Global Business and International Taxation.

1. Global Business and International Taxation.

The first TNCs had already emerged by 1914, resulting from the growth of world trade and investment, and the increased concentration of large­scale business institutionalised in the corporate form, in the period 1865­1914, from the end of the American Civil War to the outbreak of the First World War. However, long­term international investment at that time primarily took the form of loans, in particular the purchase of foreign, especially government, bonds. It has been estimated that of the total 44 billion of world long­term foreign investment stock in 1914, no more than one­third, or some 14 billion, could be classified as foreign direct investment Dunning 1988, p.72. Even this figure includes as investments involving `control ¶ many which were significantly different from subsequent international direct investments. British lenders concerned with the high risk of foreign enterprises used syndicated loans, for example to invest in US breweries in the 1890s Buckley Roberts 1982, 53­6. A common pattern in mining was for a syndicate to secure a concession to be transferred to a company floated for the purpose, thus securing promotional profits as well as a major stake for the founders, as for example the purchase of the Rio Tinto concession from the Spanish government by the Matheson syndicate in 1873 Harvey and Press 1990. Similarly, Cecil Rhodes raised finance from a syndicate headed by Rothschilds to enable the centralization and concentration of Kimberley diamond mining after 1875 under the control of De Beers Consolidated Mines; and Rhodes and Rudd again raised capital in the City of London for the development of gold mining, setting up Gold Fields of South Africa Ltd. in 1887, and in 1893 Consolidated Gold Fields, to pioneer the mining finance house system, in which control of the companys affairs typically was divided between operational management on the spot and financial and investment decisions taken in London. These were the successes among some 8,400 companies promoted in London between 1870 and 1914 to manage mining investments abroad Harvey and Press 1990. A high proportion of foreign direct investment prior to the First World War was directed to minerals or raw materials production in specific foreign locations, and did not involve internationally­integrated activities. These were certainly the major characteristics of British international investments, which were dominant in that period: Britain accounted for three­quarters of all international capital movements up to 1900, and 40 of the long­term investment stock in 1914 Dunning, in Casson 1983. Indeed, by 1913 the UKs gross overseas assets were worth nearly twice its gross domestic product, and the gross income from abroad including taxes paid in the UK by foreign residents has been estimated at 9.6 of GDP Mathews, Feinstein and Odling­Sime 1982. Some 40 of British investment was in railways, and a further 30 was lent directly to governments. Nevertheless, it was in the period 1890­1914 that the first TNCs were established, in the sense of international groups of companies with common ownership ties Wilkins 1970, Buckley Roberts 1982. However, the coordination of their activities was relatively undeveloped: they were indeed referred to at the time as `international combines ¶ and there was not always a clear distinction between an international firm and an international cartel Franko 1976. In the 1920s there was a resumption of foreign direct investment, especially by US firms in some new manufacturing industries, notably automobile assembly. The crash of 1929 and the ensuing depression caused fundamental changes. Not only did it result in the virtual ending of new net international investments until after 1945, it caused changed attitudes which affected the prospects for its resumption. State policies, especially exchange controls, as well as the caution of investors, limited international capital movements. After 1946, new foreign investment was largely by major corporations, usually building on previous ties with specific foreign markets. Above all, this direct investment characteristically involved relatively little new outflow of funds: the investment frequently took the form of capitalization of assets such as patents and knowhow, with working capital raised locally, and subsequent expansion financed from retained earnings Whichard 1981, Barlow Wender 1955. This investment growth was facilitated by tax treaties whose basic principles emerged before 1939 and which quickly spread after 1945. These treaties did not directly tackle the issue of allocation of the tax base of internationally­organised business among the various jurisdictions involved. Instead, they allocated rights to tax specific income flows: the country of source was essentially limited to taxing the business profits of a local branch or subsidiary, while the country of residence of the parent company or investor was entitled to tax its worldwide income from all sources, subject at least to a credit for valid source taxes. This was intended to ensure equality of taxation between investment at home and abroad; however, capital­importing countries and TNCs argued for primacy of source taxation, to ensure tax equality between businesses competing in the same markets regardless of the countries of origin of their owners see Chapter 2 below. This debate viewed investment as a flow of money­capital from a home to a host state: it was therefore already irrelevant to the growth of direct investment in the 1950s, which took place largely through reinvestment of retained earnings and foreign borrowing; and became even more inappropriate with the growth of global capital markets from the 1960s. TNCs pioneered the creative use of international company structures and offshore financial centres and tax havens for international tax avoidance. Thus, they were able to reduce sometimes to zero their marginal tax rates, at least on retained earnings Chapters 5 and 6 below. This in turn tended to undermine the fairness and effectiveness of national taxation Chapter 4 below. The tax authorities of the home countries of TNCs responded by measures attempting to claw back into tax the retained earnings of `their ¶ TNCs, initially with unilateral provisions which were later coordinated Chapter 7 below. These have met with partial success, but have also encountered great technical and political difficulties, reflecting continued jurisdictional problems. International arrangements for taxation of international business still assume that, subject to a reasonable right for source countries to tax genuine local business activities, the residual global profits belong to the `home ¶country of the TNC; but there are no clear criteria for the international allocation of costs and profits between home and host countries Chapter 8 below. More seriously, however, this assumption is becoming increasingly inappropriate as TNCs have become much more genuinely global, combining central strategic direction with a strong emphasis on localization and diversity, with complex managerial structures and channels aiming to combine decentralised responsibility and initiative with global planning Bartlett and Ghoshal 1989. Shares in them have become internationally traded and owned; they often draw on several centres for design, research and development located in different countries in each major region; and even their top managements are becoming multinational. Businesses such as banks and stockbrokers involved in 24­ hour trading on financial markets around the world have become especially global, and able to take advantage of even tiny price differences in different markets. While the international coordination of business taxation has come a long way, it seems still to lag significantly behind the degree of globalization developed by business itself.

2. The Rise of Business Taxation