November 3, 2014

Sovereign reputation and investment location decisions

A question came up at a roundtable discussion I led recently with tax directors of a handful of multinational firms: if your advisor came to you with a tax plan that included a tax haven in the structure, would you consider it?

The answer was an astounding no as almost all of the dozen or so tax directors in the room shook their heads in unison. Given the current environment, setting up a tax structure centred around prominent tax havens was considered a non-starter. Way too BEPSy!

And that got me thinking about sovereign reputation. We normally think about sovereign reputation in terms of debt and credit ratings, but does sovereign reputation impact multinational firms' investment location decisions?

Luxembourg. Photo by Wolfgang Staudt / CC
I believe that sovereign reputation does have an impact on investment location decisions. All else being equal, I expect that a multinational will choose to avoid a jurisdiction that is known for facilitating behaviour that the European Commission and others might find unacceptable.

It is no secret that a tax auditor is likely to take a harder look at your file if your company has a lot of intercompany dealings with tiny Caribbean islands. This isn't to say that having presence on tiny Caribbean islands is by itself problematic-- it is just expected to draw scrutiny. Some countries have taken the extreme step of publishing blacklists of tax haven countries, dealings with which draw extra scrutiny or even taxation of income earned in those tax haven countries. And now with the European Commission publishing its opening decisions in state aid investigations of Ireland and Luxembourg, one can't help but wonder whether these jurisdictions are now, somehow, tainted because of these decisions.

The focus of these state aid investigations has been rulings and agreements between the state and the taxpayers that provided selective advantages or individual concessions to a taxpayer. (You can find more on State aid here; it isn't the point of this post.) These state aid investigations also come at the same time as the OECD proposals on greater transparency and recommendations for disclosure requirements on such rulings and agreements as a part of the transfer pricing documentation master file. I expect that a tax auditor looking at your transfer pricing documentation in a couple of years would know whether you had special rulings and agreements in certain "tainted" jurisdictions, resulting in prolonged, more painful audits. And my hypothesis is that all else being equal, a tax director is likely to avoid these jurisdictions due to this risk of prolonged, more painful audits.

It is therefore no surprise that Ireland has so quickly taken steps to remove the provisions that allowed for Double Irish structures. It isn't just the EU investigations and possible sanctions that motivated Ireland in my view; it is the fear that if Ireland as a jurisdiction becomes tainted, that on its own will drive away foreign investment. That doesn't mean that Ireland will cease to provide incentives for multinationals to locate there, because its economy is dependent on that kind of foreign investment. So Ireland has now focused its attention on patent box regimes, which are likely considered a less risky proposition because larger and more reputable islands like the UK have also introduced such regimes.

Others will follow Ireland's example. The economies of Ireland and Luxembourg are so dependent on activities of the multinational firms that they can't afford to lose them completely. Hence they will find new and creative (and sometimes not so creative) ways to retain their advantage, and their reputation.

In the mean time, if you have operations in jurisdictions with tainted reputations, you should have a plan B in mind.

October 19, 2014

Why is transfer pricing inherently an art?

On a recent episode of the popular TV show, The Good Wife, the main character Alicia Florrick (played by Julianna Margulies) states that she was drawn to the legal profession because the rules meant right and wrong was clear. Being a lawyer afforded her clarity and helped her understand right from wrong without ambiguity.

I like clarity. I like rules that tell me what’s right and what’s wrong. (…) I just wanted to be inside something made sense to me.” (Alicia Florrick, The Good Wife – Season 4, Episode 6)

And while I don’t agree the law is as black and white as Alicia would like to believe, I enjoy transfer pricing precisely because there is no black and white. There is almost never one answer. The right answer is almost always in a range of possibilities. My instinctive first response to most clients when they ask me a seemingly straightforward question is “it depends.”

October 7, 2014

Reputation and corporate taxation

When I started working in transfer pricing, it was rare to find anyone other than my colleagues who knew what transfer pricing was. It was rarer still to find many references to transfer pricing in the media. There were no TV shows starring tax geeks. No movies that explored the intricacies of international taxation.

But it has all changed now thanks to Starbucks, Apple and Amazon. So much so that a movie premiered at the Toronto International Film Festival this past month, exploring whether corporations are paying their fair share of tax. I haven't yet watched The Price We Pay but I do intend to get to it soon. 

The trouble really started as the world media got a whiff of high tech American multinationals' incredibly low effective tax rates in the international markets. The tech companies were the key culprits, using a mixture of Irish, Dutch and Barbados based tax structures (also known as the Double Irish with a Dutch Sandwich) to make their income disappear, tax less.

September 8, 2014

Does internationalization lead to innovation?

Export promotion programs, like EDC, have historically been based on the assumption that internationalization leads to greater innovation, higher productivity and above-average returns. In a recent article, Bill Currie of Deloitte Canada raised all of these arguments and more to encourage Canadian companies to look beyond their domestic markets. I believe he completely missed the mark.

While the statistical data would show that multinational Canadian companies experience higher growth rates and have higher productivity than their purely domestic peers, this is a case of misidentifying cause and effect. The multinational Canadian companies do

September 1, 2014

Why study the impact of taxation on investment location decisions?

The recent economic downturn and deficit challenges have focused political debate on revenue generation, and specifically corporate taxation, making international tax reform one of the most important areas of discussion on public policy. The Occupy movement, an international protest movement that first gained prominence in 2011 for its protests against the alleged corporate greed on Wall Street, has consistently pointed to the relatively low tax rates paid by large corporations as a prime reason for growing inequality and gap between the rich and the poor in the US and elsewhere around the world. In a recent paper on base erosion and profit shifting, OECD (2013) highlights what it considers the low share of corporate taxation in overall governmental revenues, at less than ten percent. Mandated by the Group of Eight (“G8”), Organisation for Economic Co-operation and Development (“OECD”) has expended a significant amount of effort over the last year in proposing recommendations for fixing what it describes as loopholes and gaps in the international tax system. The work done by OECD over the last year has been unprecedented in its scope, multilateral buy-in and the speed at which it is forging ahead to plug gaps that purportedly result in base erosion and profit shifting.