Unprecedented: Kenya-Mauritius tax treaty ratification struck down in court

Back in 2014 I was in touch with Nairobi-based Tax Justice Network Africa, as they prepared to take the Kenyan government to court over its tax treaty with Mauritius, signed in 2012. The treaty seemed a pretty poor deal for Kenya, lacking adequate anti-abuse protection, preventing Kenya from imposing withholding tax on technical fees, and restricting its ability to impose capital gains tax, which it was in the process of introducing. It has taken more than four years, but on Friday the High Court ruled, and it has declared the ratification of the treaty in Kenya to be invalid.

This is a landmark case, because tax treaties are usually technical instruments that undergo only cursory parliamentary scrutiny, if any at all. For a civil society organisation to challenge one in court, let alone win, is quite astonishing. Kenyans I know were excited by the possibilities of the country’s new constitution, and this shows their optimism was not misplaced!

TJN-A argued that the treaty was unconstitutional for two reasons: in content terms, the treaty would lead to an unacceptable loss of revenue; in process terms, it should have been subject to public consultation and approval by parliament. The court actually sided against TJN-A on both counts, stating among other things that it should have provided figures for the revenue lost (which should make it untenable for governments to refuse to do the same) and that consultation with Kenya Revenue Authority constituted adequate public participation. The ruling is that the statutory instrument giving effect to the treaty should have been laid before parliament, and was not. I disagree with a lot if what is in this judgement, but its political impact is nonetheless huge and welcome, as this message from TJN-A’s Alvin Mosioma illustrates:

Here are a few documents for reference:

TJN-A’s press release summarising their argument

My expert opinion submitted to the court by TJN-A (pdf)

The court ruling (pdf)

TJN-A’s press release on the judgement


Response to the OECD consultation on taxation of the digital economy: taking the politics seriously

Yesterday I was part of a group of political scientists who made a submission to the OECD’s consultation on taxation of the digital economy. The text of our submission, also available as a PDF document, is below, first published on Rasmus Christensen’s website.

The undersigned are a group of political science academics working on issues of international taxation. Such a coalition has rarely involved itself in the OECD’s technical consultations. This submission reflects two compelling factors. First, the global tax system and its governance stand at a critical junction. The current debate on solutions to the tax challenges of digitalisation has the potential to shape global tax policy and its outcomes for countries and citizens across the world for decades to come – and this has motivated us to prepare this submission. Second, our research offers important insights that can help the global tax policy community pursue sustainable reforms. Below, we offer some general comments before moving to specific responses to the consultation questions.

Vincent Arel-Bundock, Université de Montréal; Rasmus Corlin Christensen, Copenhagen Business School; Lukas Hakelberg, University of Bamberg; Martin Hearson, London School of Economics and Political Science; Wouter Lips, Ghent University; Thomas Rixen, University of Bamberg; Indra Römgens, Roskilde University and Radboud University; Leonard Seabrooke, Copenhagen Business School; Laura Seelkopf, Ludwig-Maximilians-Universität München; Saila Stausholm, Copenhagen Business School; Duncan Wigan, Copenhagen Business School

General comments

We wish to highlight three key considerations for effective and sustainable action on the tax challenges of digitalisation.

  1. The objectives of the consultation and the taxation of the digital economy policy discussion more broadly are as much political as they are technical. By ‘political’ we mean that the drivers of this consultation are rooted in the popular politics of taxation, and that the political implications of policy solutions are not incidental or secondary considerations. This includes the consequences for inter- and intra-national (re)distribution, for citizens’ experiences of fiscal systems, for the viability of global tax governance, and for the wider economic transformations occurring as a result of digitalisation, where tax policy will help determine winners and losers. Historically, the relative isolation of international tax policy-making from popular politics helped produce a remarkably stable cross-border tax system. However, isolation challenges responsiveness to political demands for change. In today’s context, international tax politics has become both more mainstream and highly politicized. The risks of not engaging proactively with diverse political stakeholder interests – including ordinary citizens, civil society, business groups (large and small), academia, etc. – are significant. For instance, one reason for the recent struggles of multilateral trade cooperation is that the trade agenda extended into areas where social and environmental concerns implicated new political actors. Yet, the multilateral regime continued to treat these issues through a narrow trade lens. Technical approaches to taxing the digital economy are unlikely to be sustainable unless their substance and the process by which they were produced are perceived as fair by a broad range of stakeholders.
  • The recent expansion of the OECD’s tax policy-making institutions to include non-OECD members brings important dilemmas. While this expansion represents an important step towards global inclusiveness and accountability, it also calls into question the balance between inclusiveness and the coherence of the global tax system itself. Global economic shifts are raising the profile and influence of historically marginalised countries in global economic governance. In some cases, incrementalism has been enough to satisfy ‘rising powers’; in others, dissatisfaction with the status quo has led to the pursuit of outside options or to stalemate over wholesale reforms. The balance between building on the work undertaken over decades and responding to these new challenges is critical for achieving effective and coherent global action on the tax challenges of digitalisation. Institutional expansion at the OECD challenges the historical division of labour between the OECD and other bodies for international tax cooperation (such as the United Nations), which allowed one group of like-minded countries to move quickly while the process of global consensus-building could take place at a necessarily slower pace. We believe that the success of institutional expansion is contingent on a serious reconsideration of policies and processes that were not historically designed to accommodate the interests of emerging and developing countries. To turn again to the example of international trade cooperation, developed countries’ unwillingness to respond to developing countries’ longstanding concerns about agricultural protectionism was a major contributor to the breakdown of the talks.
  • The move towards binding, global cooperation on taxation creates costs as well as benefits. The reluctance of governments to enter into binding cooperation has shaped the global tax system for a century, at times hindering effective action and enabling harmful tax competition. Commitments to strong cooperation on international taxation are a key prerequisite for governments’ abilities to make and enforce fiscal policies in their own interests. Moreover, given the significance of the tax challenges of digitalisation, and the increasing willingness of states to act unilaterally, the risks of furthering cross-national mismatches and unintended externalities (in the form of double taxation or double non-taxation) in the international corporate tax system are high. Nonetheless, setting the bar too high creates a risk of short-term failure, as the OECD experienced in the past with the Multilateral Investment Agreement, or long-term instability as countries defect from binding agreements. In this context, the sustainability of any policy option depends on managing effective cooperation that prevents harmful tax competition while recognising that it is contingent on meeting the interests and expectations of all its members, and limiting incursions into the design of national tax systems when such a balance is not feasible. Moreover, it is important that each government is open and transparent with its domestic stakeholders about the likely costs and benefits of entering such cooperation

Specific comments

What is your general view on the proposals? In answering this question please consider   the   objectives,   policy   rationale,   and   economic   and   behavioural implications.

  • Distributional considerations should be foregrounded. Discussing the three suggestions on revised profit allocation and nexus rules, the consultation document usefully acknowledges that while they all have the objective of recognising value created in market jurisdictions, their implications for shifts of taxing rights are different. These differences, which we take to be highly significant, have implications for the considerations on effective action outlined above. Of the three proposals, the ‘significant economic presence’ idea, given its greater sectoral scope, seems to offer the potential to shift taxing rights covering most profit, although this would naturally be contingent on the final design of the mechanics.
  • The emerging differences between taxation on the basis of source and residence vs. market/destination merit further consideration. The Inclusive Framework is committed to considering solutions that reallocate the tax base. In today’s economy, the distinction between source and residence taxation is indeed increasingly unhelpful; yet, there is a risk that a singular emphasis on ‘market jurisdictions’ may unduly disadvantage traditional source jurisdictions without sizeable markets and limited purchasing power. The interests of these jurisdictions – often less powerful and underrepresented at the OECD – should receive significant attention.

How would you suggest that the rules should best be co-ordinated?

  • Coordination design is contingent on meeting stakeholder expectations. A number of implementation measures are available to the Inclusive Framework, including standard-setting, peer review, blacklisting and sanctioning, which have proven effective to varying degrees. These measures differ in their balancing of binding ‘lock-in’, national flexibility to pursue government policy choices (especially as regards raising effective capital taxation), and international redistribution. All of these critical considerations are interrelated and must be taken into account together in coordination design. For instance, the reopening of the distributional debate on allocation issues has become necessary because of the challenges faced by the current international tax system in enforcing effective capital taxation. Thus, on the one hand, should a workable and commonly agreeable solution that matches all members’ distributional interests and national policy choices be found, strong and binding cooperation is preferable. If, however, and we see a real risk of this, the envisaged solution is unfavourable to emerging/developing countries (see previous paragraph), then strong and binding cooperation is undesirable.

What could be the best approaches to reduce complexity, ensure early tax certainty and to avoid or resolve multi-jurisdictional disputes?

  • The consultation should seek to refocus public debate away from ex post criticism of the outcomes of tax rules once they are implemented, and towards ex ante debate over rules as they develop. A core component of tax certainty is political stability – the certainty of a tax position given the likelihood of future political action affecting that position. Such action may be in the form of legislative initiatives that change tax results, changed administrative practice, or public pressure on companies to alter approaches to tax planning. The stability of any policy solution(s) on the tax challenge of digitalisation developed by the Inclusive Framework depends critically on engaging with the voices and objectives of a broad range of stakeholders, and on a reconsideration of entrenched interests. In this context, the limitations of the consultation to primarily consider ostensibly technical questions on ‘aligning value creation’ may hinder positive engagement with a broader range of stakeholders. Such consultation design erects barriers of language and expertise that limit diverse engagement, closing off stakeholder engagement. In turn, this may negatively affect the likelihood that its policy outcomes will be broadly seen as fair.
  • Deeper and broader stakeholder engagement. In this context, we encourage the OECD and the Inclusive Framework to pursue more proactive engagement with non-traditional and diverse stakeholders in relation to the tax challenges of digitalisation. At the national level, this should mean an active approach to education and consultation with stakeholders around national negotiating positions, and parliamentary debate over the adoption of new rules that moves beyond the rubber-stamping that has thus far characterised the adoption of BEPS outcomes by most countries. At the multilateral level, this would go beyond the currently institutionalised TUAC and BIAC partnerships and the few substantive consultation letters received from non-expert interests, and would include sustained interactions on questions of the political implications of the tax challenges of digitalisation, including the inter- and intra-national distributional implications. Inspiration could, for instance, be drawn from other policy domains of the OECD where non-state actors have been successfully integrated through increased voice and access channels, implementation partnerships, institutionalised reviews, etc. More generally, we suggest the Inclusive Framework could – at a minimum – set out its formal ambitions for the involvement and diversity of stakeholders in global tax policy-making, and specific initiatives to achieve these ambitions.

Transnational expertise and the expansion of the international tax regime

Hearson, M, 2018. Transnational expertise and the expansion of the international tax regime: imposing ‘acceptable’ standards. Review of International Political Economy 25(5):647-671.

We are living through a period of instability and change in the international tax regime, perhaps unprecedented in its depth and duration. It’s driven by economic and political changes, such as austerity politics, the digitisation of the economy, and the rise of China and other emerging powers. To understand the impact of these pressures on the institutions of tax cooperation, we need to know how the politics at international level works, and we have two complementary lenses to do so. One focuses on conflicts and alliances between states with different preferences: developed versus developing, offshore versus onshore, US versus Europe, and so on. The other takes a sociological approach, studying the transnational policy community that makes international tax rules and its interactions with other actors such as politicians and campaigners. To explain why the OECD, G20, EU or UN have reached a particular conclusion, we probably need to use both of these lenses.

But how do states arrive at their national positions? Those positions set the parameters for subsequent transnational discussions, but they also determine if and how states will implement international agreements. For example, with whom will they negotiate bilateral tax treaties, and on what terms? The same sociological lens is important here, because national tax policy is made by a community of people, many of whom are also involved in tax standard-setting at the OECD and elsewhere. At both national and international levels, international tax has historically been an obscure topic, the preserve of this small community of experts. Every so often – as in recent years – the community faces a conflict with others who aren’t steeped in the principles underlying the tax system, nor its technical details. Such conflicts can play out at the national level, as well as in the transnational sphere.

In an article published over the Christmas break, I explore this using archival documents that show how the UK formed its policy towards bilateral tax treaty negotiations with developing countries. I reach two important conclusions:

  1. Often it was the UK, rather than its developing country negotiating partner, that initiated and drove forward negotiations. The UK’s aim was to reduce the tax paid by British businesses abroad, making them more competitive in comparison to firms from other countries. So we can’t explain the expansion of the international tax regime into developing countries solely through a focus on developing countries’ actions.
  2. Tax experts, from the Inland Revenue and the business community, dominated policy formulation. They saw tax treaties as a means to lock developing countries into ‘acceptable’ OECD tax standards, a long game designed to protect British businesses from anything unconventional. Meanwhile, their non-expert counterparts in other government departments and businesses had different priorities derived from a focus on short-term tax gains. They were mostly unable to influence policy, however, indicating that business power over tax policy depends a lot on expertise.

I’ve uploaded all my photographs from the archive files that I cited into a zip file (warning: it’s very large: 660 pages and 273MB). Below is a selection to illustrate the argument.

First, Alan Lord, Deputy Chairman of the Board of Inland Revenue, sets out the tax expert view in 1976:

Here is an extract from the minutes of a typical meeting between the Inland Revenue and tax professionals from British businesses. As can be seen, businesses are being consulted not just about which countries to negotiate with, but also about the sticking points in individual negotiations – in this case Malaysia.

Below is one of my favourite exchanges, from a few months later. In contrast to the open attitude to the CBI tax committee, the same Inland Revenue civil servant (Ann McNicol, now Ann Smallwood) refuses to share even a list of current negotiations with other departments.

Extract from a letter from Smallwood, Inland Revenue, to Harris, Foreign and Commonwealth Office, 1973. Click to see the whole document.

Smallwood’s letter provokes a round of very angry memos within those departments, of which this is a good example.

Extract from a memo by Kerr, Foreign and Commonwealth Office, 1973. Click to see the whole document.

A particular bone of contention between the two groups (Inland Revenue and the CBI tax committee on the one hand, Foreign Office, Departments of Trade and Industry, and their business interlocutors on the other) was the stalemate in negotiations with Brazil. In the paper I show how the tax experts in business and the Inland Revenue did not want to set what they saw as a bad precedent by caving in to Brazilian demands to sign a treaty that contravened OECD standards. They came under strong pressure to sign a treaty “at any price” from business lobbyists who thought UK firms were losing out to German and Japanese competitors that did benefit from treaties with Brazil. The consequence, as Smallwood put it in 1975, was that business “spoke with two voices”.

Extract from a memo by Smallwood, Inland Revenue, 1975. Click to see the whole document.

Ultimately, as the absence of a UK-Brazil treaty today underlines, it was the tax experts who won the day. This illustrates that, while businesses have certainly helped shape the design of the international tax regime, the corporate lobby is far from monolithic in its preferences and its ability to influence. A lobbying position stands more chance of success if it is coherent with the underlying design principles of the international tax regime, and articulated by members of the community of tax professionals at its heart. Whether this conclusion still holds in an era of politicisation and rapid change perhaps merits some further investigation…

China’s challenge to international tax rules and the implications for global economic governance

Hearson, M & W Prichard, 2018. China’s challenge to international tax rules and the implications for global economic governance, International Affairs 94(6): 1287–1307.

In scholarship on international economic governance – areas such as trade, the monetary system and development assistance – a lot of attention is now devoted to the rise of China. This literature appears to be settling on a consensus that China is a cautious reformist rather than a supporter of more dramatic change, and that it pursues outside options where existing institutions do not serve its interests. Meanwhile, work on the politics of the international tax regime is still largely preoccupied with the power that the US, as a ‘great power’, wields on the international tax regime. Our view is that this underestimates the influence a rising power can wield, and so we try to link the two literatures up. We focus on the Arm’s Length Principle, which underpins OECD-led international agreement on the distribution of multinational companies’ tax bases through transfer pricing. This international regime differs from areas such as trade and aid, which have fragmented in recent years, because it is a cooperation regime characterised by strong incentives for states to find and follow multilateral agreement.

Interests: Chinese exceptionalism

We begin with China’s interests. They align neither with developing countries, despite official rhetoric to that effect, nor with OECD countries. This is partly because China is undergoing an economic transition, summarised in table 1: its past, present and future interests differ from each other. In bilateral tax treaties, China has been able to manage this situation by adopting different negotiating stances with developing countries compared to developed countries. It faces more of a challenge in multilateral negotiations.

china1

China’s interests are also different because of what it calls its location specific advantages (LSAs). As a tax administration document states:

China has a huge population and a fast-growing middle class that form a great market capacity and huge consumer groups. This factor is unique in the world and inimitable by other small and medium-sized developing countries.

By arguing that the LSAs firms obtain from operating in the Chinese market (roughly divided into location savings for manufacturing, and market premiums for retail) are unique to it, China avoids the need to choose between its old and new interests. It has simply begun to claim a larger share of multinational firms’ taxable profits. We quote from an article written by some staff of the law firm Baker Mackenzie:

Most multinationals do not realize that their strategy of allocating ‘routine profits’ to China is under severe attack. To quote a Chinese tax director who has negotiated extensively with the Chinese tax authorities, ‘[i]t became clear that the State Administration of Taxation believes China has unique factors, including location savings and market premiums, that are not addressed by the OECD Transfer Pricing Guidelines […]’.

Capabilities: often underestimated

China has a particularly strong position in international tax negotiations because the same economic transition that is changing its preferences is also strengthening demand from multinationals to access its markets. Previous work by Lukas Hakelberg and Wouter Lips has focused on absolute market size, where China lags behind the US and EU, but we think three other variables also matter:

  1. Growth. China is undergoing huge economic and social shifts that make it a uniquely attractive place to do business, whether measured by the exploding size of its middle class, or its ascendency towards the top of the patent registration league tables. China’s attraction to investors is thus about future potential as well as present performance.
  2. Profitability. Its fairly new and rapidly growing consumer market is relatively untapped in many areas, has a taste for foreign goods and services, and is more willing to pay a premium for higher-quality products.
  3. Value-chain positioning. Chinese manufacturing has become indispensable to the production of a huge proportion of products consumed in the West, most iconically the iPhone, and this position is becoming increasingly institutionalized.

For these reasons, China can afford not to take too seriously any threats from multinational companies and foreign governments if it differs from international tax norms, giving it the kind of autonomy that only the US was thought to possess.

Strategies: Janus-faced

LSAs allow us to analyse how China has interacted with the established institutions of global tax governance. We conclude that its approach is neither conciliatory nor confrontational, but both, simultaneously. China adopts a rhetoric of common cause with developing countries, but pursues an agenda that is designed to maximize only its own share of the tax ‘pie’. It flirts with outside options such as the United Nations, while enjoying a privileged position within the G20-OECD complex at the heart of international tax rulemaking, and diverging from existing rules when it finds this to be in its interest. “China needs to strike a balance between conforming to international conventions and acknowledging its unique situation in transfer pricing legislation and practice,” wrote Chinese officials in a United Nations document in 2017. In practice, however, its actions have been more aggressive than this might imply.

In particular, China’s implementation of LSAs chips away at a core norm of the international tax regime, the Arm’ Length Principle (ALP). OECD rules require that the ALP be applied to each subsidiary of a multinational in isolation, in comparison to a locally owned independent enterprise. By contrast, the Chinese position is that:

With more and more companies poised to conduct business as groups, economic activities are more and more likely to take place in the inner circle of MNE groups. It is nearly impossible to take out one piece of a value chain of an MNE group and try to match it to comparable transactions/companies

This has ruffled some feathers, as can be seen in this quote from the United States’ former international tax negotiator, Robert Stack:

The OECD countries all ascribe [sic] to the arm’s-length standard and to what they call the basic OECD principles. Other countries have not signed on to the full implementation of the arm’s-length standard and the OECD guidelines, even countries that are in the G-20. And the reason this is very important is the question of market premium and intangibles that relate to markets and things like location-specific advantages that are specifically talked about in the OECD guidelines … [China should] not pick a rifle-shot issue that favors a large-market country and try to gerrymander the debate from that narrow issue.

The destabilising effect of China’s actions could lead to one of two outcomes, we suggest. In the first scenario, China would behave very much like the United States, throwing its lot in with the G20-OECD complex. Its growing influence would allow it to use a combination of incremental changes at global level and selective unilateralism to adapt as its place in the global economy evolves. In the second, by design or by accident, China’s approach could destabilise the core norms of the international tax regime. By opening cracks in the existing system, LSAs may induce other countries—perhaps led by other large emerging markets—to seek their own accommodations, thus placing increasing strain on the multilateral foundations of the international tax system. It remains to be seen whether China’s successful challenge to the ALP will similarly prompt subsequent challenges from elsewhere.

The European Union’s tax treaties with developing countries: leading by example?

Yesterday a report I wrote for the European United Left/Nordic Green Left (GUE/NGL) group in the European Parliament was published. It was used as input for a hearing of the Parliament’s TAX3 committee, at which Hannah Tranberg from ActionAid, Eric Mensah from the Ghana Revenue Authority and UN Tax Committee, and Sandra Gallina of DG Trade spoke. (This link is to a video of the hearing, which begins with Margaret Hodge and Tove Ryding discussing Brexit, then moves on to the tax treaties discussion at around 16:30).

When the GUE/NGL approached me about working with them on this report, I jumped at the chance. It uses the Tax Treaties Dataset, a project funded by ActionAid and launched in 2016. Earlier this year I had used much of the same analysis in a European Commission workshop for treaty negotiators, and the comparative element certainly caught some of their attention. Just last week I used the dataset at a workshop of African treaty negotiators organised by the Organisation Internationale de la Francophonie, at which it helped them to begin the process of analysing their treaty networks and developing renegotiation strategies.

But the EU is partiuclarly important. Most of the world’s tax treaties – and 40% of those with developing countries – have an EU member as signatory. Combined with its commitment to policy coherence for development, this makes the EU uniquely placed to ‘lead by example’. Indeed, the European Parliament has already called for “Member States to properly ensure the fair treatment of developing countries when negotiating tax treaties, taking into account their particular situation and ensuring a fair distribution of taxation rights between source and residence.”

 

The report has two main messages, from my perspective. The first is that, while the recent attention paid to treaty shopping is most welcome, the basic balance between ‘source’ taxing rights – which allow countries to tax inward investment from the treaty partner – and ‘residence’ taxation in tax treaties with developing countries is also a problem.

The dataset, which includes over 500 tax treaties signed by developing countries, includes a measure how much of a developing country’s source taxing rights each treaty leaves intact. It turns out that EU treaties remove more source taxing rights than average, even when compared with other OECD members.

eu4

 

What’s more, the difference is growing.

eu6

Source/residence has been the elephant in the room in the debate over international tax rules in recent years, as we saw when it was dropped from the BEPS process at an early stage, only to re-emerge in the context of digital taxation. Countries conducting ‘spillover analysis’ or otherwise analysing their treaty networks need to take this into account.

The second message is that there’s a great deal of variety within and between countries’ treaty networks. There’s loads of variation within each EU Member’s treaties, and between the average values for EU members. The same is true when drilling down to individual provisions. So there is plenty of potential to ‘level up’ based on precedent

eu5

The report echoes the European Parliament in arguing that, if the EU wants to be a leader on policy coherence for development, Member States need to level up the source taxing rights across the different provisions of their treaties with developing countries. Simply saying that on balance their treaties are no worse than anyone else’s – a point the report questions when looking at the EU as a whole – is not enough. The four summary recommendations are for Member States to:

  1. Conduct spillover analyses incorporating reviews of their double taxation treaties, based on the principle of policy coherence for development and taking into account guidance from the European Commission and other bodies.
  2. Undertake a rolling plan of renegotiations with a focus on progressively increasing the source taxation rights permitted by EU members’ treaties.
  3. Reconsider their opposition to a stronger UN tax committee, as the Parliament has previously requested.
  4. Formulate and publish an EU Model Tax Convention for Development Policy Coherence, setting out source-based provisions that EU member states are willing to offer to developing countries as a starting point for negotiations, not in return for sacrifices on their part.

“A gathering of international chatterers for the purpose of chattering.” The birth of the OECD’s Committee on Fiscal Affairs.

In my previous post I explored the United Nations’ brief post-war flirtation with a Fiscal Commission, which came stuttering to a halt in 1951 due, it seemed, to the lack of a compelling purpose that might have motivated states to fight to retain it. The United Kingdom had supported a Russian proposal to wind up the UN’s tax work, a position that seems consistent with its subsequent opposition to the creation of what is now the UN Committee of Experts on International Cooperation in Tax Matters two decades later. It’s perhaps more surprising that, as we will see, the British were initially opposed to the creation of a Fiscal Committee at the Organisation for European Economic Cooperation (OEEC), the predecessor of the OECD, as well. Today the UK is a strong supporter of the OECD’s position as the dominant site of international tax cooperation, but it did not start out that way.

We begin, as the League of Nations’ tax work did, with a resolution of the Executive Committee of the International Chambers of Commerce resolution, in 1954. The resolution identified double taxation as a “serious obstacle” to trade and investment in Europe, and for OEEC members to take steps to relieve it. It asked for unilateral measures, bilateral treaties and, ideally, a multilateral convention. The OEEC’s secretary general was sceptical that the organisation could add any value here, especially given that the UN had not at this point formally dissolved its Fiscal Commission.

He also set out another surprising objection to the ICC’s proposal. It is often asserted that the OEEC picked up the League of Nations’ London draft model bilateral tax treaty, which favoured the interests of capital exporters, rather than the capital importer-favouring Mexico draft. While it is probably true that the eventual OECD model is closer to the London than the Mexico draft, the ICC’s proposal that the OEEC use the London draft was actually a problem for the OEEC, because not all of its member and associate countries had endorsed it. “If an approach of this kind were to be adopted by the OEEC, therefore,” concluded the Secretary General, “it would be necessary for the Organisation to set up an expert body charged with the duty of attempting to produce a more acceptable draft.”

Extract from OEEC Secretary General's memo, 12 November 1954

Soon after this, Switzerland and the Netherlands began to circulate proposals for a fiscal commission. In a curious echo of the current debate around digital taxation, these proposals all expressly mentioned turnover taxes, increasingly imposed by states on the rendering of services, as the main new problem motivating their concerns.

The Dutch note circulated in 1955 noted that “the number and extent of problems relating to taxation has been steadily increasing, not only in the national field but also and especially, in connection with the gradual intensification of international economic relations, in the international sphere.” It advocated work under the umbrella of the OEEC because it was consistent with the organisation’s mandate, and because of the need to discuss in “a smaller circle than the United Nations.” In December 1955 the Netherlands and Switzerland were joined by Germany, publishing a joint memorandum proposing the creation of a expert committee of “specially qualified high-ranking Government representatives,” and in January 1956 an ad hoc committee was created to conduct a study into the matter. The ad hoc committee immediately recommended the creation of a full committee, citing “ample evidence that there are cases of double taxation which constitute obstacles to international trade and investment, and that action to remove these obstacles should be possible within a group of like-minded nations such as the members and associated countries of the OEEC.”

Extract from Dutch memo to the OEEC, 11 July 1955

In March 1956, the Fiscal Committee was created, against the judgement of the British and Scandinavians. Britain’s attitude throughout had been sceptical, but acquiescent. The British representative, Sir Hugh Ellis-Rees, “criticised the memorandum for being vague and for not revealing what the usefulness of the study would be, nor what were its precise objectives.” On the other hand, he told the Inland Revenue, “I think that in our position in the organisation it would be tactically unwise to try to suppress at this stage a movement which has some support however ill-founded it may turn out to be.” Two handwritten notes in the Inland Revenue files are worth quoting at length here. One is from Alan Lord, who eventually sat on the Committee for the UK.

We regard the whole idea as, if I may borrow the FO [Foreign Office] words, “futile and unrewarding” or, in cruder terms, as a gathering of international chatterers for the purpose of chattering.

We must, in the interests of international unity, agree to attend a meeting, which is [illegible] but if anything on this should turn up with Mr Daymond and [illegible] you will no doubt determine your answer by reference to our Policy of being Against It.

The author of the second note is unidentified, but it shows how the UK viewed the Swiss and Dutch proposals, as well as – in the third paragraph – a pessimism that seems rather anachronistic when compared to the kind of work conducted by the OECD today.

1. Insofar as I can discover from this rather Crazy Going file, the pace is being made by: (i) the Dutch, who seem to be resentful about the liquidation of the Fiscal Commission of UN (which we ourselves regard as a Good Thing) and so want to set up a new Committee or Commission to discuss, inter alia, fields, spheres and bases, & (ii) the Swiss, who seem to be engaged in a private brawl with the French.[…]

2. If this be so, the answer to (i) is that we regard this exercise, to use the FO phrase, as “futile and unrewarding” and (ii) that this is a private fight in which we do not wish to join.

3. There seems to have been later on a ganging up of Germans, Swiss and Dutch to give a regrettable academic flavour to the whole thing and to discuss domicile, “classification of income” and “localisation of income”, whatever these terms may mean. Presumably some attempt to reach, for example, agreement on whether interest should be charged by reference to origin or residence, an exercise which long experience has shown to be pointless.

The British concerns were, I think, unfounded, as the new committee raced through a list of five thorny areas within a year, finding consensus on topics such as permanent establishment and the taxation of shipping and airlines, which are recognisable today as core components of the OECD model convention.

The most recent document in this particular file is an interim report from the Fiscal Committee in 1957. It shows how within 18 months the committee was already consolidating its ways of working (Working Parties on each specific issue, just as the OECD has today) and forming a clear raison d’être. In the excerpts below, I’ve picked out three things that struck me from the committee’s interim report. First, how forcefully it began to make the case for tax cooperation, as European economies became more integrated. Second, the recognition that other countries might be incentivised to follow Europe’s lead, because of its “placement in the world economy.” It is interesting to reflect on how much this echoes the EU’s tax cooperation efforts today, perhaps more so than the OECD, for which the economic power of its members complicates its authority.

Extract from interim report of the OEEC Fiscal Committee, 3 July 1957

Finally, the committee members had already begun to “harmonise their views”, perhaps the first conscious expression of what would become a powerful driver of successful tax cooperation: the formation of a consensus about how to do tax among an international community of practitioners.

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“Futile and unrewarding”: the wilderness years of the international tax regime

Almost all histories of the international tax regime begin with the League of Nations: from the model conventions issued by its Fiscal Committee in 1928, to the Mexico and London draft model conventions.  The latter was agreed by a group of primarily European countries in 1946 at Somerset House, just across the road from where I am now. The League never reconciled the differences between the two conventions, and so the modern history of the regime is usually dated from 1963, when the OECD’s Fiscal Committee first agreed an OECD model bilateral tax convention. For the last 50 years, the OECD model has been the foundational text of the international tax regime, even forming the template for its United Nations equivalent.

While I knew that the United Nations initially tried and failed to pick up the League’s work, the interregnum between 1946 and 1963 is often raced over quite quickly in tax history stories: Sol Picciotto devotes five pages to it in his magisterial International Business Taxation [pdf]. So I decided to sit down in the British National Archives to see what I could find out about this intervening period. The transition from the League to the OECD is important because it is often stated that the OECD picked up and ran with the London Draft, which suited the interests of its members. The Mexico draft, largely agreed among developing countries, fell to one side, according to this account, paving the way for an international tax regime that has a bias in favour of capital exporting states. While I will shed a bit of (sceptical) light on this in what follows, I am mainly going to tell the story through some of the more colourful excerpts from the archives. Today we will look at the UN Fiscal Commission, and I’ll follow this up next week with the OEEC (later OECD) Fiscal Committee to which the baton passed.

Part 1: The “Imperialist” powers’ efforts fail at the United Nations

The sense one gets from both the official reports of UN Fiscal Committee meetings between 1947 and 1951, and the British participants’ own readouts, is that political divisions between groups of states were less problematic than the lack of a clear and compelling mandate to achieve anything in particular. In the committee’s first session, it was the participant from the United States who drafted the proposals for further work that made their way into the final draft, even though he also initiated a protracted (and familiar) discussion about being realistic given limited secretariat resources. Indeed, at the second session, “the secretariat work had been unevenly done and was on the whole badly presented”, said the British participant, WW Morton, who regarded the secretariat’s approach as “over-academic”. (There is a theme of hostility towards things being ‘academic’ in these Inland Revenue files, which I am not taking personally).

By this point, cold war divisions had already emerged, although the sense from the British accounts is that they were not insurmountable, since the Soviet group was content on occasions to make its statements and then abstain from votes, or else be outvoted. Still, here is a flavour of the kind of thing, taken from Morton’s readout. He describes the member from the USSR stating that international work on double taxation put “pressure on the under-developed countries to the advantage of highly developed countries” since it primarily reduced the taxation of their investors.

Extract from British participant's report of the UN Fiscal Committee's second session

Of the second session, Morton observed that “the session was not very productive” but was keen to support anything that might allow the UK to conclude more tax treaties with developing countries. Everyone could agree to support information gathering and dissemination, and the translation of the secretariat’s compendium of international tax agreements into Spanish was something the British supported enthusiastically, keen as they were to obtain tax treaties with Latin American countries (more on that here).

Extract from British participant's report of the UN Fiscal Committee's second session

 

It is in the Commission’s third session that we can first see a divide between developed and developing countries. The International Civil Aviation Organisation (ICAO) had brought a proposal for reciprocal exemption of airlines, by which companies operating flights would be exempt from taxation in the countries to which they fly, paying it only in the country where they were based. India, Pakistan, Venezuela and Cuba raised objections, pointing out that if only one country signing the treaty had an airline, “reciprocal exemption is quite unfair.” The ICAO proposal was, however, consistent with the treaty policy of the UK, and other countries with their own airlines. The ICAO proposal fell after a vote in which the developing countries were joined by the Soviet group, but Morton attributed this to a “procedural tangle” and poor chairing, rather than an insurmountable division. “As will be observed, the work of the Session was only modestly productive. Nevertheless, it is probably worth holding.”

When the Commission’s work reached the ECOSOC, however, it appears that sentiment had changed. Morosov, the Russian participant (also its representative on the Commission itself) expressed his familiar objection that the Commission’s work on double taxation “was in reality intended to promote economic conditions favourable to the activities of British and American monopolies,” concluding that the Commission “was engaged in futile operations, and that it was therefore useless to keep it in existence.” According to his Polish counterpart, “the majority of the Commission had, by certain of the recommendations adopted by that body, tried to exploit the authority of the Economic and Social Council to relieve investors from the highly-industrialised capitalist countries of the taxation which those less highly developed countries were entitled to enforce.”

Extract from ECOSOC discussions of the report of the third session of the UN fiscal commission

 

Morton, the British representative on the Commission, had previously reported an informal conversation with Morosov from which he concluded that this language was more of a formality, and that Russian objections were far from fatal to the Commission. It was thus the British who really plunged the knife in to the Commission, responding that the UK was “in agreement with the Soviet Union and Polish delegations as to the desirability of winding up the Commission’s activities, although for other reasons than those advanced by them.” The UK wanted to see preparatory work for ECOSOC discussions carried out by “small groups of experts with the assistance of the Secretariat,” rather than by a permanent functional commission serviced by a dedicated secretariat. This would appear to have been the death knell for the UN Fiscal Commission, which was wound up in 1954.

So in this quick look through the archives, we’ve seen that the demise of the UN Fiscal Committee was not only a product of inter-country rivalry (though that produced some entertaining diplomatic fireworks). Perhaps more significantly, it was a matter of failure to gather institutional momentum, in part due to the lack of effective secretariat support, and lukewarm support from across the board. The UK and US were never strongly in favour of a permanent international committee examining taxation issues. As we will see in part 2 next week, this was not merely scepticism of the UN: the British also opposed the creation of a “gathering of international chatterers” at the OEEC, which eventually became the OECD Committee on Fiscal Affairs…