The IMF has prepared a paper outlining the most important international tax issues currently under discussion and setting out a work plan for using its international expertise in these areas, working with other international organizations such as the OECD. The two most important tax areas identified by the IMF as of immediate concern are tax avoidance by multinationals and tax evasion by individuals. In addition to these problems of tax compliance and collection there are other problems relating to the structure of the international tax system, for example the trend towards territorial taxation by many countries and the consequences for developing countries.
Whether examining tax avoidance by companies or tax evasion by individuals, the underlying problem is that the differences in national tax systems and policies give rise to gaps and inconsistent treatment of transactions or entities within the international tax system. These cross-country spillovers may be exploited by enterprises or individuals to reduce their tax liabilities or hide their income from tax authorities. When countries determine their tax policy without taking into consideration the tax treatment imposed by other countries, they create difficulties that are wider than the problems of avoidance and evasion. This can for example lead to distortion of economic activity as differences are exploited by taxpayers, or a lower aggregate amount of tax may be collected than would be the case if the national tax systems were more harmonized.
The issue of tax avoidance by multinationals has recently received increased publicity with examination of the low tax bills of some multinational companies. There is public concern that at a time when individual are being asked to pay a fair share of tax some international enterprises are paying small amounts of tax relative to their accounting profits. Reforms are required on the grounds of equity and efficiency to ensure that the general public continues to have confidence in national tax systems.
As the OECD report on base erosion and profit shifting pointed out, the international tax system originally developed when companies were largely based on bricks and mortar, using tangible assets to trade in goods. The system has not adequately adapted to recent developments in business activity including the increasing amount of cross-border transactions between related parties and complex, globally integrated business models. The development of the digital economy has had the consequence that physical presence is not necessary to perform services in a country and enterprises therefore do not have the physical nexus required by the current international tax framework for becoming liable to tax in a particular country.
Financial innovation has made it easier for enterprises to exploit differences in the treatment of active and passive income and in the treatment of different kinds of passive income, for example through hybrid instruments, while the growing importance of intangible assets has caused difficulties owing to the difficulties of establishing the valuation and ownership of the assets. This gives rise to opportunities for base erosion and profit shifting by exploitation of the mismatches between tax laws. These opportunities include treaty shopping, avoidance of withholding tax, taking multiple tax deductions in high tax jurisdictions or accumulating profits in low tax jurisdictions.
Countries are therefore concerned that their tax base is being eroded by the shifting of income but the amount of income shifted is difficult to quantify. The large extent of profit shifting is however indicated by the amounts at stake in some high profile transfer pricing and other tax cases and by studies suggesting that changes in the earnings of parent companies are often followed by larger rises in profits of affiliated companies in low tax jurisdictions.
Individuals can evade taxes by transferring funds to low tax jurisdictions which do not adequately share tax information with other countries. Although these individuals are normally liable to pay tax in their home country on foreign earnings, this tax can only be imposed if the tax authorities are receiving the correct information, either from the taxpayer or from the foreign tax authority. It has been estimated that around six percent of the net financial wealth of households is not declared and is hidden away in low tax jurisdictions. Secrecy provisions for banks and professional confidentiality rules of lawyers and accountants have been misused by individuals to conceal taxable income.
The IMF points out that there is a spillover effect whereby tax measures taken in one country affect the tax collected in other countries. For example, a tax system that allows groups to set up conduit companies could divert revenue away from other countries, causing the tax base to shift from one country to another or to disappear altogether. This also causes distortions in flows of investments and creates larger administrative costs. Business and investor behavior can also be changed by straightforward tax changes such as an amendment to the tax rate in one country, or a move by a country to territorial taxation.
Countries do not take into account these spillover effects when formulating tax policy and often change their tax laws to attract economic activity in response to measures taken in other countries. This leads to a kind of tax competition between countries that may lower the tax collection generally as countries offer more tax incentives or reduce their tax rates in response to similar moves in other jurisdictions.
Countries have taken various measures to combat cross-border tax avoidance and evasion, including programs to encourage declaration of foreign income in return for reduced penalties. The problems are also being tackled internationally by the OECD/ G20 action plan on base erosion and profit shifting (BEPS) and by the promotion by the OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes of measures such as multilateral or bilateral agreements to ensure the effective exchange of tax information. Disclosure of foreign income is also required by the US Foreign Account Tax Compliance Act.
The work that the IMF plans to do in the area of international tax is intended to complement rather than replace the current BEPS and information exchange initiatives. The reason for IMF involvement in international tax policy issues is that these are significant for the mandate of the IMF, given that tax issues are related to national and international macroeconomic stability. Tax policy impacts on revenue mobilization and influences investment and capital movements. The IMF is experienced in giving technical assistance to countries in respect of the relevant financial issues and has expertise in economic analysis. The IMF also has the advantage that most countries of the world are members of the Fund.
A paper to be prepared by the IMF on spillovers in international taxation will look at the cross border impact of tax policies and assess appropriate responses to the issues. Drawing on the extensive academic literature on spillovers and international tax competition the paper will address issues of design and implementation arising in dealing with spillovers. One aspect of the problem is to understand and assess the tax spillovers, including not just revenue implications but also the effect on financial stability, growth and development. The effects may be particularly significant for developing countries which have limited administrative resources. The IMF intends to drill down to particular economic sectors and examine the effect of spillovers on industries such as extraction of minerals, telecoms and financial services.
Tax policy issues such as the asymmetric treatment of debt and equity, which have previously been examined by the IMF and other parties, are important. Also, although the Financial Action Task Force (FATF) money laundering standard now encompasses tax crimes, practical changes to work processes in the anti money laundering (AML) and tax authorities are needed to collect the amounts owed, and the IMF is well placed to produce general policy recommendations on this.
In addition to these issues, more radical alternatives to the current international tax framework need to be considered, even if it is eventually concluded that they are not feasible. These include the consideration of methods such as formulary apportionment or the imposition of minimum taxes. Their impact generally and on developing countries in particular would need to be considered.
Bilateral tax treaties are an important part of the current international tax system; however the IMF wants to consider the alternatives, such as multilateral instruments or the adaptation of domestic tax systems to achieve similar or improved tax effects. Another issue concerns how tax administrations can deal with the current international tax challenges and strengthen revenue mobilization. If deeper cooperation on international tax matters is required the IMF will examine ways in which this may be achieved.
The IMF can also contribute to technical discussions on international taxation, drawing on its experience from technical assistance projects. The technical contributions would cover, in addition to work on spillovers, contributions in relation to tax treaties and transfer pricing. The IMF has already been involved in projects relating to transfer pricing risk assessment by tax administrations with limited resources. The work would involve consultations with interested parties and would be carried out in coordination with the work of the OECD.
