OECD cracks down on tax-dodging companies

Last week, the OECD proposed a major new initiative aimed at cracking down on tax avoidance by multinational corporations. The 40-page report follows widespread international criticism of aggressive tax planning by high-profile U.S.-based firms such as Starbucks, Apple, and Google.

The OECD report, called the Action Plan on Base Erosion and Profit Shifting, makes 15 recommendations including:

• Cracking down on transfer pricing, especially for intellectual property and other intangible assets. This practice allows firms to shift assets and expenses among its subsidiaries in a way that maximizes revenue in low-tax jurisdictions and maximizes deductible expenses in high-tax countries.
• Requiring additional transparency by firms. Companies would have to disclose their profits, sales, and taxes on a country-by-country basis.

The plan has already kicked off an important discussion. But chances of many of these proposals ever being adopted are slim. The OECD timeline calls for the group to gradually turn its framework into specific recommendations by the end of 2015. After that, each member country would have to approve the proposals for them to have the force of law.

But critics are already chipping away. Even before the plan was released, the OECD backed away from even tougher rules proposed by French Finance Minister Pierre Moscovici. The OECD also rejected still more ambitious steps such as creating a system that apportions the income and expenses of a multinational among countries by formula based on economic activity in each individual country.

And, not surprisingly, big U.S. multinationals that benefit from the current international tax regime have already lined up against the plan. So have low-tax jurisdictions such as Ireland and the Cayman Islands. They insist they are not tax havens but don’t want the current system changed. Indeed, even as they object to aggressive tax planning many countries still encourage such tax-shopping.

Even with great good intentions, it will be enormously difficult for the OECD to develop workable solutions to the problems it identified. For instance, curbing transfer pricing requires taxing authorities to benchmark a firm’s internal price of intellectual property that is transfered from one business unit to another against a market price. But what is the right price for, say, proprietary software code? With no market to reference, that’s no easy task, though it seems worth a try.

The most important proposals, however, are those aimed at increasing transparency. This seems to be a necessary first step for international cooperation.

We know, for instance, that firms have found ways to avoid paying any tax at all on much of their income. Harvard University tax professor Steve Shay memorably calls this “ocean income”—revenues that simply disappear into the deep and avoid tax by any jurisdiction.

But with current opaque reporting rules, even taxing authorities struggle to sort this out. Full disclosure by firms would shine more light on this practice and, perhaps, encourage countries to work together to address it.

The goal, as always with good tax policy, is to be sure that multinational firms pay tax once, but only once, on their worldwide income. This will require real cooperation from countries that often see themselves as engaged in tax competition with one another. For all its limitations, the OECD report is a first step to getting that conversation going.