Why I love the United Nations tax committee, part 1

International tax, the way countries coordinate and negotiate tax rules between themselves, is often talked about as if it’s about finding technical solutions to technical problems. But it’s not. Just as the tax system inside a country is at the absolute core of its political debate, so you can look at international tax and see right to the heart of global political economy. What I love about UN tax committee meetings, such as the one I attended this week, is that you can see this in action.

Take transfer pricing, the system through which, in most cases today, the right to tax multinational companies is divided between the countries in which they operate. The pre-eminent international standards defining how this works in practice are the guidelines set by the Paris-based OECD, broadly speaking the world’s “developed” countries. The OECD’s guidelines are facing a number of challenges.

Many of these challenges are technical, because the foundations of the transfer pricing were laid at a time when most international trade revolved around physical commodities, whereas today much of the most valuable parts of the economy are intangible and footloose things such as business services, finance and intellectual property. These criticisms and proposals for alternative systems were given a good airing at a Tax Justice Network conference in Helsinki earlier this year.

But transfer pricing also faces a political problem. The OECD itself can no longer count many of the most significant economic players amongst its members. Take note in particular of China, India and Brazil. These countries aren’t content to be ‘rule takers’, and their economic weight means that they don’t need to be too concerned about the repercussions of diverging from international standards. Instead, they use OECD guidelines when it suits their interests, but are quite willing to do their own thing at other times.

These countries and the OECD have been locked in a battle for some time over the UN tax committee’s new practical manual on transfer pricing in developing countries, approved by the committee on Monday despite howls of protest from the United States Council for International Business (pdf). The eventual document asserts its consistency with the UN’s model convention, which in turn refers to the OECD guidelines, despite USCIB’s anxiety that parts of it “undercut” the OECD. But it also includes an appendix, which outlines the Brazilian, Chinese, Indian and South African approaches.

So far, so timid, but as someone said on Monday, “the baby has been born”. The UN now has a foot in the door on transfer pricing, and over time it would be possible for its manual to gradually diverge from the OECD’s guidelines, just as its model convention and that of the OECD have been diverging for some time.

All this is important because of fundamental differences between the characteristics of developing and developed countries’ economies. Larger developing countries are choosing to remake the transfer pricing system, not just with a few technical fixes, but to make a grab for a greater share of the “taxing rights” over multinational businesses. The Chinese approach [pdf], for example, starts from the idea that value is distributed unfairly within the global economy, and quite explicitly seeks to correct for this in its transfer pricing system. The fundamental basis of the OECD approach to transfer pricing is that taxing rights should follow the distribution of value in the free market.

In tax language, this is the balance between “source” and “residence” taxation. A typical example to explain these terms is a multinational company with its HQ, or residence, in the USA, and some of the business activities that are the source of its profits taking place in India. (It gets more complicated, because the countries I’m talking about here, in contrast to smaller developing countries, have enough multinational companies of their own that they are also residence countries vis-a-vis much of the world.)

At the UN tax committee, participants talk openly about the balance between source and residence taxation. Shifting the balance towards source taxation would mean that less developed countries gain more. Indeed, it was in exactly these terms that a proposal to update the UN’s model tax convention to allow source countries to tax technical service, management and consultancy payments made to someone abroad was discussed this week. Conversely, changes made by the OECD to its model convention have previously been rejected by the UN committee for inclusion in its updated convention because they pulled the balance towards residence and away from source.

The really interesting question is what will happen to this international tax architecture in the future. Will the OECD manage to bring the BRICS inside its tent, will they continue to do their own thing and drive a movement towards a more multi-polar international tax system, or will the UN emerge as the forum in which the interests of source and residence countries are reconciled through inclusive international standards?