Information asymmetry has always been the bane of tax authority, especially in dealing with multinational enterprise. Prior to transfer pricing documentation regime, tax authority relies much on domestic tax return and financial statements in order to understand MNE's structure.
Those aforementioned sources, understandably, do not paint a complete picture of the functions performed, assets used, and risks assumed by each of MNE's constituent entities. The closest analogy that we often use is "blind men and elephant". A group of blind men heard that a strange animal, called an elephant, had been brought to the town, but none of them were aware of its shape and form. The first person, who touched the trunk, said, "This animal is like a snake". Another one whose hand reached its ear, it seemed like a kind of fan. Another person, whose hand was upon its leg, said that the elephant is like a tree-trunk, or a pillar. They are not entirely incorrect, of course, but they are missing the big picture.
CbCR attempts to bridge this asymmetry by requiring MNE to report its economic activities in each jurisdiction it operates. CbCR's first main forms, CbC-1, lists MNE's financial information (revenues, profit/loss, taxes, assets, capital, and employees) in per country basis. The second form, CbC-2, lists MNE's entities alongside its functions (e.g. manufactures, procurement, distribution/marketing, R&D, service, financing, etc.)
CbC-1 and CbC-2
Nevertheless, this trove of information comes with a trade off.
Firstly, CbCR's functions are limited to transfer pricing and other BEPS-related risks assessment, as well as for statistical purposes. It cannot be used as conclusive proof that there exists incorrect transfer pricing. It also cannot be used for global formulary apportionment purpose. In short, it cannot be used directly for transfer pricing correction in tax audit, but only to initiate further inquiries.
Lastly, CbCR is not public, rendering its use for public accountability limited. (Some MNEs voluntarily made their CbCR public, however, but this is not a requirement.) For the purpose of measuring BEPS risks, OECD collects aggregated and anonymised CbCR from many jurisdictions. By aggregating and anonymising the CbCRs, it make them difficult to trace back to certain MNEs, which once again serve CbCR's private characteristic. The part of OECD's report on Indonesia serves as the basis for our profit shifting measure here.
Global Profit Shifting and Revenue Loss Measures
Profit shifting to country, \(i\), denoted \(S_i\), is measured from the profit booked \(\pi_i\), and theoretical profit \(P_i\), i.e.
\(S_i = \pi_i - P_i\)
The profit booked is taken from profit (loss) before tax in CbC-1.
We employ 2 estimation strategies. First, we follow Tax Justice Network (TJN)'s formula in measuring share of economic activity.
\(P_i\) is calculated by multiplying the total profits by the share of economic activity. The share of economic activity is calculated on the basis of unrelated party sales, \(R_i\), and number of employees, \(E_i\), i.e.
\(P_i = \sum\limits_{i}{\pi_i}\cdot (\frac{\frac{1}{2}\cdot R_i}{\Sigma_i R_i}+\frac{\frac{1}{2} \cdot E_i}{\Sigma_i E_i})\)
We also employ the so-called "Massachusetts formula", where instead of using half-revenue half-employee as weights, we use weighting from unrelated party revenue, employees, and tangible assets \(A_i\), each with a third of weight.
\(P_i = \sum\limits_{i}{\pi_i}\cdot (\frac{\frac{1}{3}\cdot R_i}{\Sigma_i R_i}+\frac{\frac{1}{3}\cdot E_i}{\Sigma_i E_i}+\frac{\frac{1}{3} \cdot A_i}{\Sigma_i A_i})\)
Massachusetts formula is used in US to apportion income or cost of a corporation among US states, by placing equal weights on sales, payrolls, and assets.TJN’s choice of two weights – revenues and employees only, but not tangible assets – follows their rationale that tangible assets are biased by profit shifting. On their analysis, tangible assets in Luxembourg are greater than Germany, France, and African countries combined, despite the former is not renowned for their real sector economy compared to the latter.
Arguably, the same reasoning could be used to suspect that revenues might be biased. For example, if the MNEs employ third party to act as distribution hub in Singapore to perform sales in Asia-Pacific region and consequently books massive unrelated party revenues in Singapore. We thus include Massachusetts formula that incorporate tangible assets to still account for MNEs that have real economic activities that have low level of labour but significant capital investment in properties, plants, or equipments.
To obtain estimates of profit shifting, \(S^c\)is then defined as the sum of positive values of \(S_i\) for countries where the effective tax rate is below 15%, such that
\(S^c = \sum\limits_{i}{S'^c_i} - P_i\), where
\[S'^c_i =
\begin{cases}
S^c_i & \text{if } S^c_i > 0 \text{ and } ETR^c_i < 15\%\\ 0 & \text{otherwise } \end{cases} \] TJN argues that this correction allows us to remove some resource-rich countries with large profits and high tax rates, therefore obtaining a more conservative estimate of profit shifting.
The choice of break-out threshold in 15% follows TJN's methodology, based on their finding that every country with an effective tax rate above 15% loses tax revenue through profit shifting.
The global tax revenue loss, \(TRL^c\) is calculated by multiplying shifted profit \(S^c\) with the average effective tax rate in countries that is higher than 15%, weighted by the measures of real economic activities, i.e.
\(TRL^c = S^c \cdot \widehat{ETR^c}\)
Effective tax rate (ETR) is calculated as follows:
\(\widehat{ETR^c}=\sum\limits_{i\in{\{N-c\colon ETR_i \geq 15\%\}}}ETR_i(\frac{\frac{1}{2}\cdot R_i}{\Sigma_i R_i}+\frac{\frac{1}{2} \cdot E_i}{\Sigma_i E_i})\) , for TJN weight, and
\(\widehat{ETR^c}=\sum\limits_{i\in{\{N-c\colon ETR_i \geq 15\%\}}}ETR_i(\frac{\frac{1}{3}\cdot R_i}{\Sigma_i R_i}+\frac{\frac{1}{3}\cdot R_i}{\Sigma_i R_i}+\frac{\frac{1}{3} \cdot A_i}{\Sigma_i A_i})\) , for Massachusetts formula weight.
\(\widehat{ETR^c}=\sum\limits_{i\in{\{N-c\colon ETR_i \geq 15\%\}}}ETR_i(\frac{\frac{1}{3}\cdot R_i}{\Sigma_i R_i}+\frac{\frac{1}{3}\cdot R_i}{\Sigma_i R_i}+\frac{\frac{1}{3} \cdot A_i}{\Sigma_i A_i})\) , for Massachusetts formula weight.
However, their definition of effective tax rate is taxes paid divided by profit before tax, which is closer to the definition of cash ETR in tax avoidance literature. We supplement this analysis with our measure of effective tax rate which is taxes accrued divided by profit before tax. From this point on, CETR will be used to denote TJN's measure, and ETR to denote "traditional" ETR.
Results
We estimate around 1-3 trillion IDR of shifting out, depending on the measure used.
To these following countries.
Plotting the distribution into box plot, there are significant variants if cash ETR is used.
How much revenue is lost? Depending on the measure of ETR and weighting, this translates to 200-600 billion IDR of global tax revenue loss.
NOTE: Due to its aggregated nature, this is not the tax revenue lost of Indonesia only, but collective tax revenue lost for some countries where Indonesian MNEs operate.
Conclusion and Further Remarks
Based on the aggregated and anonymised CbCR, there are indications that MNEs engage in global profit shifting, resulting in significant revenue loss.
Aggregated and anonymised CbC Report released by OECD is a neat tool to monitor global profit shifting lost. This type of analysis could even be conducted on MNE level, and with the indicators outlined in the OECD Handbook of Effective Tax Risk Assessment, this may be used to complement current compliance risk management analysis. Incorporating the information of CbC-2 as weights and employing different ETR threshold (e.g. using MNE's own group ETR) could also improve future analysis. It may be even useful for the purpose of Pillar 2, Global Anti-Base Erosion proposal to address digital economy and other economy of scale without mass.
Reference
INFINITE (2020), Comments on Public Consultation Document: Review of Country-by-Country Reporting (BEPS Action 13) https://www.infinite-tax.org/2020/05/19/comments-on-public-consultation-document-review-of-country-by-country-reporting-beps-action-13/ (Accessed 13 July 2020)
OECD (2020), New corporate tax statistics provide fresh insights into the activities of multinational enterprises http://www.oecd.org/tax/new-corporate-tax-statistics-provide-fresh-insights-into-the-activities-of-multinational-enterprises.htm (Accessed 13 July 2020)
OECD (2017), Country-by-Country Reporting: Handbook on Effective Tax Risk Assessment, OECD, Paris.
www.oecd.org/tax/beps/country-by-country-reporting-handbook-on-effective-tax-risk-assessment.pdf (Accessed 13 July 2020)
Tax Justice Network (2020), Watershed data indicates more than a trillion dollars of corporate profit smuggled into tax havens, https://www.taxjustice.net/2020/07/08/watershed-data-indicates-more-than-a-trillion-dollars-of-corporate-profit-smuggled-into-tax-havens/ (Accessed 13 July 2020)
Tax Justice Network (2020), Methodology: Analysis of OECD country by country reporting data, https://www.taxjustice.net/wp-content/uploads/2020/07/Methodology-Analysis-of-OECD-country-by-country-reporting-data-July-2020.pdf (Accessed 13 July 2020)
No comments:
Post a Comment