A few comments on tax evasion and avoidance of transnational companies and big fortunes in the European Union

There are different types of tax evasion and tax avoidance. However, what has been the object of the several leaks that have been made public in the last years (Swiss leaks, Lux Leaks, Panama Papers, Paradise Papers, and in Argentina, JP Morgan’s) relates to cross border tax evasion and avoidance, or tax evasion and tax avoidance achieved by transnational conglomerates and high-net-worth individuals (HNWI) through cross border transactions; and with some exceptions in the case of the Paradise Papers, it refers to Income Tax, Corporate Income Tax, and inheritance tax.

In 2011, TJN estimated the tax evasion and avoidance loss to the EU28 Member States to be of around EUR 1.05 trillion (TJN, 2011).

During the PANA Inquiry Committee a study was conducted which calculated the base erosion considering companies that have a link to tax havens, and the percentage in which they have been able to increase their profits by operating in such tax havens; being such increase in their profit equivalent to the amount of tax loss for the country considered. Such study estimated that the amount of tax revenue lost to national authorities due to schemes involving tax havens to be between EUR 109 and EUR 237 billion in EU 28 Member States in 2015  (Malan, et al., 2017).

Companies that can play this game are necessarily multinational, operating cross-border. National Small and medium enterprises (SMEs) operating locally -even when they also engage in tax evasion and avoidance- have less opportunities to benefit from the use of these schemes, and thus have a heavier tax burden, and cannot compete with companies operating cross-border on a level playing field.

The European Parliament’s Report of the Panama Paper’s Inquiry Committee (PANA Report) adopted by the committee in October 18, 2017 observes in its paragraph 1 that one of the problems that prevents the adoption of adequate and effective legislation to counteract tax avoidance, tax evasion and money laundering is the absence of single definitions on what constitutes an offshore financial centre (OFC), a tax haven, a secrecy haven, a non-cooperative tax jurisdiction or a high-risk country in terms of money laundering.

Tax havens have existed since the beginning of the 20th century for tax evasion and avoidance, money laundering and capital flight. OFCs are more recent, as they came into use in the 1980s, and they generally specialized in non-resident financial transactions[1]. The thing is that tax havens do not like being called that way, and the array of secrecy provisions[2], lax regulation, zero or near-zero taxation, and no capital controls, made it attractive for tax havens to develop an OFC. Many tax havens impose income tax on the worldwide income of their resident populations, while ensuring tax exiles for the non-resident tax payers, and some, like Jersey, have enacted very stringent anti-tax avoidance legislation to penalize their own residents who want to use the services of other tax havens (Palan, Murphy, & Chavagneux, 2010).

In any case, the absence of a definition is not necessarily the most important problem preventing effective legislation to counteract tax avoidance, tax evasion and money laundering.

There have been adequate legislations, or there have been, and still are, tools in different legislations that allow governments to counteract tax avoidance, tax evasion and money laundering.

However, from the great boom of the financiarization of the international economy starting in the 1970s, and the movement towards further and further liberalization of the economy, what has happened is that the movement of capital has been favoured in the international political arena.

In the name of the international movement of capital, corporate income tax rates are being lowered in Member States of the Organization for Economic Co-operation and Development (OECD)[3], as well as in non-OECD ones; tax incentives for the very rich or the multinational corporations are being promoted; withholding taxes are being removed; and the OECD recommendations for the pricing of intragroup transactions (“transfer pricing”), which are largely based on the “separate entity criteria” and the “arm’s length principle” (which basically unrealistically understands that entities that are part of an economic conglomerate should act as individual separate entities in each country), are being forced upon OECD and non-OECD countries.

The 1995 and 2010 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations suggest a number of methods which can be used to establish the prices between related parties as if they were between independent parties, based on 5 suggested methods. Except when the Profit Split Method is used, the application of the “arm’s length” principle requires a search for operations or financial results of independent companies to be undertaken in order to compare them with the operations conducted by the entity being analysed with its related parties. (Grondona, 2015)

This is the reason why transfer pricing is so generally used for tax avoidance, because it is almost impossible for tax administrations to tackle it with the current legislative framework.

It should be noted that the strategies used for transfer pricing manipulation can also be used for shifting the profits generated by trafficking in persons and labour exploitation. For example, a local entity may “contract manufacture”[4] for another entity located in a low or zero tax jurisdiction. The entity in the low or zero tax jurisdictions (the intermediate entity) will thus obtain the goods at a low cost and retain the profits associated with their sale through another entity which will also receive a limited profit. To distance themselves from the exploitation of humans in sweatshops, corporations create intermediate entities which, instead of being related to the manufacturing activity themselves are characterized as providing purchasing services for other affiliates of the transnational corporation. Manufacturers are said to be non-related entities, although they perform manufacturing activities exclusively for the client as is the case of corporations in the textile industry. Similar examples are observed in agricultural global value chains (Grondona, Bidegain Ponte, & Rodríguez Enríquez, 2016).

In this context, the maintenance of the arm’s length principle is the key reason why the OECD Action Plan on Base Erosion and Profit Shifting (BEPS Action Plan)[5] process has not been successful at effectively reducing corporate global tax avoidance.

Politicians, journalists and sometimes even civil society organization often talk about tax avoidance being legal, while tax evasion being illegal. However, what seems clear is that tax avoidance “has been legalized”. The separate entity criteria together with the arm’s length principle, the prioritization of legal contracts above economic reality, and a very vast set of vehicles, preferential regimes, and benefits provided to investments from non-residents in different jurisdictions have made tax avoidance more and more attractive, and impossible to tackle.

How are tax administrations supposed to tackle it if they can only use arguments that are based on the comparability of the activities performed by related parties to those performed between independent parties? How are they supposed to tackle tax avoidance if they are told by their legislation to trust a written contract between to related parties (or a party and another subject to it) above the economic reality of having a company in a jurisdiction with no tax to which profits are being allocated? How are they supposed to tackle tax avoidance if they cannot even have a clear picture of which are the related parties to a transnational conglomerate?

So, being conservative, it could be said that tax avoidance may be difficult to prove to be illegal; while in the current context it would be more accurate to say it is tax evasion guaranteed by the government.

Tax havens play a specific role in the movement of capital, as they facilitate the flow of all types of assets, without asking any question regarding its origin or its destination, and they do so without taxing that capital, or by providing sufficient exemptions or vehicles to avoid taxation.

No wonder some authors (Palan, Murphy, & Chavagneux, 2010) understand that tax havens are at the heart of the globalization that we have witnessed since the 1980s, as they do not work in the margins of the world but are an integral part of modern business practice.

Yes, it is difficult for very small open economies to sort out alternative ways of attracting cash flows. However, financial flows going through tax havens do not benefit the bigger part of their population, among other things because they do not pay taxes (or they pay very small ones) and thus re-distribute wealth. In most cases, they only benefit those working in the financial sector.

Moreover, as it has been noted by Christensen, Shaxson and Wigan (2016), in the same way in which countries that are heavily dependent of natural resources suffer a series of effects from that resource-dependence, such as poor job creation, high inequality, reduction of political freedoms, economic instability and corruption, among others; countries that are excessively dependent of the financial sector have been found to suffer similar problems. Financialization can crowd-out manufacturing and non-financial services, entrench regional disparities, increase economic dependence, increase inequality, and expose the economy to violent crisis.

Tax benefits, in the form of exemptions and incentives targeted to attract foreign investment, not only bring limited benefits for long term sustainable growth, they also place domestic firms at a competitive disadvantage. More perniciously, tax preferences are generally given together with secrecy to enable and encourage tax avoidance and evasion on a massive scale, and in many instances play a role in attracting money laundering operations (Stiglitz J. E., 2016)

There may be certain circumstances in which tax incentives for corporations are justifiable as a policy tool. However, there will always be a risk of abuse or lobbying by politically-connected sectors for special treatment, or simply that a tax incentive does not justify its cost but remains in place due to inertia and lack of scrutiny. (ICRICT, 2016)

However, the European Commission continues to promote “fair tax competition” as a principle of good tax governance; the only thing seemingly precluded is “special deals” which are treated as State Aid, for which Ireland has been chastised.  (ICRICT, 2016)

Taxation is the most sustainable and predictable source of financing for the provision of public goods and services, as well as a key tool for addressing economic inequality, including gender inequality (Grondona, Bidegain Ponte, & Rodríguez Enríquez, 2016).

Moreover, when a state´s ability to collect revenues and control IFFs is more restricted, revenue loss tends to be compensated through higher taxes on compliant taxpayers, such as small and medium-sized companies and individuals or by relying more heavily on indirect taxation. Therefore, if states do not tackle tax abuse, they are likely to be disproportionately benefitting wealthy individuals to the detriment of the most disadvantaged. Also, international tax avoidance, tax havens and the offshore secrecy system have been found to give corporations that make use of these avoidance opportunities very significant competitive advantages over national firms. There is a gender dimension to this, since women are overrepresented in small and medium enterprises (that benefit less from avoidance opportunities) and at the bottom of the income ladder. Women tend to use larger portions of their income on basic goods because of gender norms that assign the responsibility for the care of dependents to them. This means that they bear the brunt of consumption taxes (Grondona, Bidegain, Rodriguez; 2016).

To continue reading, go to the document on Tax evasion and avoidance in the European Union, by Verónica Grondona for GUE/NGL.

[1] The original OFC developed in London, and became known as “offshore” because it escaped nearly all forms of financial supervision and regulation. (Palan, Murphy, & Chavagneux, 2010)

[2] However, GUE/NGL’s initiative to include secrecy among the usual features of an offshore financial centre in paragraph 3 of the PANA Report was rejected by the great anti-progressive alliance in the Committee.

[3] See http://www.eurodad.org/tax-games-2017

[4] Extreme cases of these structures are known as “toll manufacturers” and “stripped distributors”, where even the inventories remain in the hands of the “principal”, and are placed on consignment on the taxpayer’s premises during the manufacturing process or at the time of the sale to the end client. (Grondona, 2015)

[5] See http://www.oecd.org/ctp/beps-actions.htm