The Interaction of National and International Equity

1. The Interaction of National and International Equity

A global approach would have required these issues to be tackled head on, as was shown by the analysis in the Carroll report of the fractional apportionment method see ch.1 above. Fractional apportionment would need international agreement both on the general basis for the establishment of the integrated accounts of a global business, as well as on the formula for the fractional apportionment of the overall profit. This would require the global enterprise to accept an obligation to report on its worldwide business to every national tax administration. For their part, national authorities would have to accept an allocation of tax revenue to them that was not only determined by the agreed formula, but also depended on the profitability of the enterprise as a whole. A country would be obliged under this method to accept that no tax would be due to it from an enterprise making a loss globally, even if it considered that the local branch was operating profitably see Chapter 1 section 5 above. Clearly therefore, legitimation for the global approach would have to be established at the international level. However, the legitimacy of direct taxes on income rested on the principle of equality of treatment of taxpayers, which was rooted in the national state. Furthermore, and perhaps more seriously, such a process of international legitimation would have to be based on a new approach to equity. The Carroll report showed that the experience of the fractional apportionment method, in particular in Spain, was that neither the determination of the global accounts nor the fractional apportionment could be carried out on the basis of general principles or a single formula. The particular characteristics of different industries, as well as of different firms, would require a case­by­case evaluation, which was carried out in the Spanish system by a jury. This in turn would have undermined the principle of equality of taxpayers embedded in national tax systems. The majority opinion of those experts participating in the Carroll study therefore favoured separate accounting, despite the major difficulties it entailed, because the immediate establishment of a global approach and fractional apportionment posed too many problems. The German report summed the matter up by arguing that although a global approach was an unattainable ideal, a nationally­based system should work towards it: It may be said that the method of fractional apportionment Verteilung is preferable, both from the viewpoint of fairness, which is identical with just taxation, and from the viewpoint of diminishing as much as possible double taxation. This method will always be of importance in practice because, in numerous cases, the separate assessment of income will not be possible. Unquestionably the ideal, and therefore perhaps the unattainable, goal would be to determine the total profits of the entire enterprise on the basis of uniform law and to divide the total profits on agreed principles. ... In international intercourse, a uniform determination of total profits is not possible, in view of the fact that there is no harmony between the tax legislation of the various countries. It would be possible for each interested State, however, even in carrying out its own internal law, to determine the total profits in accordance with rules of assessment applicable in its case. The adoption of some system of reciprocal fiscal assistance might considerably lessen the difficulty of determining the total profits ... An agreement regarding the principles of allocation would remain essential. Certain principles of allocation might be evolved in practical experience ... but they would probably have to be different for the various categories of enterprises and ... experience might lead to the establishment of certain well­defined allocation percentages Teilungsquoten. League of Nations 1933­III, p.122. However, the separate accounting method which was embodied in the international treaty system attempted to reinforce the principle of taxpayer equality by establishing the international principle of non­discrimination between national and foreign­owned firms. This notion of taxpayer equality requires the disaggregation of the global unity of the international business, and the separate treatment of its separately incorporated subsidiaries or permanent establishments located in each country. However, this approach does not resolve but postpones the problem of inter­state allocation. Each state must have the power to scrutinise and if necessary rectify the arms length accounts. If such rectification is actively pursued by national tax authorities, it will result in renewed problems of double taxation, unless the basis of such rectification is internationally agreed. This results in case­by­case negotiations involving national tax authorities and firms, as well as attempts to evolve general principles based on experience. As the discussion in subsequent chapters of this book will show, this has been the pattern of emergence of an increasingly internationalized system of tax administration in the past two decades, which resembles that prognosticated by the German report of 1933 quoted above. It could be that international businessmen would also favour the ideal of a global unitary approach, in order to establish a uniform and manifestly fair application and allocation of taxation: this was certainly the view expressed by Sir William Vestey as early as 1919, in the comments quoted above Chapter 1 section 3a. In practice, however, they have generally opposed such an approach, on the grounds that the unlikelihood of broad international agreement on basic principles would exacerbate rather than resolve the problem of multiple taxation. This viewpoint was again forcibly expressed in the campaign led by major European TNCs in the 1980s against Worldwide Unitary Taxation by state tax authorities in the USA, which will be discussed in chapter 9 below. Instead, global business has preferred to find an accommodation with the system based on separate accounting, which with its multiplicity of perspectives and arrangements continually generates overlap and conflict. What can clearly be seen, however, is that this accommodation rests on the emergence of international tax planning, which enables internationally­organised business to minimise its exposure to tax by taking advantage of the interaction of national tax systems, as well as of differences between bilateral tax agreements. In particular, as will be discussed in the next two chapters, the TNC has been able to use the network of double tax treaties, as well as the creation of captive state entities as tax havens, in order largely to avoid taxation of retained earnings. This is an example of the more general paradox, that the development of nationalism and national regulation does not retard but in some respects stimulates the growth of internationally­ organised business, especially TNCs. Globally­organised firms are able to take advantage of differences in national regulation and loopholes in international regulatory coordination, and therefore have preferred to oppose and even hinder the development of adequate globally­oriented international systems of business regulation or control. However, it has become increasingly clear in recent years that a new approach is needed to tackle the problem of international business taxation. International tax planning, especially by the exploitation of the tax treaty system and of tax havens, has greatly undermined both the effectiveness as well as the legitimacy of the international tax arrangements. As we have seen, these arrangements essentially rest on a compromise which limits taxation at source to the business profits of a permanent establishment or subsidiary, while giving the country of ultimate residence jurisdiction to tax repatriated investment income. The use of the offshore haven not only allows retained earnings to be accumulated without being taxed, it also permits reduction of taxable business profits by charges for services or overhead costs management costs, research and development, insurance, finance which can be made payable to a conveniently located subsidiary. Such arrangements have become increasingly common not only for TNCs but even for nationally­based businesses, which can reduce their taxable profits by using for example `captive ¶ offshore insurance companies. This has led to increased efforts by the main capitalist countries to claw back into taxation profits accumulated in tax havens. National measures against tax haven subsidiaries, defined in various ways as Controlled Foreign Corporations CFCs, have been combined with a drive to improve mutual assistance between tax authorities and develop a coordinated approach to the taxation of global business. The generalization of national measures against CFCs has weakened the cogency of the argument made by international business at home, that such provisions undermine their position in foreign markets vis­a­vis competitors. 1 However, TNCs have been on stronger ground in attacking the validity of the assertion of jurisdiction by their home country over their foreign profits. This has led to complex provisions in the measures against CFCs to avoid taxation of profits that could validly be said to have been earned abroad, and these complexities inevitably create further loopholes to be 1 See, for example, Board of Inland Revenue 1982, para.14; Deutscher Bundestag 1986. discussed in more detail in chapter 7 below. The underlying difficulty is still that of finding an effective and legitimate way to divide nationally a profit that has been created by global activities. Although increased international administrative coordination can try to deal with the symptoms of this problem, it is unable to resolve the fundamental cause see Chapter 10.

2. The International Crisis of Tax Legitimacy