20 December 2021
The Great Tax Robbery
Richard Brooks’ 2013 book The Great Tax Robbery is a whirlwind tour of some of the techniques that companies and individuals use to avoid paying taxes. These techniques are technically legal – though they are often at odds with the spirit of laws – and so represent tax avoidance rather than illegal tax evasion. The book focuses primarily on how these techniques affect tax revenues in the UK, but tax avoidance is inherently a global phenomenon. I’m far from an expert in this area, but here’s a distillation of the kinds of techniques that Brooks discusses.
Multinational companies can legally reduce their global tax burden by employing some kind of base erosion and profit shifting (BEPS) scheme. BEPS schemes allow companies to artificially move where profit is recorded from a high-tax jurisdiction to a low-tax one, so that the tax owed on it is less.
One BEPS technique is to lend money between companies within the same multinational group. For example, say a group wants to reduce its tax bill from operations in country A, which has a high corporate tax rate. It will set up a shell company in country B, which is carefully chosen because it has a low tax rate on received interest payments. It can transfer reserve funds into the country-B shell company tax-free via share purchases. The shell company in country B then makes big loans using these reserves to the group’s company in country A, which will make interest payments that can be deducted from its taxable income. These interest payments stay within the multinational group, and are taxed at country B’s low rate when they’re received by the shell company there. The difference between country A’s corporate tax rate and country B’s received interest tax rate on these interest payments is thus deducted from the group’s global tax burden.
This is effectively loaning yourself money and deducting the interest payments, which no tax code would accept. But, in practice, there are all kinds of complicated structures to make the scheme technically legal, obfuscate what’s really going on, and avoid countermeasures like international withholding taxes.
Another BEPS technique is to misuse transfer pricing in global supply chains. Say a multinational company makes a bar of chocolate in country A for $1 and sells it in country B for $10. The corporate tax rate in country A is high, but it’s low in country B. To minimize its tax bill, the company might sell the bar of chocolate from its production subsidiary in country A to its distribution subsidiary in country B at a transfer price of $2. If the tax rate in country B were low and the one in A were high, it might sell the bar between countries A and B at a transfer price of $9. These arrangements avoid tax in the country with higher rates; they don’t reflect the actual amount of value being added at each stage in the supply chain.
Transfer mispricing this explicit is easy for a tax authority to detect and stop, but things aren’t as clear-cut in the real world. Multinational groups can achieve similar benefits by, for example, parking their valuable intellectual property in a low-tax country and having group companies in higher-tax jurisdictions pay high fees back to the controlling company to use it. The group companies then effectively operate as contractors making a low profit, which lowers the group’s global tax burden.
For individuals, a tax-avoidance trick is to keep wealth outside of one’s home country and take out loans against it. For example, someone might establish an offshore trust in a low-tax jurisdiction, kept at arm’s length so that their home country can’t tax it. Or they might take advantage of some legal status, like the UK’s non-domiciled status, to keep assets outside of their home country tax-free. They then take out loans at home, on which they don’t have to pay tax, against their offshore wealth. They use the lent cash to fund their lifestyle, and can take out additional loans to service interest payments. In practice, someone would have to use convoluted schemes to bypass laws designed to prevent this kind of behavior.
A similar technique is possible for individuals that have significant holdings of valuable assets that appreciate over time, like stocks or property. Rather than selling the assets and paying taxes on realized capital gains, they can take out repeated loans, which are not taxable, using the assets as collateral. This technique, known as “buy, borrow, die,” was made widely known by ProPublica’s 2021 report on how the richest Americans avoid income tax.
Tax avoidance not only deprives governments of tax revenue, but it also damages industry by incentivizing global companies to artificially limit their operations in higher-tax jurisdictions. However, rather than blaming companies and individuals for legally reducing their tax burden, it’s more productive to examine the system that allows them to do so.
Tax avoidance is possible in part because the global tax system is really complicated. Tax treaties, many of which were written in a different, less-connected era, create an arsenal of complex tools for creative accountants to exploit. And, as new treaties come into effect, they tend to expand rather than reduce this arsenal. For example, foreign aid for developing countries can be tied to their adoption of policies that allow global companies to avoid paying them taxes.
There are also a number of incentive problems. For one thing, lax policies in tax-haven countries actually boost their tax revenues while reducing the revenues of other, higher-tax countries, so there isn’t any inherent incentive for them to change. Countries also compete with each other by reducing their tax rates as much as possible to attract rich individuals and corporate headquarters. While the countries that win this race to the bottom appear prosperous and business-friendly to the rest of the world, the wealthy entities they attract contribute relatively little to their tax revenues. Furthermore, tax policies in developed countries are often shaped by advisors from the very companies that they are meant to govern. This unsurprisingly leads to policies that are amenable to tax avoidance.
Different approaches have been proposed to improve the global tax system. Recent efforts to introduce a global minimum corporate tax rate show some promise, but implementing plans that directly change the tax rates of individual countries is likely to be fraught with challenges. Some experts believe that increased transparency requirements for multinational companies would indirectly deter them from avoiding tax. Schemes to improve transparency would require global groups to publicly report information about which jurisdictions their profits come from as well as how much tax they pay, how many employees they have, and how many assets they own in those countries.