Calling time on aggressive tax competition

Following on from two recent landmark rulings coming out of Europe, KPMG partner and doctoral student Mark Bamber looks into them in more detail, and the possible implications for Scotland.

The European Commission’s ruling against Apple in September, effectively accusing the company of shifting profits from its European operations into a non-existent head-office in Dublin, through which it apparently benefited by access to tremendously low tax rates, is the latest in a concerted series of actions by the OECD and the EU to target multinationals’ exploitation of tax competition by a number of jurisdictions. More recently, the European Court of Justice has ruled that British American Tobacco paid too much tax on dividends paid by its foreign subsidiaries, and ordered HMRC to reimburse the tobacco company with £1.2bn of overpaid tax.

Tax rulings are big news

Essentially, the European Commission argued that, throughout the better part of two decades, Apple booked its transactions in Europe in a company in Ireland, then passed profits through a virtual head office in Dublin which carries out no operations and has no employees, and in so doing, minimised the taxes paid on its European profits. In return, Apple argued that everything it has done is consistent with Irish tax law, but the Commission has passed its ruling under Competition rules, effectively accusing Ireland of granting Apple unlawful state aid in the form of an extraordinary tax benefit.

The value involved is material – roughly 13 billion Euros inclusive of interest. Both Apple and the Irish government reacted by announcing their intention to appeal, and other EU member states are looking on in interest. Ireland’s dilemma is evident – should it side with Apple, appeal, and be supportive of the multinationals, or should it stick to the terms of the judgement and reclaim the past underpaid tax and interest? The potential revenue implications are clearly interesting, but this course could harm Ireland’s reputation in corporate America. The net revenue implications are also not so clear-cut. Could France or Germany have a valid claim upon part of Ireland’s windfall revenue?

The British American Tobacco ruling is also interesting. The ruling effectively argues that the UK overcharged tax in contravention of EU law, and this could also be applicable to other multinationals. Potentially, the claimed £1.2bn reimbursement could increase by several multiples.

A new normal for tax competition

Away from the specifics of this judgement, the implications for other international financial services centres are also significant. For a number of years, the world’s attention has been focused on the potential impacts of tax competition, and the possible tax leakages to these countries. A number of initiatives like FATCA, BEPS, and CRS have targeted a spotlight on the practice of profit shifting.

The increased mobility of capital in the past decades has doubtlessly created opportunities for low tax jurisdictions. Fundamentally, all techniques of tax avoidance rely on the simple principle that if a firm can legitimately shift part of its profits away from a high tax location to a lower tax jurisdiction, its taxes will be reduced without affecting other operations of the company. Primarily, the techniques with which this is achieved generally fall within one of three categories – manipulative transfer pricing in inter-group transactions, transfer of intellectual property or other intangibles to create an inter-company charge, and the allocation of debt to create an interest liability and legitimate payment flows.

An increased focus on profit shifting, both by national tax authorities and by supra-national entities, heralds a change in attitudes. Perhaps fuelled by anti-globalisation emotions, by popular indignation at the actions of the multinationals, and by budgetary pressures, this is forming a new normal where zero-tax or low-tax competition is no longer acceptable. On the other hand, this is countered by an increasing focus on the fairness of tax charges.

Implications for Scotland

So what does this mean for Scotland? Today, Scotland’s economy comprises a growing financial sector, and the country is increasingly looking to balance its reliance on the oil and gas sector with a more modern service-driven macro-economy.

Presuming a future self-financing budget for Scotland, it could make sense to seek to expand the current financial sector into a fully-fledged international business economy. International business is profitable, attracts a cohort of affluent expatriates, stimulates wealth and the creation of jobs, and offers high value added opportunities to young people. It would raise incomes of the higher earning cohorts of the Scottish economy, and foster multiplier effects and economic spill-overs across most segments of the Scottish economy. It is also empirically proven that increased tax revenues from international financial services activities correlate to more effective social expenditures, and more acceptable levels of inequality.

A key decision would relate to Scotland’s competitive stance in international business. A blatant zero-tax strategy would likely transform a state into an international pariah; a low-tax jurisdiction could be a regime that compares well to neighbouring competitors like Ireland and in the Benelux. On the other hand, a reasonable and moderate tax rate would attract international approval, be attractive to business that chooses to be socially responsible in today’s global climate, probably meet the approval of public opinion in Scotland, be supportive of Scottish public finances, and offer a more reasonable environment within which Scotland would need to negotiate and conclude critical anti-double taxation treaties with countries that are important sources of foreign investment.

Transforming Scotland into an international financial services centre would entail a significant programme of work. Intense legislative work will be necessary, extensive international negotiations with treaty partner countries will be essential, the creation of competitive advantage based on incentives, support, the attraction of talent, and reactions by the educational system will all be critical. Appropriate marketing and global promotion will be central to long-term success, but the potential economic outcomes could be rewarding and transformative.