Is it or isn’t it a spillover?

Last week’s Global Tax Policy Conference at Maastricht University on “international spillovers in taxation” has got me thinking. In particular, I was fascinated by Belema Obuoforibo’s presentation on the IBFD’s methodology for ‘spillover analyses’ (here is a link to an IBFD Powerpoint describing it). The term ‘spillover’ comes from the IMF, a term they use in economic analysis more generally to refer to “the impact of policy actions in one country on others” and around which the IMF framed a whole policy paper. Since its mention in the famous international organisations’ report to the G-20 [pdf], spillover analysis has become a common civil society demand, and the Netherlands and Ireland have gone on to commission them, with a focus on the interplay between their tax treaties with developing countries and certain provisions of their domestic tax law.

But a ‘spillover analysis’ is not the same as an ‘impact assessment’, and I think it’s important to understand the distinction.

The IMF’s recent paper on spillovers in international taxation distinguishes between ‘base’ spillovers, in which an action by one country affects another country without that country doing anything in response, and ‘strategic’ spillovers, in which the change creates an incentive for the second country to change its own policies – tax competition being the obvious example. All very interesting, but I sometimes find it tricky to see how the IMF’s definition applies to the specific areas discussed later on the same report.

One reason for this is that a ‘spillover’ effect from one country on another implies that the affected country is a passive victim. This is not the only way in which one country’s tax system might affect another’s. The decision by a developing country to sign a treaty, or to adopt an international norm, makes it an active participant, but that doesn’t diminish the impact on it of doing so.

A second issue is that ‘spillover analysis’ in practice has tended to focus on how one individual country’s tax system might be different to the norm. Following the Dutch spillover analysis, the government noted that Dutch treaties with developing countries were generally on the same terms as those countries had secured with comparable treaty partners. The IBFD’s methodology is based on how aspects of one country’s tax system compare with similar countries. So the growing practice of spillover analysis, it seems, considers impacts relative to the international average, not absolute impacts. It is a way of finding out if a country is worse or better than average, rather than seeking out all positive or negative impacts.

Let’s consider some examples from the area of tax treaties, to illustrate how these limitations play out in practice:

1. Is it a ‘spillover’ if the affected country actively opened itself up to the vulnerability?

Ireland didn’t used to be a tax haven. It used to be a ‘high tax’ jurisdiction like most OECD countries. Its transformation into a hub used for base erosion and profit shifting is relatively recent, and many of its tax treaties predate this. The changes to Ireland’s tax system transformed its tax treaty network into a major headache for countries such as Zambia, and it seems quite right to describe these effects as spillovers: treaty partners could not have anticipated them when agreeing terms in their tax treaties.

The same could probably be said of the Mauritius-India treaty, which originally predates Mauritius’ generous offshore regime. But it couldn’t be said of Mauritius’ treaties with many African countries, which they signed up to at a time when the risk of treaty shopping through Mauritius would have been clear. This is not a ‘spillover’ of Mauritius’ tax system, because it was a conscious choice taken by the developing countries. But it would be a shame if any analysis of the impact of Mauritius’ treaty network didn’t consider these costs.

2. Is precedent in tax treaty negotiations a strategic spillover?

When Zambia signed a treaty with China containing much lower withholding rates than it had previously agreed to, it may not have anticipated the British reaction, which was to request a renegotiated treaty on similar terms. Zambia also wanted to renegotiate with the UK, mainly to seek improved powers for cooperation and information exchange with the British tax authorities. The implication of the Chinese treaty, however, was that the UK expected similar terms in return for Zambia’s demands, significantly lowering the Zambian tax take from British investors. It seems to me that this was a ‘spillover’ effect of China’s aggressive negotiating position…but I suspect it would be unlikely to be picked up in any ‘spillover analysis’.

3. Are most-favoured-nation effects spillovers?

In April 2003, Venezuela and Spain signed a treaty with a most favoured-nation (MFN) clause in its interest article, which would be triggered if either country subsequently signed a treaty with a lower maximum rate in the interest article. In May 2006, the bilateral MFN clause in its interest article was triggered through a kind of domino effect: Estonia and the Netherlands signed a treaty granting exclusive residence taxation rights over interest; this activated the MFN clause in the September 2003 Spain-Estonia treaty, which in turn activated the MFN clause in the Venezuela-Spain treaty. As a result, according to an article in Tax Notes International, “Venezuela’s treaty with Spain has undoubtedly become the most favorable tax treaty executed by Venezuela to date.”

This was a policy action by two countries that had ramifications for two other countries, but which they should have anticipated when they agreed to the clause. The inclusion of a symmetrical clause, which could be activated by Spain as well as Venezuela, may have been a negotiating error by the latter. But was the MFN activation a spillover?

4. Is it a spillover if a country is just an aggressive negotiator?

The countries that have tended to do spillover analysis so far are those facing accusations that they’re used for treaty shopping. And the main policy response, at least from the Netherlands, seems to have focused on adding anti-abuse provisions into its treaties. What if there is no treaty shopping, but instead just a set of treaties that take most of the taxing rights away from developing countries? As I noted in point 1, the developing countries actively signed up to these treaties at some point in their histories. The IMF spillover paper sounds a cautious note about tax treaties because of the fiscal costs to developing countries of limiting their source taxing rights, but it’s not clear (to me at least) how the plain vanilla impact of the source/residence split could meet the definition of a spillover.

5. Is it a spillover if it’s no different to the norm?

Consider many developed countries’ unwillingness to share the right to tax their shipping firms with the developing countries whose waters they use, and who are in some cases very keen to tax the profits from shipping. Developed countries have been relatively united on this, so even if we accepted that the case described in point 4 above was a ‘spillover’ effect, I think the implication of the IBFD’s methodology would be to find no negative spillover from the hardline stance taken by, say, the UK. But just because this ‘policy action’ is consistent with comparable treaties and with the model conventions, does that mean countries should not assess the impact on developing countries of the policy stance?

In conclusion, it seems to me there is a risk that the focus on the concept of ‘spillover effects’ might lead to an overly narrow analysis of the impacts of a jurisdiction’s tax policy actions on developing countries. Or, to put it another way, could the choice of terms used to discuss this issue have linguistic spillover effects?

Update: Joe Stead points out that I have slightly undersold the 2011 International Organisations’ report to the G-20:

Ireland does spillover analysis: the proof of the pudding will be in the eating

I haven’t blogged for a while, having been away, and as other bloggers will know, it’s all about getting the momentum going. But Tuesday’s announcement by the Irish government, news of which came via Christian Aid’s Twitter feed, has spurred me into action!

Ireland has decided “to undertake a ‘spillover analysis’ to research what impact, positive or negative, Ireland’s tax system may have on the economies of developing countries.” This is great news. Whatever you think of particular policies, it’s hard to argue against the principle of checking how your tax system affects developing countries…although people have tried, and I’ll get to that in just a moment.

The starting point for this agenda is a 2006 paper by the IMF’s Peter Mullins [pdf], which discusses the potential spillovers if the US were to stop taxing US companies’ foreign profits. He proposed four questions:

(i) Will it change the level and/or location of outward investment from the US?
(ii) Will it encourage other countries to more aggressively pursue tax competition to attract that investment?
(iii) Will other countries follow the United States’ lead?
(iv) Will there be an impact on the tax revenues of other countries?

The IMF has now picked this theme up more broadly in a consultation on tax spillovers.

The UK said no

ActionAid had a go at pushing for spillover analysis in the UK while I was its policy adviser. Not the general analysis that Ireland will undertake, but a specific analysis of the potential impact of proposed changes to the Controlled Foreign Companies rules, which completed the UK’s move away from taxing British companies’ foreign profits. The Treasury is quite open about what the change was designed to achieve:

The CFC rules are essentially anti-avoidance rules designed to prevent a company from artificially moving its profits abroad, to a country with a more favourable tax rate….The new rules only tax profits which have been artificially diverted from the UK, whereas the old rules would also catch profits diverted by a CFC from any other country. This allows businesses based in the UK to be more competitive internationally, creating more investment and jobs.

At the time we said:

it is essential that a development spillover analysis for the CFC reforms is conducted immediately, or commissioned from an international organisation such as the IMF or OECD. This should incorporate:

  • the potential change in companies’ behaviour that may result;
  • the characteristics of developing countries (for example investment patterns, tax legislation, enforcement capacity) that would be likely to increase exposure to this impact; and
  • the measures that developing countries or the UK could take to help mitigate any impact.

The Treasury disagreed. In oral evidence to the International Development Committee, minister David Gauke argued as follows:

The first point to make is that it is inherently very difficult to make any assessment of this, because one has to have a full understanding of the interactions between multinational companies located in developing countries and those developing countries and their tax systems, which is a very complex matter. It is not something that, frankly, either HM Treasury nor HM Revenue and Customs is well placed to make an assessment on.

Unconvinced, the Committee didn’t just recommend a spillover analysis for the CFC reforms, but “an administrative or legislative requirement for the government to assess new primary and secondary UK tax legislation against its likely impact on poverty reduction and revenue-raising in developing countries,” something the government dismissed as not “proportionate or feasible.”

Two footnotes to this. First, the OECD seemed to concede the point in its BEPS action plan in 2013:

While CFC rules in principle lead to inclusions in the residence country of the ultimate parent, they also have positive spillover effects in source countries because taxpayers have no (or much less of an) incentive to shift profits into a third, low-tax jurisdiction.

Second, just on Monday I heard Oxford University’s Li Liu give a paper analysing how the UK’s change from worldwide to territorial taxation has affected UK-based multinationals’ behaviour within the EU. She showed pretty convincingly that companies have responded by moving their investment from high-tax to low-tax countries, which both answers Mullins’ first question and disproves Gauke’s assertion!

Step forward Ireland

The Irish government evidently thinks a spillover analysis is possible, and has opened a consultation and a tender process to conduct some research. It seems this will be heavily based on an analysis commissioned by the Netherlands last year. The terms of reference [pdf] refer to the following areas:

  • Tax treaties with developing countries – comparative review of the provisions of Irish treaties as against those of their other significant trading partners.
  • Composition effects on the structuring of investment into developing countries resulting from the Irish tax system and the Irish treaty network.
  • The relevance of features of the Irish tax system relating to payments of profits onwards to third countries, in cases where investment into a developing country takes place through an Irish entity.
  • Analysis of Balance of Payments between Ireland and developing countries, with a view to quantifying any spillover effects identified as part of this analysis.

We can look at the Dutch example to see what we might get from the Irish study. The Irish terms of reference refer to an impact assessment conducted by Frances Weyzig [pdf], who has pioneered some of the economic techniques that are starting to allow us to quantify tax treaty shopping. Here’s his conceptual framework showing the ways in which Dutch tax policy might affect developing countries:

Potential pathway effects of Dutch corporate tax policy

Potential pathway effects of Dutch corporate tax policy (Source: Francis Weyzig, 2013)

Weyzig’s report is really good, but it’s not the only study commissioned by the Netherlands, nor (importantly) the one commissioned by its finance ministry. I haven’t been able to find these other studies online, but I did find a memorandum from the Dutch finance ministry to parliament discussing them. It refers a “report conducted by SEO Economics Amsterdam” and “a government-commissioned study by the International Bureau of Fiscal Documentation (IBFD) of the tax treaties the Netherlands has with a number of developing countries.”

The memorandum concludes that Dutch treaties with developing countries do need revising to strengthen their anti-abuse provisions, but no changes are needed in terms of their content (for example, the low withholding tax rates that they specify) nor in terms of their interaction with other aspects of Dutch tax law. The reason is that it’s not a study of the Netherlands in its own right, as Weyzig’s is, but rather, it’s a comparative study, just like Ireland proposes:

The IBFD investigation of the Dutch treaties with a number of developing countries shows that these countries have generally made the same arrangements with the Netherlands as in their treaties with other countries.

Just like any other aspect of tax competition, a focus on peer comparison will never do anything other than halt a race to the bottom. To have a positive impact you have to be willing to be better than your competitors. That’s obviously going to be hard for Ireland given that its next door neighbour is after its business.

Here’s hoping that Ireland’s study and the government’s response to it is more along Weyzig’s lines, contributing to a broader reflection on how national and international tax rules affect developing countries.

Cancelling tax treaties: a lesson from the 1970s

Mike Lewis at ActionAid had a blog yesterday about the problem posed by Zambia’s tax treaty with Ireland, following up on ActionAid Zambia’s call for the treaty to be renegotiated. But how easy would that be?

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