Tax Foundation Forum: Making Sense of Profit Shifting has reached its midpoint. In this halftime report, we provide a synopsis of the first nine of the 18 interviews in the series. This two-part review summarizes the key takeaways to this point and focuses on the interview series’s six underlying themes: What is actually known about profit shifting and which areas remain ambiguous; The drivers and mechanics of profit shifting; The magnitude and directional trend of profit shifting; Missing pieces for a better understanding of profit shifting; Solutions to profit shifting, with a focus on the feasibility or desirability of multilateral cooperation; The status quo and future of the corporate income tax and international taxation. Part I of the halftime report compares and contrasts opposing views for themes one through three. The single most important takeaway from the first nine interviews is the substantial degree of differences in viewpoint that exist among participants, specifically in relation to the current depth of understanding of the profit shifting phenomenon. 1. What Is Actually Known about Profit Shifting and Which Areas Remain Ambiguous? The purpose of this question is to survey the landscape of profit shifting, better understand how much is truly know about profit shifting, and whether there exists a consensus in that area. So far, there is a significant discrepancy among interviewees regarding what is curently known about profit shifting. Within the realm of the known, there is unanimous agreement that profit shifting occurs on a regular basis. There is a similar degree of consensus that firms—in terms of reported income—are responsive to tax rate differentials across jurisdictions. Moreover, participants generally have the same view on which channels for shifting profits are most important: Transfer pricing (with an emphasis on intellectual property and intangible assets and the creation of royalties and cost sharing agreements) and intra-firm or inter-affiliate debt are frequently highlighted. Finally, interviewees view the core underlying drivers of profit shifting—which we will discuss in the next section—in a relatively similar fashion. The main areas cited as still within the realm of the unknown include: the magnitude of profit of shifting, including implications for tax revenues, the ways and extent to which there are real distortions associated with profit shifting, and the corresponding costs of engaging in profit shifting. However, there are substantial differences in views on which areas are in the domain of the unknown. Some interviewees view the realm of the unknown as minute, while others see the realm of the unknown as greater than the realm of the known. 2. The Drivers and Mechanics of Profit Shifting The four core drivers of profit shifting that are commonly highlighted among participants include: 1) Differences in tax rates across jurisdistions; 2) Globalization of production and production chains; 3) Increasing capital mobility; and 4) The growing importance of intellectual property and intangible assets. However, participants also mentioned other underlying drivers—which in some cases partially overlap with the four aforementioned core drivers—such as the strategic incentives of host and residence countries, the increase in competitive pressures on global firms, the particular legal and regulatory aspects that facilitate profit shifting (e.g. check-the-box, the 2004 tax holiday), specific mentioning of stateless income planning opportunities (meaning, not only tax rate, but also tax law differences), and the characteristics of firm managers/executives (tax director, CFO). In general, participants agree in principal on which channels are most important for profit shifting. There are, however, opposing views on the granularity of the understanding of how firms use these channels. Participants see the use of intellectual property or intangibles as the most important method for shifting profits. This technique can be placed under the broader category of transfer pricing. In the 1990s and early 2000s the transfer pricing channel of shifting profits mainly pertained to the mispricing of intra-firm trade of input goods, such as piece of metal. Today, participants view the mispricing of firms’ intangible assets as the key practice under the category of transfer pricing and for profit shifting in general. In addition, interviewees view firms’ strategic use of intra-firm debt as an important channel; though, the consensus is that the importance of this channel has decreased over time. Furthermore, a substantial degree of participants highlighted the use of stateless income planning strategies, through which company income could be taxed in no jurisdiction at all. 3. The Magnitude and Directional Trend of Profit Shifting So far, the key takeaway from participants is that estimating the magnitude of profit shifting is associated with significant challenges and uncertainties, which might make the exercise infeasible at this point. Regarding the directional trend of profit shifting, a majority of participants indicate profit shifting has increased over time. Nevertheless, there are opposing views that suggest a decrease in the magnitude of profit shifting might have occurred. Part II of this halftime report will be published tomorrow, on Wednesday, May 27, and includes a review of themes four through six.
The Republican controlled Pennsylvania House of Representatives, with strong Democratic support, recently passed a bill to increase the state’s personal income and sales and use taxes. If passed by the Republican controlled Senate and signed by Governor Wolf (D.), the bill would increase the statewide sales tax rate from 6 percent to 7 percent, and make Pennsylvania’s overall sales tax burden the second highest in the Northeast region (New York is first). Pennsylvania’s statewide income tax rate would jump more than 20 percent from 3.07 percent to 3.7 percent. Supporters of the tax increase say the money raised is needed to help solve local governmental funding problems. Under the bill, the additional sales tax revenue will be deposited into a newly created School District Homestead and Farmstead Relief Fund. The additional income tax revenue will be deposited into a newly created School District Millage Rate Reduction Fund. According to the House Republican Caucus , the legislation “would ensure that every new dollar generated through the proposed changes be fully dedicated to school property tax relief.” However, this claim is not correct, some of the revenue collected will be spent in other ways, and taxpayers may end up receiving little relief if school districts choose to raise rates or future legislatures choose to redirect funding. For example, the bill’s fiscal note points out that a portion of the sales tax increase will be distributed to the state’s Public Transportation Access Fund and Public Transportation Trust Fund. Another portion of the sales tax increase will be distributed to the State Lottery Fund, where it will be used primarily to fund increased payments to eligible renters earning less than $35,000 annually, not to reduce property taxes. Most of the new tax revenues will go to local governments, which will remain free to increase property taxes. Claims that the tax revenues will be used to reduce property taxes are suspect in light of Pennsylvania’s recent history. In 2004, when the Pennsylvania legislature approved a new gambling law, the primary argument in favor was that the new revenues would be used to reduce property taxes. While some property owners did see reductions, the vast majority of school districts used the increased revenues to offset spending hikes that might not have happened absent increased state funding. Furthermore, the legislature has taken to skimming off the top of the gambling revenues to pay for politically favored projects like a new arena for the Pittsburgh Penguins, public transit projects, and local convention centers . At least one legislator is convinced the newly created dedicated funds will later be used for purposes other than property tax relief. Rep. John Mayer (R.) said of them: “Find one dedicated funding source in the history of this Commonwealth that has not been invaded and redirected for other purposes. There is a 100 percent track record that these funding streams do not remain dedicated.” It will be interesting to see whether Pennsylvania’s Senate Republicans favor the plan passed by the Republican controlled House. The Senate Republican Caucus has previously called a similar proposal from Governor Wolf that would have raised income and sales taxes to fund property tax relief an “economic scorched earth policy” partially because it failed to include safeguards that would have prevented property taxes from rising again. Governor Wolf actually proposed a smaller sales tax hike than the House has, but the Republican Senate Caucus noted that even that smaller hike “could have a devastating effect on businesses in Pennsylvania’s border counties as consumers look to neighboring states for purchases.” The Caucus also noted that Wolf’s income tax hike would take a “substantial, if not fatal” bite out of small businesses. As they consider whether to support this proposal, legislators should weigh it against other solutions to the state’s local government fiscal issues. The Pennsylvania Senate believes it has identified one fix: pension reform . Another option might be a much less harmful option for revenue raising : asset sales. The Pennsylvania House has identified one large state asset that could be sold off without reducing government services: the state owned alcohol stores . Reforming is almost never easy, but any solution worth doing will be one that actually fixes the problem it is meant to solve. More on Pennsylvania.
With adjournment sine die looming, Nevada Governor Bryan Sandoval (R) and state legislators are racing the clock to reach an agreement on revenue. The Governor’s initial proposal, the adoption of a gross receipts tax assessed through the state’s business license fee structure, passed the Senate but stalled in the Assembly. (We analyzed that proposal , embodied in SB 252, at length .) An alternative plan ( AB 464 ) cosponsored by Assembly Majority Leader Paul Anderson and Assembly Tax Committee Chair Derek Armstrong (both Republicans) emerged some time thereafter, and yesterday the Governor made his counteroffer in the form of a proposed amendment to AB 464. We previously blogged on initial reports of this revised proposal, but now that the full language is available, a summary is in order. Key Components of Revised Plan Business License Fees Currently set at $200 per year, the Governor’s revised plan would adopt a two-tiered structure, with a $500 fee for corporations and a $300 fee for all other business entities. This proposal is borrowed from AB 464 as introduced and closely follows one of our recommendations. The Governor’s office estimates that this component would net $46 million in new revenue annually. Modified Business Tax Currently a payroll tax of 1.17 percent on wages above $85,000 per quarter (two percent on financial institutions), the Governor’s proposal is an adaptation of AB 464, which raised the Modified Business Tax (MBT) rate and broadened the base by reducing the exemption to $50,000 per quarter while adding mining to the 2 percent rate. The Governor’s plan sets the general rate at 1.475 percent and adopts the lower exemption, but parts with AB 464 as introduced by maintaining an existing employer-provided health care deduction which the Armstrong-Anderson bill eliminated. A credit would be available for a portion of taxes paid under the proposed Commerce Tax, described hereafter, and should total revenue from all business taxes exceed projections by more than four percent, the MBT rate would be adjusted downward, though to a rate no lower than the current 1.17 percent. The modified MBT is projected to net $516 million a year, of which about $94 million would be new revenue. Commerce Tax In lieu of the Governor’s prior proposal to impose a gross receipts-based tax through the state’s Business License Fee, the new plan envisions a gross receipts-based Commerce Tax with twenty-six industry-specific rates on businesses with Nevada revenue of $3.5 million or more. Fifty percent of taxes paid under the new Commerce Tax would be available to be taken as a credit against MBT liability. The administration projects that up to 10,000 businesses will be subject to the tax and anticipates that this tax will net $61 million a year in additional revenue, taking into account the revenue offset by the 50 percent credit taken against the MBT. The Commerce Tax is reviewed in greater detail below. Miscellaneous Tax Changes The Governor’s plan rolls back a 10 percent increase in the vehicle registration fee which was added in 2009 and reduces the minimum amount of the Governmental Services Tax from $16 to $6. The Commerce Tax vs. the Graduated BLF Like the Business License Fee-based gross receipts tax proposed under SB 252, the Commerce Tax is imposed on Nevada gross revenue under industry-specific levies developed based upon an analysis of the incidence of the Texas Margin Tax. It does, however, differ in a number of particulars: It is now structured as a tax rather than a fee schedule with 67 distinct rates for each business category. By imposing specific tax rates rather than a range of “fees,” the new Commerce Tax avoids the “cliffs” faced by businesses earning one additional dollar above a particular income range. The amount generated by the Commerce Tax is lower, with most (but not all) rates halved from the prior effective rates, reflecting a greater reliance on the MBT under the new plan. Since three industries do not experience rate adjustments, and two experience reductions of more than half, the incidence of the tax differs meaningfully from that levied under SB 252. (See below.) A partial credit is offered against liability under the MBT, limiting the degree to which businesses are subject to taxes on two different measures of liability. The number of industry-specific rate declines one, to 26, with the combination of the telecommunications and utilities categories. This results in a significant reduction in the rate for telecommunications, which was previously more than double the rate on utilities generally. The following table summarizes the tax rates on Nevada gross revenue above $3.5 million, compared against the previous levies under SB 252: As members of the Nevada Legislature continue to grapple with the size of the state’s biennial budget and the best means to fund it in the waning days of session, this revised proposal will give them much to consider. Our original proposals for Nevada policymakers can be found here . More on Nevada here .
Pascal Saint-Amans is Director of the OECD’s Centre for Tax Policy and Administration (CPTA). Under a mandate from the G20 leaders, Mr. Saint-Amans is directing one of the most significant transnational efforts in the history of international taxation, the OECD’s Base Erosion and Profit shifting (BEPS) project. Regardless of the final recommendations presented at the G20 meeting in October of this year in Lima, Peru, the BEPS initiative is transforming the landscape of international taxation, redefining the international tax arena for host countries, residence countries, and multinational firms, alike. During his tenure at the CPTA, Mr. Saint-Amans has held several positions prior to assuming the role as Director, in 2012—among others, as Head of the International Cooperation and Tax Competition Division and Head of the Global Forum Division. Previously, Mr. Saint-Amans served in the French Ministry of Finance in various capacities—including as supervisor of the EU work on direct taxes, overseeing legislation and policy on wealth taxes and mergers and spin offs, as well as heading tax treaty negotiations and mutual agreement procedures—for nearly a decade. Mr. Saint-Amans graduated from the National School of Administration (ENA) in Strasbourg, France, in 1996. He also holds a history degree and a degree from the Paris Institue of Political Science. In this interview with the Tax Foundation, Mr. Saint-Amans discusses the evolving landscape of international taxation, tax planning, and multilateral cooperation. Specifically, Mr. Saint-Amans highlights areas such as the challenges in pinpointing the location of value added on a geographic basis, the future of the corporate tax base, and how he defines a successful outcome for the BEPS project. This interview is part of our 2015 Tax Foundation Forum series. Tax Foundation: What are the unique factors or drivers underlying the profit shifting phenomenon? Pascal Saint-Amans: The international common principles drawn from national experiences to share tax jurisdiction have not kept pace with the changing business environment. Tax rules are still grounded in an economic environment from 30 or more years ago. Today’s economic environment is characterized by a high degree of economic integration across borders (global value chains), major importance of intellectual property and other intangible assets as value drivers, and by major developments in information and communication technologies. The current national tax rules are not coordinated, so there are gaps and frictions among different countries’ tax systems which are not dealt with by bilateral treaties or in the design of national tax rules. Sophisticated multinational enterprises (MNEs) can take advantage of these technically-legal tax asymmetries. They are often aided by some governments willing to engage in harmful tax practices, which can be addressed with greater transparency and economic substance requirements. TF: How does profit shifting alter the behavior of firms? Saint-Amans: BEPS relates chiefly to instances where the interaction of different tax rules leads to double non-taxation or less than single taxation. It relates to arrangements that achieve no or low taxation by shifting profits away from the jurisdictions where the activities creating those profits take place. It is associated with practices that artificially segregate taxable income from the activities that generate it. These are tax planning activities, not economic business activities. Conducting innovative research and development in one country, then putting the patent into a cash-box in another country where no R&D is done, at an artificially low price, is one example of profit shifting. Shuffling paper around and creative valuations to shift reported profits are much easier than moving research scientists, production facilities, and management. There is tremendous talent being wasted on minimizing taxes based on artificial schemes. There are tremendous resources being misallocated because the tax rules aren’t grounded in today’s economic and business models. Companies are investing in tax mining, rather than real mining. They are investing in devising tax schemes, rather than future business opportunities. These BEPS behaviors result in greater leverage due to excessive interest deductions, distortions in foreign direct investment, and unfair advantages in product competition due to the inappropriate tax savings. The world would be better with firms competing for investments and people based on their innovative ideas rather than on their artificial tax schemes. What specific challenges are there in determining where—in what jurisdiction—income from multinational corporations should be booked? Measuring economic income is difficult in a domestic context, and manyfold more difficult in an international context. Establishing true arms’-length prices between related entities, especially for relatively unique intangibles and services, is a major challenge, but the BEPS Project is making significant progress. Transfer pricing between related entities involves valuations which by their nature are difficult and can be questioned by tax administrations. There are many other difficult issues, such as permanent establishments, hybrid mismatches, excessive interest and others which the BEPS project is tackling. The BEPS project, while strengthening the transfer pricing rules and other international tax rules, is also trying to make dispute resolution mechanisms more effective. It is important that multinational corporations are not caught between two countries trying to tax the same income. The OECD has long been concerned about double or triple taxation of multinational corporations as they invest and grow globally, but we must also be focused on double non-taxation. It is important that multinational enterprises pay the single layer of corporate tax that domestic corporations pay or that other multinational corporations not undertaking aggressive tax planning pay. There will be future debates about who has the jurisdiction to tax multinational corporations’ foreign income, whether source or residence countries. The BEPS project is trying to ensure that the international corporate tax rules are coordinated, rather than individual countries attempting to address their concerns in an uncoordinated fashion. What is the future of the corporate tax base in an increasingly global, technology-driven, and knowledge-intensive economy, where determining the economic nexus of income may be growing in difficulty? You have identified some of the key drivers to why the current uncoordinated national tax rules need fixing. I think the BEPS Project will go a long way in addressing the current major problem areas. Whatever happens over the next 20-30 years, tax administrations and tax policymakers will need to closely monitor and periodically update the international tax rules to be in sync with how the future economy and business models work. It is interesting that many commentators expressed concern about the digital economy and thought special rules were needed for the digital economy. However, after looking carefully at the issue, the BEPS project concluded that the digital economy is increasingly becoming the economy itself, so it would be difficult, if not impossible, to ring-fence the digital economy from the rest of the economy for tax purposes. The digital economy exacerbates BEPS risks, but those risks are being addressed by the other Action Items such as transfer pricing and permanent establishment rules. Some academics have talked about the possibility of corporate cash flow taxes or taxing corporate income at the shareholder level on an accrual basis. Those are worth studying as potential future reforms, but the G20 and OECD leaders want the current corporate income tax to be fixed now. Why and for whom is it important to address profit shifting? The BEPS Action Plan notes that profit shifting harms many different groups. It undermines the integrity of the tax system, so taxpayers deem reported low corporate taxes as unfair, and could adversely affect voluntary compliance of other taxes. Public resources are short-changed and tax administrations have to make extra efforts to ensure compliance. In many developing countries, the lack of tax revenue leads to critical under-funding of public investment that could help promote economic growth. Misallocated resources can also hurt economic growth. Individual taxpayers are harmed when they have to pay higher taxes to make up for the loss from profit shifting. Businesses that operate only in domestic markets, including family-owned businesses and new innovative companies, are harmed when they have to compete with MNEs that have lower tax costs due to profit shifting. MNEs that are not aggressive in tax planning can be put at a competitive disadvantage. MNEs increasingly face significant reputational risks when their effective tax rate is viewed as being too low. Finally, MNEs face the threat of increased multiple taxation and burdensome uncoordinated rules and requirements, unless profit shifting is addressed in an internationally coordinated manner. Finally, it is very important to address profit shifting for international tax rules to sustainably eliminate double taxation. If we do not fix double non-taxation, there is a high risk that countries will walk away from consensus on existing rules, which would jeopardize the investment climate. Equally, fixing the rules will strengthen them and the involvement of G20 countries will also ensure the broadening of their territorial coverage. How can the BEPS project help address profit shifting? The G20/OECD BEPS Project has 15 specific Actions that will address the key issues of profit sharing. I’ve already mentioned many of the Actions, including neutralizing hybrids, strengthening CFC rules, limiting interest deductions, countering harmful tax practices, preventing treaty abuse, preventing artificial avoidance of permanent establishment, and aligning transfer pricing with value creation. In addition, there is a need for greater transparency about BEPS. The Project has proposed improved transfer pricing documentation, including country-by-country reporting by large MNEs, and to require taxpayers to disclose their aggressive tax planning arrangements to tax administrators. It will also include an analysis of the scale and economic impact of BEPS and BEPS countermeasures and tools to monitor BEPS in the future. Finally, it will make dispute resolution mechanisms more effective and expedite the implementation of these changes with a multilateral instrument, so the changes don’t have to be done on a treaty-by-treaty basis. How do you define a successful outcome for the BEPS project, and what are the key steps in reaching that outcome? There are many ways to define success. One will be the acceptance by the G20 Leaders of the BEPS Project in November, where the 15 Action Items will have been developed by consensus of over 50 different countries. Such internationally coordinated action will be a major accomplishment. Another measure of success will be that BEPS is no longer headline-grabbing stories around the world. When businesses are competing fiercely in providing innovative new goods and services in new markets, rather than facing parliamentary scrutiny over their tax affairs, that will mean that the BEPS project has aligned tax with value creation, reduced the perception of unfairness, and improved economic efficiency. Businesses should consider the BEPS project to be a success when they are not having to comply with 100 different disclosure requirements or 150 different anti-avoidance measures. They should appreciate the high compliance costs that will have been avoided. So there are a lot of different measures of potential success. Any outcome requiring political consensus will not be perfect, and will require careful implementation, monitoring, and eventual recalibrations, but I’m looking forward to the approval of the BEPS Project by the G20 Leaders in October as a clear signal of success. How should high-tax, low-tax, developed, and developing countries, respectively, respond to the BEPS initiative? If they are not already involved, and 62 countries are actively involved, they should be ready to start implementing the BEPS Action Items later this year. In the next 1-2 years, what major developments do you expect with respect to the BEPS project? I’m looking forward to the G20 Leaders meeting in Lima in October of this year. Then, hopefully, we can all take a breather for a brief while, then focus on the implementation of the BEPS Action Plan by individual countries. The start of country-by-country reporting for the 2016 tax year will be an important development. Additional guidance on some of the Action Items will be forthcoming in 2016 and 2017, and the multilateral instrument will be moving forward. There are a lot of other important tax issues in addition to the BEPS project, which we have continued to make progress on the past two years, and those projects will get more attention. There is exciting progress in the Automatic Exchange of Information, Tax Inspectors without Borders, and Value-Added Tax guidelines, among many others.
Tax treatment of beer varies widely across the U.S., ranging from a low of $0.02 per gallon in Wyoming to a high of $1.29 per gallon in Tennessee. Check out today’s map below to see where your state lies on the beer tax spectrum. Click on map to enlarge. (See our reposting policy here .) State and local governments use a variety of formulas to tax beer. The rates can include fixed per-volume taxes; wholesale taxes that are often a percentage of a product’s wholesale price; distributor taxes (sometimes structured as license fees as a percentage of revenues); case or bottle fees (which can vary based on size of container); and additional sales taxes (note that this measure does not include general sales tax, only those in excess of the general rate). The Beer Institute points out that “taxes are the single most expensive ingredient in beer, costing more than labor and raw materials combined.” They cite an economic analysis that found “if all the taxes levied on the production, distribution, and retailing of beer are added up, they amount to more than 40% of the retail price.” For more info on alcohol taxes, click here . For more state tax rankings, check out Facts and Figures 2015: How Does Your State Compare? Follow Scott on Twitter.