UN tax committee meets this week: but what is the UN model for?

I’m on my way to the UN tax committee’s annual session in Geneva. This year’s agenda contains quite a few interesting topics. I can’t write about them all, but I thought I might pick out three that seem particularly interesting. Since they are all discussions about the model treaty and its commentary, the common question that they pose is, “what is the purpose of a model tax treaty?” I think you can take three (not mutually exclusive) views about this:

  1. It tells countries what works technically. It combines the wisdom of some of the most experienced tax officials in the world to produce a technically sophisticated template that negotiators can rely on.
  2. It tells countries what is politically palatable. If a provision is included in the UN model, for example, a group of experts from developed and developing countries have all been willing to agree to its inclusion, so neither side is going to consider it too outrageous.
  3. It tells countries what is acceptable behaviour. The models sketch out the concepts and principles that committee members think should underpin a country’s international tax system. It conveys an expectation that a country’s tax rules should be compatible with these concepts and principles.

From an international relations side, we might say that the first two purposes are about reducing transaction costs for negotiations, by providing countries with information ahead of time. The last one, on the other hand, would suggest that treaties act as instruments through which norms about acceptable behaviour are established and diffused within an international community.

The status of the OECD transfer pricing guidelines

When the 2010 update to the UN model treaty was being finalised, there was some controversy around article 9, which deals with transfer pricing and the arm’s length principle. The commentary to the previous version of the UN model stated that the OECD’s transfer pricing guidelines were “internationally accepted guidelines” and recommended that countries should follow them. A minority of committee members didn’t accept this view, and so rather than resolve the conflict, the commentary now records that [pdf] “The views expressed by the former Group of Experts have not yet been considered fully by the Committee of Experts, as indicated in the Records of its annual sessions.” Unusually, the record of the discussion identifies the dissenters as the Chinese, Brazilian and Indian members of the committee. It is worth noting that none of these three individuals are still members of the committee.

The new committee is going to discuss a proposed wording to resolve those differences. This wording states only that the OECD guidelines “contain valuable guidance” and adds that

the Committee has developed the United Nations Practical Manual on Transfer Pricing for Developing Countries which pays special attention to the experience of developing countries, reflects the realities for such countries, at their relevant stages of capacity development, and seeks broad consistency with the guidance provided by the OECD Transfer Pricing Guidelines.

There is a furious letter [pdf] from the US Council for International Business, which seems to be targeted directly at India, China and Brazil:

It seems inconsistent for G20 countries and other non-OECD countries that are now advocating for their views to be reflected in the OECD Transfer Pricing Guidelines to accept concessions from others participating in the development of those Guidelines and then undercut the very outcome of those negotiations by arguing elsewhere for positions that were rejected in that forum. If any notion of “fairness” has relevance in international tax, surely it should include the concept that acceptance of an invitation to bargain on an equal footing over a set of rules carries with it the good faith obligation to live by those same rules.

The letter argues that the UN Manual was not produced with enough participation from businesses, that the OECD guidelines are now formulated with input from “a broad spectrum of countries”, and that the proposed UN aim of “broad consistency” will permit “multiple, inconsistent applications of that principle, will lead to multiplied disputes, increased double taxation, and ultimately to serious damage to the cross-border trade and investment that fuels economic growth and development.”

This might be an argument based on purpose 1, 2 or 3 above. On 1, USCIB is arguing that the changes will create technical problems. On 2, it is arguing that the political signalling effects of the OECD and UN models undermine each other when countries agree to one thing at the OECD and push a different position at the UN. Finally, on 3, it is clearly concerned about diluting the clear message sent by the treaty commentaries at present, which is that the OECD guidelines are the only internationally accepted authority when it comes to transfer pricing.

Capital gains

Both as a discussion in its own right [pdf], and through a paper for the Extractive Industries subcommittee [pdf], there’s a lot of discussion of “indirect transfers”, where a capital asset in a developing country is sold, but the transaction takes place through the sale of a holding company located in another country. I have written about an example of this recently, and it was highlighted in the recent IMF spillovers report. As I observed, it doesn’t look like the G-20/OECD processes are going to look at this problem in any depth, so this is an instance where the UN committee is examining an issue of clear concern and interest among developing countries.

The discussion focuses on article 13(4) which covers the sale of a company whose value consists principally of immovable property. This may include a mine, or a capital-intensive business such as a mobile phone network. The UN papers highlight a range of administrative issues: how a developing country can know if a sale taking place abroad falls within the scope of this article, how to value the gain, how to define “immovable property” since the model treaties are not as clear as they could be on this matter.

What interests me most is the question of how to actually collect the tax, when the payment is made outside the country, and when by definition the company making the gain may no longer have any assets in the country. As the extractives paper observes:

While both the UN and OECD Models now contain optional Assistance in the Collection of Tax Debt Articles for countries wanting to provide for this in bilateral tax treaties, and there is a multilateral OECD/ Council of Europe Convention on Mutual Administrative Assistance in Tax Matters on the subject, this is not yet something most developing countries have provision for in their bilateral or multilateral relationships.

This is something tax authority officials from developing countries are definitely seeking from renegotiations. In the meantime, the extractives paper describes alternatives, which include asking the purchaser (who by definition will have assets in the country) to withhold the capital gains tax when paying for the transaction, and refusing to grant export licenses until the capital gains tax has been collected.

I don’t know how controversial this is going to be, but insofar as it is about providing advice to developing countries, I think that makes it a matter of purpose 1.

Services taxation

The committee is going to discuss a draft article [pdf] that would allow developing countries to tax technical services. This is a provision that exists in some form in many tax treaties already, and has been introduced into models such as the East African Community’s new model treaty. But neither the UN nor OECD model treaties include it. From a technical point of view (purpose 1), this new addition should be a good thing: since these provisions are fairly popular among developing countries’ tax treaties already, having an international Committee of Experts formulate a model provision built on their collective wisdom is surely a good thing.

That’s not the view taken by the International Chamber of Commerce in a letter [pdf] that outlines the main arguments likely to be raised against a withholding tax on management fees. The ICC is opposed to such a tax per se, but it emphasises that it is even more concerned about the double taxation that might result if countries impose such a tax it unilaterally. Here is what it says:

Given that it is the unanimous view of OECD Member States that the source basis taxation is not appropriate for services performed by a nonresident outside that State, it is unlikely that the country where services are performed will give up its right to tax and therefore such a provision is unlikely to serve as an effective model for bilateral agreements. While the UN Model reflects different interests than the OECD Model and different rules are therefore appropriate in some cases, it should be considered if deviating from a rule in the OECD Model that reflects unanimous agreement among OECD member countries will inevitably lead to conflicts in treaty negotiations. Doing so will likely encourage countries to take aggressive unilateral positions (in the absence of a treaty). The adoption of this rule on a unilateral basis will increase double taxation, reduce cross-border trade and increase costs for local consumers.

This is an argument that really goes to the heart of what the UN model is for. I think the ICC’s concern is that including an article sanctioning withholding taxes on technical fees in the model treaty will embolden developing countries to insist on the right to levy such taxes, and that this will make it harder for them to reach agreement with developed countries. That’s purpose 3.

An opposite argument, of course, would be that the UN committee, with members from OECD and non-OECD countries, should be in a good position to formulate an article that reconciles the concerns of OECD members and non-members. That’s purpose 2.

Following the ICC’s argument cited above, the model treaty’s job is not to provide a template that is to be used where countries do agree to include a particular provision. It is about circumscribing a definition of what is considered reasonable behaviour by a developing country. Keep it out of the model, they are saying, to discourage developing countries from doing it altogether.

Some political questions for Unitary Taxation

It sometimes feels like, when discussing unitary taxation [pdf], one is expected to self-identify as either a UT advocate, interested in how it could be made a reality, or a sceptic, determined to defend the status quo. I’m neither. As a political scientist, I want to understand (among other things) how our international tax instruments came about, how they affect what individual countries do, and how different actors influence national and international policymaking. These are empirical questions that I think are relevant to the UT debate.

Unitary tax is certainly a case in point for each of these questions. If it really is a better system than transfer pricing, then a political economist would want to explain the persistence of the latter. It seems clear enough that developing countries, when they decide to get serious about taxing multinational companies, head almost automatically down the transfer pricing route. Yet the people making these decisions are often, in my experience, very sharp, with a healthy scepticism of the international tax institutions from which transfer pricing standards have emerged. So have they considered other options? Are their decisions based on legal or economic preference, political calculation, or the hegemonic power of the OECD guidelines? I’d like to know.

There is a tremendous body of legal literature arguing that unitary taxation would be a more effective way to administer corporation tax than transfer pricing. I find this more convincing than the argument for the status quo, as made for example in the OECD guidelines. This seems to boil down a political impossibility theorem: to prevent double taxation there would need to be global agreement on a formula, but this would be impossible, so we should stick to the status quo.

What I find odd about it is that the same surely applies to transfer pricing, and yet there has never been a global agreement on those standards: just an agreement between OECD countries. Everyone should do what the OECD countries do, it seems, not because of its technical merits, but because it would be too difficult to do anything else.

I’ve argued elsewhere that moves in some of the BRICS countries are specifically undermining any notion that there’s an international consensus on the arm’s length principle. What India and China are doing is not, like Brazil, just based on the idea that they have found a better way to approximate the arm’s length price: they seem to argue instead that they are entitled to a larger-than-arm’s length share of taxing rights, because that’s what they consider fair.

If there has been a breakdown in the transfer pricing consensus, and one that leads to double taxation, that substantially lowers the bar for UT: it no longer needs a tight global consensus in order to match transfer pricing. Furthermore, if a debate is opening up over the fair distribution of taxing rights, that’s comfortable territory for unitary taxation, where the debate is articulated clearly over the choice of formula.

In making a judgement about which international tax system is best, we need to ask ‘best in what way?’ I think we can look at it through the classic three-way lens of tax policy valuation:

  • Equity: does it produce a fair (we might say ‘progressive’) result?
  • Efficiency: does it minimise the role of tax factors in shaping economic decisions?
  • Administrability: can it be administered and enforced effectively without imposing too large a burden on taxpayers and revenue authorities?

Looking at one of Sol Picciotto’s recent papers, it seems that his main argument in favour of unitary taxation is an administrability one: under UT there would be less avoidance and evasion than under transfer pricing. (He also touches on the impact of tax planning on economic efficiency, and we could discuss how it affects equity as well). Efficiency is interesting, but I am certainly not able to do the kind of economic modelling that we’d need to predict behaviour change under UT.

But what if we start from equity? There is the question of equity between taxpayers, and in particular how the tax treatment of multinationals compares to domestic firms – a matter of vertical equity. But I am interested in ‘inter-nation equity’. How would (or indeed could) unitary taxation affect the distribution of taxing rights between countries, and in particular between developed and developing countries? Sol’s paper ends on this point:

Some might also wish to see even more ambitious projects for global taxes, which might be used for international redistribution to assist development. Those, however, are topics for another occasion.

To me, this is a political question. Considering how different formulae would change the distribution of taxing rights is the starting point, but you can’t end there: you have to ask what a politically viable settlement would look like. If global consensus is needed, is it possible to imagine one in which developing countries have a bigger share of taxing rights than under transfer pricing? If global consensus is not needed, how are developing countries likely to act? One hypothesis might be that larger, more powerful economies would adopt formulae that maximise their tax revenues, just as they are doing with their transfer pricing standards, while the choice of formula could become a matter of tax competition for smaller countries.

Of course it may not be a zero sum game. If avoidance and evasion are reduced under UT, the overall cake to be divided up would be bigger. In that case, it may just be a question of working out how to divide up the spoils.

My view is that these questions can’t be asked through only thinking about unitary taxation in the hypothetical. Key to determining if unitary taxation produces a more equitable outcome is developing a model of how countries behave in international tax. To do this, we need to study how countries act under the current international tax system – both unilaterally and in international negotiations. Coincidentally, that is what I am trying to do!

PS: on the technical side, I’m also watching the International Centre for Tax and Development’s unitary tax workstream and the unitary taxation project on Andrew Jackson’s blog with interest

 

Is tax treaty arbitration really a bad thing for developing countries?

I’m at the United Nations tax committee annual session this week, where I’ve learnt that I have to be careful what I write here, after a couple of posts from this blog were included in an input document [pdf]. Erk!

I’ve been taking the opportunity to discuss with delegates the recent article [£] by the chief of the UN committee’s secretariat, Michael Lennard, on the inclusion of arbitration in tax treaties with developing countries. Lennard begins from the concern that I’ve raised here too, which is that the BEPS Action Plan implies the use of a multilateral treaty to introduce mandatory arbitration clauses into existing tax treaties.

There are a number of potential problems with arbitration from a developing country perspective, which Lennard outlines, drawing on the experience of investment treaty arbitration. Briefly:

  • the cost of a full blown arbitration could be prohibitive for developing countries, forcing them to capitulate on some occasions, or alternatively stacking the process in favour of more wealthy countries who can afford the most skilled and experienced legal representatives.
  • Because transfer pricing expertise is limited in developing countries, it’s likely that most arbitrators themselves will come from developed countries, in which case their neutrality – or at least their sensitivity to the realities of developing country tax administration – might be questioned.
  • There is a range of concerns about the lack of transparency in arbitration outcomes, which is a problem for scrutiny (I’ve shared before a paper by Alison Christians on this topic), but could also mean that countries and lawyers only have their own experience to learn from, further biasing the arbitration process against developing countries to whom arbitration would be new.

Lennard also talks about a range of ways that arbitration might work better for developing countries. I’m just going to focus on one aspect of this, which is the ‘simplified procedure’ that is used in the UN model’s optional clause. (It’s also known as ‘baseball arbitration’, because it’s used in pay negotiations in the US baseball league).

Under the simplified procedure, the arbitrator doesn’t have to produce her own solution that tries to synthesise the concerns of the two sides. Instead she just chooses between one side’s position or the other.

Delegates I spoke to here said that the analogy with investment arbitration doesn’t hold when the simplified procedure is applied:

  • The costs are much lower, because there’s no need for lengthy meetings, the process demands much less time from the arbitrator, and – so one committee member said to me – you don’t need a lawyer to prepare written submissions.
  • The arbitration tends to move countries’ positions closer together, because it’s an all or nothing outcome, and a more conservative position might be more likely to succeed.
  • The democratic scrutiny point notwithstanding, transparency isn’t such a concern because the arbitrator is only permitted to choose one side, not to explain her reasoning – so there is very little to learn from past experience.

These discussions have certainly changed my thinking a bit, but I’m not sure that it is as clear-cut as those who favour arbitration suggest. In a judgement-based process, as opposed to a purely rules-based one, the quality of submissions is sure to affect the outcome. And it’s inevitable that an imbalance between countries in resources, expertise and experience will translate into an imbalanced outcome. Isn’t it?