In this guest contribution, Olaf van der Donk explains how US tax rules encourage base erosion outside the USA. He also identifies a new tax haven, which has never appeared on any blacklist, but which is certainly a contributing factor for BEPS in the EU. Welcome to Atlantis!
Thankfully the European economy, finance and tax commissioner, Pierre Moscovici, feels urged to take action against base erosion and profit shifting (BEPS). His boss Juncker, former premier of the Grand Duchy of Luxembourg, was embarrassed by ‘Luxleaks‘ : a long list of tax rulings reflecting the Luxembourg tax practice; a practice where Luxembourg assists companies, for a small amount of tax, to reduce their tax bills by eroding the tax base in other EU-member states.
The attention should not focus on Luxembourg only, which is a link in these transactions, but rather on those who suffer e.g. the EU Member States and those who gain e.g. multinational companies. About those who suffer we can be brief. The amount of taxes not paid in the various EU member states due to these rulings vastly exceeds Juncker’s 21 billion Euro investment plans.
Who stands to gain from the Luxembourg rulings?
Now on to the question of how and which companies receive the most benefit from those Luxembourg rulings.
The state aid investigation by the European Commission and Luxleaks reveal that predominantly US companies enjoy the Luxembourg rulings. This is remarkable because at first glance the US tax system does not form an incentive to reduce the foreign tax burden. After all, once low taxed foreign profits are distributed to US group companies, the difference between the foreign and domestic tax on these profits is taxed. The US tax system aims to tax all profits, no matter where they arise, at the same corporate tax rate of 35%. This gives rise to the first possibility of tax planning by US multinational companies: the repatriation of foreign profits is deferred. Back in 1962, President Kennedy thought this deferral to be undesirable and introduced the so-called Subpart F rules, an anti-deferral regime requiring certain foreign income to be taxed at US rates regardless of whether the profits have been repatriated.
Subpart F incentivizes minimization of non-US tax…
The Subpart F rules have proved to be of little effect. A great number of US multinational companies make the headlines because of their ability, in spite of the Subpart F rules, to keep their foreign profits offshore and untaxed. This is not an insider’s educated guess, this has been researched extensively and published by a senate commission and is clearly stated in the annual reports of the relevant companies. The bottom line is that current US tax rules form an incentive to minimize foreign taxes; the current Subpart F rules do not and cannot change this.
… and the ‘check the box rules’ don’t help
The foremost component of the ineffectiveness of the Subpart F rules are the so-called check the box regulations. These regulations create a possibility for US multinational companies to decide if foreign entities are considered transparent or non-transparent for US tax purposes. Combined with other regulations these check the box rules are instrumental in avoiding the Subpart F rules. Again, this phenomenon has been widely known for years by the US legislators and the US tax authorities (IRS).
This results in most US multinational companies benefitting greatly when eroding their foreign tax base with deductibles such as interest and royalties; there is no corresponding taxation of this income in the US. So with respect to their foreign profits, these US multinational companies can act in a tax haven. This bothers the American citizens. Why do these US multinational companies not pay the normal US tax rate of 35% on their worldwide profits? The harsh reality is that politics keeps this system alive. After all, it’s a cheap way to reduce the high corporate tax rate to a more friendly rate at the expense of foreign nations.
Atlantis: the US supported tax haven
Back to an EU-perspective; the tax base of EU-member states is eroded by payments, possibly through Luxembourg, to subsidiaries of US multinational companies without any corresponding taxation. The profits are absorbed somewhere in the Atlantic, Atlantis I suppose, where a US supported tax haven lies.
This issue deserves the full attention of EU commissioner Pierre Moscovici. The EU needs to be protected from this kind of tax base erosion where there is no corresponding taxation. Sadly though the current EU actions such as the re-launch of Common Consolidated Corporate Tax Base, the transparency boost and the draft Anti Tax Avoidance Directive will not put a final halt to these practices The anti-BEPS initiatives of the OECD and the G20 have a too narrow scope to tackle this issue.
My advice to Pierre Moscovici would be to introduce the fair rule that deductions can only be claimed in the EU if there is an immediate mirroring equal taxation in the EU or outside. This would make most of the rules proposed superfluous. This reciprocity is at the heart of every national tax system. Why shouldn’t it be at the heart of our global tax system?
This is the entirely personal view from Olaf van der Donk
Illustration by Fondo Antiguo de la Biblioteca de la Universidad de Sevilla from Sevilla, España – “Situs Insulae Atlantidis, a mari olim obsorptae ex mente AEgyptiorum et Platonis discriptio.”, CC BY 2.0.