Like Law & Order reruns, offshore corporate tax havens have been around so long it’s hard to imagine a world without them. What would become of the national identity of Cayman Islanders? The country’s Wikipedia entry mentions its status as a “major world corporate tax haven” in the first paragraph, well before noting that this is a place where pirates once dwelt and where the endangered blue iguana still roams (at least for now).
Recent high-profile tax haven cases have stoked resentment of the loopholes. In 2013, a U.S. Senate investigation exposed Apple’s use of two Irish subsidiaries to hold $102 billion in profits offshore; Apple had cleverly structured them so that they owed taxes neither to the U.S. nor Ireland. This fall, Starbucks was ordered by the European Commission (EC) to pay up to $34 million in back taxes to the Dutch government in recompense for a scheme – approved by Dutch tax authorities, no less – that wiped out its tax obligations to that country. (Starbucks is appealing.) The EC has opened an investigation into the tax activities of Apple, Starbucks, and Fiat. Public uproar may have also played a role in Walgreens decision not to move its headquarters to the U.K. upon its merger with Boots Alliance in 2014, a so-called “inversion” that would have allowed it to shift its primary tax obligations to Britain. As these examples illustrate, tax avoidance is a potentially expensive issue for investors in terms of reputation and financial penalties, even for those unconcerned by questions of fairness or the full funding of government programs.
The new Organization for Economic Cooperation and Development (OECD) regime includes minimum standards to level the playing field for treaty shopping, country-by-country reporting, dispute resolution, and harmful tax practices. Some measures are immediately applicable, with others require continuing work by participating jurisdictions. While the standards –the product of the OECD/G20’s Base Erosion and Profit Shifting (BEPS) Project – are not legally binding, as “soft law” there is an expectation that the BEPS outputs will be implemented by countries that helped to create them. Implementation will be monitored, and the scale and economic impact of the BEPS reforms will be measured.
Angel Gurría, OECD Secretary General, told G20 finance ministers and central bank governors in September, “Let’s be crystal clear: What is at stake is to restore the confidence of your people in the fairness of our tax systems.”
Spoiler Alert: Appalling Statistics
The examples above are only the visible tip of a staggeringly large iceberg. According to Americans for Tax Fairness, use of overseas tax havens is corporate America’s favorite tax loophole, responsible for $90 billion a year in lost government revenue. U.S. companies are keeping $2.1 trillion in untaxed profits offshore. Over half that amount is booked in tax haven countries, where rates average between 3 and 6.5%. Credit Suisse and Citizens for Tax Justice estimate that corporations would owe $533–600 billion on them if they were repatriated.
Companies in the high-tech and pharmaceutical/healthcare sectors are responsible for half of this $2.1 trillion, due to loopholes that relate to intellectual property rights.
Unrepatriated Foreign Profits of Top 20 Corporations, 2014 ($ Millions)
|Company||Unrepatriated Profits||Headquarter State|
|Johnson & Johnson||53,4000||New Jersey|
|Procter & Gamble||44,000||Ohio|
|JP Morgan Chase||31,100||New York|
Most of what corporations have been doing is legal, but that doesn’t necessarily mean their activities are ethical or even simply in their best long-term interest. Every dollar in taxes avoided by corporations has to be made up for either by increased taxes on households, government borrowing, or reducing services that keep the nation – corporations included – surviving and thriving. The tax burden has been shifting to U.S. households over time. In mid-century, corporation taxes amounted to nearly one-third of federal revenues. Today, they’re about 11%.
And when companies tread too close to the often fine line between legal and ethical, it’s easy to arouse the ire of consumers, politicians, regulators, and the media. Even the appearance of tax impropriety is inadvisable in an era when socioeconomic inequality and the factors exacerbating it are finally receiving long-overdue scrutiny.
The Wild West
The international tax system, if it can be called that, is comprised of what The Guardian has described as “thousands of bilateral tax treaties that form the arteries of global trade.” A recent article in that newspaper explained that while most of these treaties are based on a standard OECD template,
In the last 30 years … tax accountants have become adept at finding mismatches between tax rules in different countries, helping multinationals relocate valuable assets internationally to minimise their tax. The digital economy – in which companies can do business in countries while having little or no physical presence there – has added further opportunities.
For example, there isn’t a clear-cut rule for where to book profits for the purchase of a download. Was the profit was generated in the country where the content was produced, or in another country where it was downloaded? Should profits from a drug purchase be booked in the country where the medication was first formulated in a laboratory, where the point of sale took place, or where its factory of origin is? The ample room to maneuver results in many U.S. corporations paying an effective tax rate between 12 and 20%, well below the official 35% tax rate. In addition to hurting individual taxpayers, the situation disadvantages the competitiveness of American companies that do not have overseas subsidiaries and cannot shop for the cheapest tax venue.
In 2005, Congress passed a tax holiday allowing corporations to repatriate offshore profits at an 85% discount. Over 800 large firms took advantage, reducing their long-term tax bills by nearly $100 billion. The deal was sold as a means of encouraging companies to create more U.S. jobs, but instead, many of the beneficiaries ended up slashing jobs dramatically, boosting shareholder dividends, pursuing stock buybacks, and elevating executive pay. By 2014, unrepatriated profits had climbed right back up again to $2.1 trillion, from $434 billion at the time of the holiday. Congress is debating the prospect of another tax holiday to finance the highway funding bill.
The Path(os) Forward
Reviewing our holdings, we found that at least one-third of the companies on our current “buy list” take advantage of tax havens. As this prevalence illustrates, implementing a policy to avoid such companies entirely would be self-defeating by eliminating a great number that are otherwise attractive from the financial and social standpoints. So what can investors do?
First, as a matter of good investment strategy, we must try to discern when countries exploit tax havens to compensate for deficient business strategies, and adjust our holdings accordingly.
Another option is to engage with companies directly. Our colleagues at Domini Social Investments have gone down this road, filing proposals at Alphabet (the company formerly known as Google), which called for a set of principles to address the impact of the company’s tax strategies on its stakeholders. (Domini managing director Adam Kanzer has written eloquently on why investors should view taxes as an investment.)
The Google resolution gained only 1% of the vote. Kanzer told us, “For a lot of investors, taxes are the problem – ‘less money for me.’” Making the case for voluntary restraint on a company-by-company basis is one long, tough slog. Therefore, we’ll also be looking for opportunities to support U.S. lawmakers seeking to integrate the BEPS reforms into U.S. tax law. Shortly before becoming Speaker of the House, Congressman Paul Ryan squared off against the Department of Treasury and its support of the BEPS proposals, signaling a fight to come. We’ll catch it live on C-SPAN, unless another channel is broadcasting Law & Order: Tropical Tax Haven.
“Corporate Tax Strategies Threaten Wealth Creation,” Adam Kanzer, Domini Social Investments, June 10, 2014.
Engagement Guidance on Corporate Tax Responsibility: Why and How to Engage with Your Investee Companies, United Nations Principles for Responsible Investment, November 2015.
“Combating Tax Avoidance,” Prem Sikka, Corporate Knights: The Magazine for Clean Capitalism, October 16, 2015. Critiques shortcomings of the OECD proposal.
Independent Commission for the Reform of International Corporate Taxation is a “group of leaders (including Nobel Prize-winning economist Joseph Stiglitz) from around the world who believe that, at this moment in history, there is both an urgent need and an unprecedented opportunity to bring about significant reform of the international corporate taxation system.”
The Financial Accountability and Corporate Transparency (FACT) Coalition seeks “an honest and fair corporate tax code, greater transparency in corporate ownership and operations, and commonsense policies to combat the facilitation of money laundering and other criminal activity by the financial system.”Tags: Americans for Tax Fairness, BEPS, OECD, tax havens