Multinational Corporations,
Stateless Income, and Tax Havens
Sinclair Davidson
The public perception
• There has been a lot of
public protest about wellknown multi-national
corporations not paying
“their fair share” of tax.
• Source:
http://www.huffingtonpost.co.uk/2012/12/10/googlestarbucks-amazon-tax-spoof-logos_n_2270830.html
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The public perception
• Source: http://www.blog.rippedoffbritons.com/2012/10/starbucks-google-facebook-amazon-ibm.html
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The Claim
The decline in corporate-tax collection in recent decades has contributed to
budget deficits. It has also aggravated income inequality: a company’s
shareholders ultimately pay its taxes, and with a smaller tax bill, shareholders,
who tend to be much more affluent than the average American, see their
wealth increase.
“It’s clearly a broken system,” said Michelle Hanlon, an accounting professor at
M.I.T.
Corporate taxes burst into the spotlight last week, with the release of a Senate
committee report on Apple’s tactics to reduce its tax payments. More quietly,
but perhaps more significantly, the House Ways and Means Committee has
begun work on a potential overhaul of the tax code. Edward D. Kleinbard, a tax
expert and former Democratic Congressional aide, said he had been impressed
so far by the seriousness of the committee’s work.
– David Leonhardt, Who Will Crack the Code?, The New York Times, May
25, 2013.
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The Fiscal Challenge
General government revenue
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
50
48
46
44
42
40
38
36
34
32
30
2000
% GDP
Figure 1: The fiscal challenge faced by Advanced Economies
General government total expenditure
Source: International Monetary Fund, World Economic Outlook Database, April 2013
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The Fiscal Challenge
Figure 2: The fiscal challenge faced by the Euro Area
52
50
% GDP
48
46
44
42
General government revenue
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
40
General government total expenditure
Source: International Monetary Fund, World Economic Outlook Database, April 2013
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The Corporate Income Tax and Fiscal Illusion
12
11
10
9
8
7
6
5
4
3
2
1
0
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
%
Figure 3: OECD Corporate income tax revenue as a percentage of GDP and total tax
Corporate tax revenue as percentage of GDP
Corporate tax revenue as percentage of total tax revenue
Source: OECD.stat
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The Corporate Income Tax and Fiscal Illusion
Figure 4: Tax revenue by sector as percentage of total taxation
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
0%
Individuals
Corporate
Social Security
Payroll
Property
Goods and Sevices
Other
Source: OECD.stat
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Is the Corporate Tax Base being eroded?
Figure 5: OECD Corporate Tax Revenue and Corporate Tax Rate
60
50
%
40
30
20
10
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
0
Average OECD Corporate Tax Rate
OECD Corporate Income Tax Revenue to GDP
Source: OECD.stat and Jane Gravelle (2012: Table A-1)
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Is the Corporate Tax Base being eroded?
• Peter Birch Sørensen has provided a test where the ratio of corporate income
tax revenue to GDP is decomposed into its component parts:
R/Y=R/C*C/P*P/Y
– R = corporate tax revenue,
– Y is GDP,
– C is total corporate profit and
– P is total profit earned in the economy.
– R/C is a proxy for the average effective corporate income tax rate,
– C/P is the share of corporate profits and
– P/Y is the profit share of the economy.
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Is the Corporate Tax Base being eroded?
Figure 6: Corporate tax decomposition for the United Kingdom and the United States
Source: OECD.stat and author calculations
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Is the Corporate Tax Base being eroded?
• Australia
70
60
50
%
40
30
20
10
0
2000
2001
2002
2003
R/Y
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2004
R/C
2005
C/P
2006
2007
2008
2009
2010
P/Y
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Double Irish Dutch Sandwich
• Source: AFR 20 June 2013
http://www.afr.com/p/markets/gaping_legislative_loopholes_mean_twxDlS6YlGZ6qqNos31HbM
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A Critique of the Stateless Income Doctrine
• Edward Kleinbard, Professor of Law at the University of Southern California,
has developed the notion of “stateless income”.
– Influential in the current debate.
• Definition:
– Income derived by a multinational group from business activities in a
country other than the domicile (however defined) of the group’s ultimate
parent company, but which is subject to tax only in a jurisdiction that is not
the location of the customers or the factors of production through which
the income was derived, and is not the domicile of the group’s parent
company.
– Complex and convoluted.
– Stateless income thus can be understood as the movement of taxable
income within a multinational group from high-tax to low-tax source
countries without shifting the location of externally-supplied capital or
activities involving third parties.
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A Critique of the Stateless Income Doctrine
• Kleinbard claims that stateless income is not equivalent to capital mobility or
aggressive transfer pricing.
– “The phenomenon of stateless income risks appearing vague, and its
analysis tedious”.
• The fact, however, that some multinational corporations do not pay (very
much, if any) corporate income tax in any one particular jurisdiction is
necessary but not sufficient evidence of wrong-doing on the part of those
corporations.
– “Stateless persons wander a hostile globe, looking for asylum; by contrast,
stateless income takes a bearing for any of a number of zero or low-tax
jurisdictions, where it finds a ready welcome.”
• The basic problem with Kleinbard’s argument isn’t that MNCs don’t pay tax
but that they don’t pay tax in the US.
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A Critique of the Stateless Income Doctrine
• The source of stateless income appears to be two-fold:
– MNCs locate their valuable intellectual capital in those economies with
legal regimes that value them most highly.
– Highly mobile.
– Easily expropriateable.
– But … Kleinbard does not recognise this point.
– Kleinbard views the source of stateless income as being, “an inevitable byproduct of fundamental international income tax norms” and “nations’
collective failure to agree on other critical international tax norms that
would determine the “source” of income”.
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A Critique of the Stateless Income Doctrine
• Kleinbard’s position is fragile:
– “the recognition of the separate tax personas of different juridical persons”.
– “the general practice of treating interest on indebtedness as deductible to
the payor”.
– “the norms of freedom of contract”.
– It is the ready acceptance by countries of the fantastic notions that
– (i) a wholly-owned subsidiary has a mind of its own with which to
negotiate “arm’s-length” contractual terms with its parent,
– (ii) capital provided to the subsidiary by the parent somehow becomes
the property of an independent actor (the subsidiary) with which it can
take business risks that for tax purposes are not simply assimilated into
those borne by the parent (as both provider of the capital and ultimate
economic owner of the assets acquired therewith), and
– (iii) a multinational enterprise that exists as a global platform to exploit a
core set of intangible assets best is analogized to wholly independent
actors taking on limited and straightforward roles in a vertical chain of
production or a horizontal array of distribution of a product.
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A Critique of the Stateless Income Doctrine
• So what is he saying?
– It is not at all clear that
– separate tax personas,
– deductibility of interest payments,
– freedom of contract,
– limited liability, and
– the veil of incorporation,
are “fantastic notions”.
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A Critique of the Stateless Income Doctrine
• Realising that his argument is weak, Kleinbard is reduced to scaremongering:
– When unchecked, stateless income strips source countries (including the
United States as the location of subsidiaries of foreign-controlled groups)
of the tax revenues attributable to income generated in those jurisdictions.
Its availability also distorts the investment decisions of multinational firms,
and under current U.S. rules distorts a U.S. multinational firm’s decision
whether to repatriate that stateless income back to the United States.
• Problems:
– Having just argued that the problem is a by-product of tax conventions
stateless income is a definitional problem not base erosion.
– He provides no evidence of distortion.
– At worst this might be a governance problem not a tax problem.
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A Critique of the Stateless Income Doctrine
• Kleinbard claims:
– Stateless income “destroys any possible coherence to the concept of the
geographic source of income, on which all territorial tax systems rely”.
– But that is wrong:
– Stateless income tax planning does not make geographic source
incoherent – it transfers it from one location to another.
– As the WSJ indicated:
– “We wonder what the Irish think of the spectacle of an American
Senator expressing outrage that an American company doesn't pay
enough Irish taxes.”
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A Critique of the Stateless Income Doctrine
• Kleinbard undervalues intellectual property.
– “there is nothing in the [double Irish Dutch sandwich] structure that relies
on any unique business model or asset of Google’s”.
– As if Google’s business model itself is not intellectual property.
– Why would firms choose to invest across a national border rather than
simply export into that market, or licence production in another economy.
– John Dunning argues that multinational firms own firm-specific
intangible assets and can best exploit the value of those assets by
investing across national borders.
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Tax Havens and Multinational Corporations
• What sort of multinational corporations establish activities in low-tax
jurisdictions?
– Large firms with high shares of international activity are the most likely to
have haven affiliates, and firms in industries characterized by high R&D
intensities and significant volumes of intrafirm trade similarly exhibit the
greatest demand for tax haven operations.
– Mihir Desai, Fritz Foley and James Hines Jr., (2006a)
• Does investment in low-tax jurisdictions crowd-out investment in high-tax
jurisdictions?
– No. Desai, Foley and Hines also report that tax haven activity increases
economic activity in nearby non-tax haven economies.
• Finally if income shifting is occurring, how large are the quantities of potential
tax revenue involved?
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Tax Havens and Multinational Corporations
• Finally if income shifting is occurring, how large are the quantities of potential
tax revenue involved?
– Dhammika Dharmapala and Nadine Riedel investigate the amount of profit
shifting that actually occurs using 5400 European multinational affiliates
over the period 1995 – 2005.
– The magnitude of the profit being shifted, however, is only two per cent of
parent corporation profits.
– Consistent with estimates in the literature of the gains to be made from
tax harmonisation.
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Tax Harmonisation
• Kleinbard has advocated tax harmonisation with a global corporate income
tax rate of 25 per cent.
Table One: Best Case Scenario of Tax Competition and Coordination.
Competition
Coordination
Policy Variables
Capital Tax Rates
12.7
42.3
Labour Tax Rates
44.4
44.4
Transfers
100.0
177.0
Infrastructure Spending
100.0
95.0
Other Variables
Capital Stock
100.0
88.0
Employment
100.0
99.0
Profits
100.0
95.0
GDP
100.0
95.0
Average Real Wage Rate
100.0
96.0
Real Interest Rate
100.0
109.0
Welfare Gain %GDP
0.94
Source: Adapted from Peter Sørensen, 2004, Table 1, pg. 1201.
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Conclusions
• There is no such thing as “stateless income”, rather there is income that the
governments of the United Kingdom and the United States do not tax
because under their own legal systems that income is not sourced in their
economy.
• When these governments complain about stateless income, the question
rather should be, “Why do the owners of intellectual property not locate their
property in your economy?”.
• An implicit assumption of the stateless income doctrine is that multinational
corporations maximise their value to society only when they pay tax.
• The argument is that the corporate income tax base is being eroded by
aggressive tax planning on the part of multinational corporations – yet the
evidence to support this argument is lacking.
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Final word to the WSJ
The Apple units are based in Ireland, so U.S. law does not consider them to be
U.S. corporations subject to U.S. corporate tax. But since they are managed
and controlled by Apple in the U.S., Irish law doesn't consider them Irish
companies and thus they are also not subject to the 12.5% Irish corporate tax.
This isn't alchemy; it's accountancy.
…
None of this required a Senate “investigation” to discover because Apple is
constantly inspected by the IRS and other tax authorities. These tax collectors
are well aware of Apple’s corporate structure, which has remained essentially
the same since 1980. An Apple executive said Tuesday that the company's
annual U.S. tax return adds up to a stack of paperwork more than two feet high.
Review and Outlook, 2013, The Apple Tax Diversion: Senators beat up a U.S. success for following the
tax laws they wrote, The Wall Street Journal, May 21, 2013.
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