Unitary Taxation – building a test system

I have reservations about Unitary Taxation, so I’d like to build a model of how it works so I can test it for weaknesses, and compare any weaknesses which come up to the arm’s length principle to see whether UT is a better system.

At this stage I’m looking more at the mechanics of how it will work, rather than any ideological questions of whether the results are better – though I think some of those will come up along the way.

To do this I’m working mostly from Sol Picciotto’s paper “Towards Unitary Taxation of Transnational Corporations”, as this seems to be the most detailed exposition and is used as an example by Richard Murphy, Prem Sikka, the Tax Justice Network, and others.

It’s a fairly long paper, so I’ve attempted to summarise it below to give me some parameters for the system.  In my next post, which at the moment looks like it’s going to be rather longer than this one, I’ll list out some questions of detail which have arisen.  But if anyone thinks I’m misunderstanding anything so far, please do shout before I get too far along and make a fool of myself.

Overview

A UT system can be implemented unilaterally.  We don’t need agreement between states as to how it will work, we just need a reasonable amount of co-ordination with some mutual agreement procedures.

A big advantage of UT for governments is that they can’t offer tax incentives to companies to invest in their country.  Or rather: it removes the temptation to offer incentives, which is good because doing so is not generally to their advantage.  They can therefore compete on tax rate, but nothing else.

In the absence of differences in tax rates between countries in which a given TNC has economic activity, universal adoption of UT would leave no scope for avoidance.  I’m not sure how this squares with the suggestion that countries may compete on tax rates, but that is perhaps the sort of philosophical question I’m not looking at just yet.

Outline

The basic tax return for a business is a report consisting of:

–       The business’s consolidated accounts, with all internal transactions eliminated
–       Inputs and outputs of the UT formula

A UT Business is all legal entities under common control (using a 50%test , but with (unspecified) anti-avoidance rules) which operate in the same or related business.   There is a presumption (rebuttable?) that businesses are related if there are a significant number of transfers between them, or share common resources/services.

A TNC will have one or more UT Businesses within it.

For the Report we need to look at the whole Business, not just the element which falls within the countries using UT.

Consolidated accounts

I’m not an accountant, so I shall wave my hands and assume that these can be prepared as required.

Allocation formula

The formula has three inputs:

– Assets
– Labour
– Sales

“Assets” includes all fixed tangible property.  This includes leased assets, to avoid sale-and-leaseback avoidance.  It excludes inventory (and so by extension all other circulating capital?).  It excludes intangibles, because it’s hard to tell where they are and they can move about easily – we look through the intangibles to the assets and staff that create them, and anyway we are more interested in how the IP is used than how it is created.

“Labour” is a combination of payroll costs and headcount; it is the place of work that counts, not the residence of the employer.  They are weighted 50:50.  We include all persons working for the firm, including employees of subcontractors providing labour services – I assume this means staffing agencies rather than all sub-contractors.

“Sales” is the amounts received from selling anything outside the Business, grouped by the residence of the customer rather than the supplier.  There is a reference to the Business needing to have an establishment in the country of the customer, so it can be said that it is doing business there, but this is a much broader term than your normal Article 5 PE under current rules.  The paper is silent about sales to a customer in a country in which you have no establishment.

The three factors need to be weighted in the formula, and there is no conclusion about how this should be done.  It is noted that equal weighting has been usual (though the paper doesn’t specify for whom it is usual).  US states have been tending to go towards 25:25:50, lately (Assets:Labour:Sales).  The EU, on the other hand, has been suggesting 45:45:10.

It is noted that different sectors will have different needs: in particular transport and extractive industries are cited as requiring some careful thought.

The formula itself is not explicitly stated.  I assume that we do the obvious: simply say “Country A has X% of this factor”, take the weighted average of the three percentages, and apply the resulting percentage to the profit of the UT Business in question.  Then we tot up the profits of all Businesses of the TNC in that country, multiply by the headline tax rate, and away we go.

Advertisements

12 thoughts on “Unitary Taxation – building a test system

  1. I’m so glad you did this, so I can build on yours rather than the other way round…

    My understanding is that the sales in countries where there is no economic establishment are linked to the economic establishment which makes them, but I’m not sure if I got that from SP or RM.

    Consolidated accounts take a bit more than you waving your hands, but are a well-enough understood concept. The unexplored issue, so far as I know, is how you apply tax adjustments to a proportion of consolidated accounts.

    Look forward to the next post!

    • Sales: I thought so too: destination if you can do it and source if you can’t. My first thought is that this replaces a single set of source rules with two sets, plus potentially a tie-breaker, but hopefully that won’t make for a problem.

      Accounts: I know consolidation is well understood – I understand it reasonably well myself, I think – but I want to keep it simple and concentrate on the tax side so I’m looking for an excuse to ignore an area which may have its own issues 🙂

    • That’s the implication. It’s an interesting point I should bear in mind in testing – I should try using a distillery alongside the normal widget businesses.

      How do we account for the whisky value? Presumably any increase in value of stock would go into the profit pool, which will then be allocated by the formula. Following that through: an increase in stock value now is essentially anticipating the sale price in several years’ time, but (assuming constant assets and labour) is allocated by reference to sales this year. So by the time the whisky is sold, the profit on it has been allocated by reference to a different pattern of sales. Hmmm…

      However: we’d have a load of assets involved in the whisky maturation process – warehousing, at least – and thus we would get a certain amount of the profit allocated across to the distillery to reflect the maturation activity. Would the barrels be assets, or are they consumables? I think they get re-used, so would be assets… I shall include this in my hand-wave accounting, I think 🙂

  2. This may be question for later , but:
    Doesn’t UT just make life more difficult for the local managrmrnt? Each business unit would need to predict not only the overall group profits, but also the share of those profits on which it would be taxed by reference not just to its own staffing and investment levels objectively, but as a proportion of the group results as a whole.
    Accordingly, a successful territory within a rapidly expanding group could see its tax charge falling against the background of ‘loss making startups’ elsewhere around the planet.
    Likewise, a struggling element of a group which has just divested itself of other ‘loss making’ entities could in fact see its tax charge go up despite a decline in local receipts, purely as a result of the change in its relative importance to the group, rather than to the wider economy.
    Given that the majority of local business decisions are based upon a consideration of the cash return on a particular investment, rather than its proportional importance to the owner’s other investments, would we end up with a new version of managment accounts for MNCs where the tax line was totally independent of local commercial profits, and handled exclusively by head-office independent of local trading results? Would that be a good thing, or not? (That’s definitely a philosphical question for elsewhere)

    • I think is is probably one of those questions for later. I agree that you could get some interesting situations where the tax in a country is unrelated to the profit or loss there, but it seems to be a feature of the system rather than a bug: as UT looks at activities in context, then if the context changes the tax must change too. Whether this is appropriate: well, that would be an ecumenical matter.

      Interesting point about local management and their forecasting and so on, that’s definitely something to look at in terms of the business impact of UT. If local management have to factor tax payments into their cashflow forecasts even if they’re making losses, then groups are probably going to have to change their ways of working to at least some extent.

      • I’m afraid it may end up inextricably interlinked with the philospohical fundamentals. Rebuilding corporate reporting & management structures to suit tax requirements sounds rather like ‘allowing the tax tail to wag the commercial dog’, which is something I was always cautioned against as a trainee. But, if you’re analysis is that givernments’ rights to the money trump businesses’ rights to the money then you’d be happy to do it.

  3. Just looking at your last para, I don’t think the factors are done by company, they are done by the country by country consolidated report that is part of Sol P’s system. so you just have to multiply the result by the headline rate.

    The bit I can’t get my head around is that he says international agreement on the formula is desirable but not necessary. Seems to me that could lead to “race to the bottom” competition, particularly on employment; and also, more importantly, to the total taxed profit being either less than or greater than 100%. He bases this on the work of Michael Macintyre and US state tax allocations, but I haven’t had time to read that yet.

    • IIRC Mike the risk of inconsistent application of criteria by local authorities has specifically been cited in Commission papers on CCCTB as a potential stumbling block, resulting in potential over/under taxation of results. (I don’t have time to check the reference right now, but will be doing so in due course anyway for other purposes and will post link here if I remember!)

    • I think the factors are done by Business, which is an intermediate level between the group and a whole and the individual legal entities, and is the level at which the report is produced. Any given TNC might have several Businesses, each of which includes results of a number of legal entities; to get the profits taxable in any country you need to aggregate the profits of each Business. I suspect that determining what exactly is in each Business could be a bit messy: I think there will be a future post on this area.

      I agree with your second paragraph. The implication seems to be that any given country applying UT will get the right result for that country, so to an extent any differences don’t matter to that country; the TNC will presumably then need to broker discussions between jurisdictions that seem to be causing problems, hopefully with a MAP. I’m not sure where any adjustments woud be made, though: if the formula is immutable then if a country wants to give a TNC some relief it would have to either tinker with the inputs, which suggests there is some subjectivity over how those are to be measured, or give simple credit for part of the tax charge – but on what basis?

  4. Pingback: Some political questions for Unitary Taxation « Martin Hearson

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s