International tax laws need reviewing

Give to Caesar what belongs to Caesar, urged Jesus. But the sentiment worldwide has been that multinational companies are not giving Caesar a fair share of taxes. This explains the uproar from taxi operators on the Kenya Revenue Authorities’ ruling that Uber was exempt from paying VAT.

The advent of globalisation has led to the rise of what the Economist calls “superstar companies”. These include multinationals such as Uber, Google, and Facebook among a gaggle of Silicon Valley unicorns that have emerged as a new breed of “robber barons” that consider the world to be their playing ground.

To maximise returns, superstar companies reduce their tax liabilities by exploiting gaps in international tax laws. They engage in aggressive tax planning through base erosion and profit shifting techniques.

This offers them a competitive advantage over local companies, which cannot apply international tax rules. This distorts competition and causes countries to suffer revenue losses. It threatens countries’ tax sovereignty and makes global tax unfair.

Taxes are used to provide services to the people. When superstar companies fail to pay their equitable share of taxes, this is comprised. Therefore, base erosion and profit shifting presents the ugly side of globalisation, a phenomenon Harold James, a Princeton professor, aptly describes as “globalisation eating its young”.

Getting superstar companies to pay taxes is an uphill mission. They operate in the digital world, which is characterised by high mobility, reliance on data, and network effects. Their business models are multi-sided and operate on networked platforms. Their trading is high-speed and payments are made online. Commercial laws are yet to get sophisticated enough to be in tandem with the evolution of the digital economy.

These include, one, transfer price manipulations in intra-group, cross-border transactions. A multinational company is able to shift income from a high-tax jurisdiction to a low-tax one through transfer mispricing.

Second is the use of royalty payment schemes on intangible assets. Superstar companies are technology-intensive. Their value resides in their proprietary intellectual assets. They transfer these assets to their affiliates in low or zero-tax countries and have their head office and affiliates pay royalties, eroding their taxable bases.

Third is interest deductions on intra-corporate loans, where a company located in a low-tax jurisdiction extends loans to its affiliates in high-tax nations, then makes huge interest payment deduction, thus eroding the taxable base of the high-tax country.

Fourth is the use of tax havens. Multinationals incorporate holding companies in zero- or low-tax jurisdictions, where they attribute their profits, reducing the overall corporate tax. Lastly, they use inversions, where a superstar company shifts its corporate headquarters to a low-tax jurisdiction by acquiring or merging with a firm there, therefore reducing its corporate tax liability.

Kenya has attempted to tackle base erosion and profit shifting by requiring multinationals operating in the country to formulate transfer pricing policies to control transfer to foreign affiliates. There are also thin capitalisation rules that put a ceiling on debt financing and deemed interest provisions aimed at preventing interest-free loans within a multinational. In addition, tax laws attempt to restrict artificial avoidance of permanent establishments.

Addressing base erosion and profit shifting requires inclusive and proactive efforts to re-write obsolete international tax law rules.

These should include, one, establishing a global tax body to spearhead coordinated and comprehensive reform of international tax law.

Second, establishing a unitary system where multinational firms are taxed as a single entity on consolidated accounts and profits apportioned to each country where the multinational operates.

Third is the abolition of tax havens for they distort the international tax regime.

Lastly, the territorial approach in taxation should be enforced, obligating multinationals to pay taxes in the country where income is earned. This can be achieved through country-by-country tax reporting mechanisms to spot tax payment mismatches between where firms do business and where they are taxed.

Of course, this is easier said than done, but if achieved, these measures would bring fairness in international taxation, curtail base erosion and profit shifting techniques, and contribute to reforming global taxation.

The author is an advocate of the High Court of Kenya. [email protected] @gatuyu