Internationally taxing

I've advocated a number of times (e.g. this post) the benefit of analysing an issue by considering multiple viewpoints, and have been annoyed how so few articles do so (i.e. I don't trust anyone's analysis if they can't name a few reasons why those who disagree could/should do so...). Time to try living up to my own standards.
Source: http://www.hhcpa.com/services/international/international-tax-compliance.php
The topic? Something that has come up a lot in Australia at least, which is the taxation of multinational internet-economy-based corporations (MNC). Full disclaimer: I used to work at one, but was in no way involved in the financial/political side. I no longer work there, and the views contained here were mine beforehand too, and not based on any knowledge internally.

To start, a brief summary: The internet is widely used in Australia (like most of the western world) and there are a number of companies founded internationally who profit from selling products or services to people in Australia. In discussions for the recent budget, the Australian government proposed that funds could be obtained by cracking down on 'tax avoidance' by multinational companies who have set up profit distribution systems in order to reduce taxation payments (places like Apple, Google, Microsoft, ...). For those unfamiliar with what sort of stuff this involves, I'd suggest checking the Double Irish wikipedia page or the multitude of youtube videos on the subject.

To structure this post, I'll try presenting points from either side - labelled 'status-quo' = corporations are ok as-is, and 'pay-more' = corporations should pay more tax - and discuss it, with my conclusion plus the problems with my approach. I'm also assuming that most readers are on the pay-more side, so you should probably watch this video first. It's from an earlier instance when something similar came up - an Australian senate hearing from 1991, with Kerry Packer being asked about tax avoidance for ACP (now PBL).

Ok, jumping in to the arguments, starting from one brought up in the video:

status-quo: MNC are just following the law, there's nothing wrong with that.
I agree with the first part, but not the second, and you can hear why in the video above: "you were doing so in ways that were contrary to the spirit of the law". It's an age-old debate - yes, it is technically following the letter of the law, but not the spirit.

This is a tricky area, so I'll try a more tech-related analogy: I've heard the comparison before that writing legislation is like writing code - you approximate what you want, and then iterate to patch over the holes as they come up. Except that with law, it's a really old code base, changes take years, and it's rarely refactored. In this comparison, tech companies are not happy if you exploit bugs in their systems, even if you are technically 'only running the code as written'. Usually, if you profit off finding these bugs, you can be charged.

Interestingly, the MNC themselves have many contests and rewards for finding these problems. Suggestion: perhaps the ATO should do likewise? There's the question of whether people would report them, or make more privately helping others use the exploit, but this is the case with tech bug rewards too. Still, as a user you're supposed to follow the spirit of the code, so I feel the same should apply to law.

The downside is that this opens up a lot of grey areas - either you don't charge people for breaking the spirit of a law (in which case, they probably still will? perhaps there needs to be some sort of public shaming as a side-effect :)) or you need to have people decide when a breakage occurs, which seems ripe for abuse. I'm not sure a good fix here, it seems like something those more involved in the legal system will have good ideas for though.

pay-more: MNC should be found guilty of tax evasion and fined.
This is where it gets tricky - I'm assuming that the ATO knows about this loophole, so it's similar to when white-hack hackers report an issue but it still doesn't get fixed. What are they allowed to do then? There have been some examples in Australia, e.g. where someone reported a Victoria police website issue, it didn't get fixed, and so they downloaded 600,000 records of PI. I don't believe any criminal action was taken there, and while it's not exactly the same, it seems fine in the legal sense to try to patch this issue quickly and only find people guilty going forwards (which seems like will be the case in Australia). Note that public opinion != law too, so feel free to keep claiming the actions weren't the best to take. In terms of the problems with this conclusion: not having a fine or criminal conviction definitely won't act as much of a dis-incentive to continue the act, but I can't think of a good way to avoid that without breaking conclusions above.

pay-more: MNC should be taxed just like normal businesses.
Taxation for stuff like this is really tricky. Traditional businesses, especially selling physical goods, are much simpler: Person A buys a good from Shop B in Country C - you transfer tax on the profit (GST in Australia) to country C, which helps both having more happy people to buy and more useful businesses to sell things.

Compare this to something like online adverstising: A company (say, based in England with offices in France and Germany) sells advertising placements to another company (say, based in France with offices in Belgium and Germany), which is then charged only when an user in Cameroon (tunneling through an IP in Niger) clicks on it. Where should the tax be applied there, in a way that helps the governments of the user, the business, and all the connections between. Does it change if the deal between countries is made in France or Germany (or via an email exchange between England and Belgium)? While it's not the case that $27B revenue should result in $193M in tax (0.7% doesn't seem enough for the user's country to make more, happier users) it's also not going to be as easy as simply applying normal rules to online business, and will result in less tax locally (which is then countered by growing a local IT services industry). Plus, to repeat the points above - whatever the ideal taxation systems are, goverments should not be too slow in their implementation, but also it companies shouldn't require having complicated revenue relocation structures.

status-quo: Why pay more tax if the government is so inefficient?
This one's really complex, so included here will just be brief points, my guess is more will come up in comments. First: government is less efficient than corporations, this is not surprising. There are a number of things that I'm very happy to be privatised (e.g. supermarkets, banks, ...) - competition has been useful here. The problems are twofold: one is where monopolies are much more efficient - e.g. I'm happy for a national (in the most part) post handler, and national rail network. It doesn't make much sense building two parallel networks for these, which is why I'm also happy that the NBN is being done by a government. The second problem is harder: it's where being 'efficient' would ignore externalities and result in bad outcomes. People in remote areas are glad that the post system still covers them, just like how people with health problems are glad that they can get government health coverage - neither of these are 'efficient', but they seem good to have in order to avoid an external social cost.

The downside here is, when allowing inefficiency, it's hard to justify what is actually allowed, and you run a risk of becoming too inefficient. Governments certainly fall down here, due to having so much cruft build-up over time ('technical debt', in tech terms). That said, I don't find them that much less skilled at fixing it than businesses, but perhaps better measures can be put in place to ensure it doesn't build too much.

Conclusion
MNC aren't breaking the law, but they're also not acting in the interest of their customers in the countries whose goverments they are avoiding tax from (and by proxy, their own interest). A great example of this is Australia's NBN: It is in the interest of the users in Australia to have fast connections, and also the tech MNC so they can get more usage. I feel then it's crazy to both be disappointed by the cost/speed of the NBN (delays, fttn vs. ftth etc.) but also minimise paying tax that would go towards paying for a better NBN. Either these MNC can build their own (which seems even less efficient, and I'm sure wouldn't have as high coverage), or cut the tax minimization strategies. Even better would be for one or two to do so pro-actively "Hey, we acknowledge we found a bug in the tax law, and you're trying to fix it, so we'll not exploit it while helping you". Unfortunately then it's in everyone's interest to let other companies do so, so that is unlikely to happen soon...

Thanks for making it this far! I hope this has been a more interesting read that the usual one-sided analysis, and please leave feedback. I'll leave you with David Mitchell's thoughts on the subject - which takes a different line but is similar in some ways, and presented in the excellent David Mitchell manner (warning: also with his language.)


A few notes:
- I have no legal or corporate finance background, so there are likely errors. Let me know and I'll fix them!
- Related: This post is no yet finished. As more points are brought up, I'll try and work them into the analysis above as seems fit, and maybe modify a few conclusions too.
Enjoy!

Oh, and to the late Kerry Packer: I don't minimize my tax. I'm in a fortunate position to have to pay tax, and be able to live on what I do without trying to minimize it. While it is in my rational self-interest to personally minimize tax, and it would have no measurable impact on what the government has to spend, I see the problems in applying personal logic to country-level situations (which taxation is for). I feel this is the equivalent of defecting in the Prisoner's dilemma. Yearly tax is iterative, so I guess you're implying the government should play 'tit-for-tat' - i.e. fine you heavily for minimization?

Comments

  1. Well, here's another simple solution: make just one big government all over the world :D All these problems due to different laws would be gone. (Yes, I know it's unfeasible)

    Wouldn't another solution simply be "disallow more then X levels of indirection for money?" In code, layers upon layers are bad, and here too this seems to be the problem. The money goes from original country to Ireland, then to Netherlands, then to Ireland and then to Bermuda. If there was a limit of moving money around just once, Ireland would suddenly get really rich. I know it might be a problem of tracking all the money, but hey, accountants have to have a job too.

    Also, some MNC's are building their own networks (Loon and Fi come to mind). And that MNC has a preeeeetty good track record at building networks :)))

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    Replies
    1. Thanks for the comment! I do think that international taxation agreements will improve much of this, but as you say, getting there is the hard part...

      Indirection is an interesting idea, it may be tricky to track if X > 1 (as when you deposit money, you'd have to say how many levels each part is already at - though still easier than breaking down each dollar into which countries it came from. My guess is it'd be possible to work around it and reset the counter too ('oh, we purchased from Unrelated Reseller Inc, and they bought it from OurCompanyInIreland GmbH).

      As for Loon/Fi - I think my doubts for these are summed up by their coverage maps (same with Fiber). Which is fine for businesses, who hope to make profits, but a government should aim to also cover some non-profitable areas, and can more justifiably concentrate on their country.

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  2. I just clicked on to this. It is a most excellent post. I will need to read it again (several times), and make notes so I can post complete comments.
    One thing that struck me is your use of coding as a parallel way of thinking about the tax system - this works very well. You might want to think about using this technique more generally. (I guess you have been).

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  3. Well, I think you have stated the arguments of both sides in the various areas very well. And I agree with you (even if I don't practice it often!) that it is a good idea to analyse things from differing perspectives...if you can't explain/identify the elements of the other argument, you don't really understand.
    I guess in a way it boils down to human behaviour. On the one hand, there is the extremely powerful force of self-interest (Paul Keating: 'If there is a horse running in the race called "Self Interest", bet on it, as at least you know it is trying."), and on the other the will towards doing the right thing, acting in the interest of the whole and ethical choices simply because it is right.
    Hawke/Keating managed to set off a major and in some senses unique economic/financial/social reform program that unleashed the power of self-interest, but did that in a way that preserved (pretty much) the 'we are all in this' and 'it is the right thing to do' and 'it is done fairly' view across the country.
    Another quote for you, although I don't know who said it first: 'The only thing worse than a government monopoly is a private one'.

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  4. PS -
    I think David Mitchell does say it very well.
    You may be interested to know that in his 40+ years of being a tax-adviser/accountant, your grandfather had many opportunities to advise clients on tax evasion, the 'bottom of the harbour' schemes in particular. He refused to do so.

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