Countries Must Work Together to Get Rid of Low-Tax Loopholes

Changing a law to give a foreign company residence (or secrecy) costs next to nothing, and it has spurred a corporate tax race to the bottom that includes the US. The only way out of this challenge is for nations to band together to prohibit low-tax and no-tax jurisdictions while protecting the interests of low-income countries such as those in Africa.

Businesses can avoid taxes completely and comply fully with the current international corporate tax system that relies on “residence” taxes, which tax firms in their legal home without regard to where they actually earn their income. Globalization makes it easy for enterprises to “reside” in one place while they earn in another.

Countries are obsessed with attracting foreign investment and have used foreign company residence as a loophole. But foreign investors want expensive infrastructure such as good roads, strong internet, electricity, and schools—all of which rely on tax revenue.

Pillar One of the OECD’s two-pillar solution seeks to redistribute a portion of multinational profits to countries where goods and services are sold, rather than to the company’s headquarters on paper. For example, if a US corporation has a highly profitable subsidiary in Ireland that sells software to customers in Spain, Pillar One would allocate a portion of those Irish profits to the US and Spain for those governments to tax.

While 138 countries have signed on to Pillar Two, its implementation around the globe remains patchy, particularly in developing nations facing significant administrative hurdles. Many African countries experience barriers to tax collection, for example, and the pillars are no help.

Collecting taxes is the hardest thing governments do. Countries can only tax the people and businesses they can find. Illiteracy, barter economies, large tracts of land without basic infrastructure like electricity and roads, and extreme poverty all make people and companies harder to find.

Even when a government locates a person or company, it might still have trouble discovering their income and wealth. This is why tax havens provide financial secrecy.

OECD data shows that African countries depend on taxes from large multinational corporations more than other nations, and they suffer more when these companies hide their profits in tax havens.

Pillar Two is designed so a parent company’s country of residence can tax “foreign” subsidiaries if foreign subsidiaries are in countries with tax rates below 15%. African countries want the countries where subsidiaries earn income to get the top ups instead. They point out that even though high-income nations lose the most revenues from tax havens, tax havens cost low-income governments the largest portion of their revenue.

Implementing Pillar One costs more than the new rules produce in extra revenue. African nations use digital services taxes that garner more revenue at less cost. The Organization for Economic Cooperation and Development’s proposal only reaches 100 multinational enterprises, all of which reside in high-income countries, and Pillar One requires member nations to repeal all digital services taxes. Low-income countries risk losing tax revenue by switching from digital service taxes to Pillar One.

Pillar One also only reaches companies with more than 10% in profits, and Pillar Two sets a 15% corporate tax minimum. African countries have higher corporate tax rates than other nations, and they see these rates as part of a race to the bottom.

Beyond the questions of tax revenue specifics, the OECD’s entire process has put African countries on a lower footing than others. Pillars One and Two have mandatory binding arbitration provisions. African countries are concerned that these arbitrators will come from a closed club of specialists that will consistently favor high-income governments.

The OECD’s Inclusive Framework aims to allow interested countries and jurisdictions to work on an equal footing with OECD and G20 members on the two-pillar solution. One African tax administrator, Logan Wort, described a particular Inclusive Framework negotiation in which a document was sent after 10 p.m. with a deadline for the next morning: “You can sign away your taxing rights in your sleep if you receive a deadline like this.”

Why should African countries take part in a disrespectful process that creates rules that work against their economic interests? This isn’t about African countries skirting Pillars One and Two because they want to become tax havens—it’s about protecting public finances so they can serve their citizens. The West African Tax Administration Forum makes that clear by advising its members to make their decisions about Pillars One and Two based on benefit versus cost for their citizens alone.

Tackling an issue as big as global taxation requires that nations act in concert, which requires mutual respect and understanding. The United Nations African Group thinks that the UN is a better forum for creating an international tax regime. Low-income countries have more power and autonomy within the UN than through the OECD. A UN committee recently approved a tax treaty outline that reflects ongoing disagreement between developed and developing economies.

OECD countries should recognize that they created the international tax system that allows their nations’ multinational enterprises to avoid tax. Perhaps it’s time to share the power and learn from the countries that aren’t part of the problem.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners

Author Information

US taxation and development expert Beverly Moran is professor emerita at Vanderbilt University, senior fellow at the Roosevelt Institute, and senior tax fellow at Boston College Law School.

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