slow to reach an agreement.  OECD processes have not proven clearly faster.  As I understand it, it took OECD negotiators – coming from countries that have much in common – 15 years to come to some basic approach to transfer pricing methods.

It is not a question of whether the UN has expertise in cooperation in tax matters.  At present half of the UN tax committee members are tax experts from OECD countries.  Nothing can prevent member states from sending their best tax experts to work in the committee, just as they send their best statisticians to the UN Statistical Commission.  The difference is that, in a UN committee, experts from non-OECD countries cannot be shut out or ignored as they are in the OECD.

The OECD tax work would likely continue, even with a UN intergovernmental committee if developed countries were to deign to let it happen, with the difference that  in the UN tax committee all the voices will have secure access to the agenda, the deliberations and the decision-making.

There is a very simple explanation as to why an OECD-led process will be unable address the imperative of international tax cooperation, except in a rather distorted manner and most likely disadvantageous to developing countries.  OECD is a member organization, in which members negotiate with each other agreements on standards of tax cooperation.

It is understandable that OECD member states will insist that any idea, agenda item, or proposal – no matter how pertinent or compelling – can be taken up for negotiation in the OECD only when proposed by a member state.   OECD members need to negotiate with each other about their common position, before the OECD, as OECD, can react to the proposals by non-OECD members.  Silence or neglect on the part of the OECD to non-OECD proposals or issues means in the first place that the OECD members have not arrived at a position on the issue.

Like other observers, I view the insistence that the OECD function as the sole standard setting body in international tax cooperation, which is the direct implication of the blocking of the upgrading of the intergovernmental tax committee in the financing for development conference, as an exercise in developed countries’ not walking the talk of “democracy, good governance, and the rule of law” which they like to do for the smallest of excuses.

The OECD is now inviting developing countries to participate in the implementation of BEPS “on equal footing” to the standards agreed to only among OECD member states.  It is also developing a multilateral instrument to modify bilateral tax treaties.  These and other OECD activities have increased the sensitivity of developing tax authorities to intolerable governance imbalances in this arena and motivating efforts at self-organization to counter the situation.

Manuel F. Montes is the Senior Advisor on Finance and Development at the South Centre.