As countries around the world have been working to address challenges of taxing multinational companies, one theme has been the implementation of taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. transparency measures. In theory, requiring businesses to disclose the details about where they do business around the world and where they pay taxes and book their profits will allow governments more leverage in auditA tax audit is when the Internal Revenue Service (IRS) conducts a formal investigation of financial information to verify an individual or corporation has accurately reported and paid their taxes. Selection can be at random, or due to unusual deductions or income reported on a tax return. ing business activities that are designed to shift or hide taxable profits.
Tax enforcement certainly becomes a challenge when businesses and individuals around the world can store assets and wealth in certain jurisdictions with privacy laws that assist them in minimizing their tax burden in their home countries. However, it is important for policymakers to evaluate how choices they make on transparency can impact business behavior.
One particular transparency effort includes Country-by-Country Reporting (CbCR) policies. CbCR laws require multinational businesses to report various financial information including profits made and taxes paid for every jurisdiction in which they have legal entities. The information can then be examined by tax authorities to identify areas where companies may be designing their corporate structures or transactions to minimize their tax burden or evade taxation.
CbCR policies can potentially have several mechanisms that lead to an increased tax burden on multinational businesses. First, businesses subject to CbCR requirements may choose to eliminate certain structures or practices and pay a higher level of tax in order to avoid more scrutiny based on their disclosure of their operations around the world. Second, government auditors may be emboldened to trace out tax evasion behavior after examining a company’s use of low-tax jurisdictions.
A recent study by economists Michael Overesch and Hubertus Wolff evaluates a specific case of legislated transparency and its impact on taxes paid by affected entities. In 2014, European Union countries implemented a directive from the European Commission that instituted public CbCR for European banks. The legislation requires European banks to disclose the following information by country:
- The name, activities, and geographical location of any subsidiary and branch
- Turnover (revenues)
- Average number of employees
- Profit or loss before tax
- Corporate taxes paid
- Public subsidies received
Overesch and Wolff hypothesize that the impact of these requirements would be associated with higher effective tax rates for European multinational banks relative to other banks not subject to the CbCR requirements and separately that multinational banks with operations in tax havens would be affected more strongly by CbCR than other multinational banks.By evaluating information in the country-by-country reports, Overesch and Wolff find a significant rise in tax payments by European multinational banks following the implementation of CbCR. Additionally, they find that multinational banks with operations in tax havens saw declining profitability in those jurisdictions following the implementation of CbCR.
They also evaluate whether the tax impact on multinational banks is specific to CbCR policy or if the implementation of other financial regulatory efforts and other anti-base erosion policies are also to blame. They find that instead of being part of a general trend related to financial regulation and countries cracking down on profit shiftingProfit shifting is when multinational companies reduce their tax burden by moving the location of their profits from high-tax countries to low-tax jurisdictions and tax havens. , the impact of CbCR is unique in its impact on the taxes faced by European multinational banks.
The results of this study have lessons for other CbCR policies. Action 13 of the OECD’s Base Erosion and Profit Shifting project laid out a CbCR policy that allows for the exchange of CbCR reports among countries. As of June 25, 2019, 79 countries have signed an agreement for exchanging country-by-country reports filed by multinational businesses.
The European Commission has also proposed making public CbCR a requirement for European multinational companies that have global revenues of more than €750 million (US $838 million) per year.
If the results that Overesch and Wolff identified hold true, broader efforts to legislate transparency will likely also serve to increase the tax burdens faced by multinationals in other sectors.
Beyond CbCR, many countries around the world have, in recent years, begun automatically exchanging taxpayers’ financial account information. According to the OECD, this has been “the largest tax information exchange event in history.” OECD statistics show that information was exchanged on more than 47 million financial accounts valued around €4.9 trillion (US $5.5 trillion). The OECD also points out that international financial centers, often pointed to as tax havens, have seen a decline in deposits of 20-25 percent over the last decade.
The extent to which these transparency efforts lead to higher taxes paid by multinational businesses will also determine other ancillary effects from the policies. Use of tax planning, offshore financial centers, and minimization of tax burdens can facilitate investment in higher tax jurisdictions. Though they may not connect the two, policymakers are often choosing between higher tax transparency (and associated higher tax revenues) and real investments investment activity. Increasing the cost of doing business, either through compliance or higher taxes, has real world implications beyond raising more tax revenue from large businesses.
Note: This is part of our Base Erosion and Profit Shifting (BEPS) blog series.
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