Tax havens have long existed in the popular imagination as sun-kissed offshore islands in exotic locations. The LuxLeaks scandal, however, has exposed that belief as a fallacy. It has become apparent that Western nations are competing to turn themselves into tax havens with the land-locked duchy of Luxembourg leading the pack. Despite its small population of just 550,000, Luxembourg has the world’s highest economic output per capita. In 2013, it was US$112,473, roughly double the US level. Luxembourg’s battery of lax financial and tax regulation has come in the wake of its prosperous financial sector. It has turned the Duchy into a “magical fairyland” for large corporations seeking to pay less tax.
Law professor Sol Picciotto, an expert in international tax law from Lancaster University, said action to stamp out the abuses of tax havens needed to be coordinated at national, regional and international levels. At European level, the Code of Conduct on Corporate taxation was supposed to solve the problem, but the LuxLeaks revelations revealed it as toothless.
“The Code requires evaluation of ‘harmful tax practices’, but this is done by an intergovernmental group, which is reluctant to intervene against national measures and has to agree unanimously. The result is that when they fail to reject a tax-reducing measure, other states also introduce it,” Picciotto said.
The upshot of the unwillingness, or incapacity, of regulators to act is a “race to the bottom”. International states compete with each other to lower their corporate tax rates to attract foreign companies. Ireland, for example, has exploited its famous “double Irish” tax loopholes. The Netherlands, Switzerland, Belgium, Gibraltar and Bermuda, and many others, have established similar schemes. The UK has been creating a “patent box” tax incentive to reduce the effective UK corporation tax rate to 10%, as compared to 21%, on income attributable to patents. Shaxson describes the UK move as “foolish, nasty, disingenuous and hypocritical corporate tax offerings, in the hope that by bowing down to mobile capital in a sufficiently prostrate fashion, some corporate bosses will shuffle a few profits in its direction”.
Professor Picciotto has plotted a way out of the shambles of international tax law. In an influential paper, he proposed a “unitary” approach to taxation that would compare the profits shown in the UK, or any other country, with the share of the companies’ worldwide business actually conducted in the UK. If they were seriously out of line, the UK companies’ taxable profits would adjust accordingly. Although international tax regulations have become extraordinarily complicated, and need rewriting, Picciotto said the building blocks are already available in both Europe and the US. In the meantime, tax authorities could be more ingenious and aggressive in using the weapons already at their disposal.
A European proposal for a unitary tax policy presented to the Commission in 2011 and approved by Parliament is the Common Consolidated Corporate Tax Base (CCCTB). Of course, there was opposition by states such as Ireland, Luxembourg, the Netherlands and the UK. But there are signs that the European Commission may be moving towards accepting the proposals.
The EC’s 2015 work programme says this about corporate tax: “The Commission will set out an Action Plan... to move to a system on the basis of which the country where profits are generated is also the country of taxation, including in the digital economy, which also requires agreement on a Common Consolidated Corporate Tax Base. In this context, the Commission will also make very swiftly a proposal on the automatic exchange of information between tax authorities on cross-border tax rulings.”
Picciotto said: “The CCCTB is the only effective solution and the Commission recognizes that, so they are re-launching ‘consultations’, but in the meantime are planning to try to align EU countries on common implementation of the OECD BEPS recommendations. To try to resolve the LuxLeaks issue, they propose a procedure for notification of rulings. Much will depend on how this is formulated.”