The Integrity of the Tax System after BEPS: A Shared Responsibility

International tax law has become a hotly disputed topic in recent years. There is public outcry over the aggressive tax planning practices of multinational enterprises, and over the lack of cooperation between states to counter these practices with fair and effective rules. This evidences deep concerns about the integrity of the international tax system. Rebuilding public trust in its integrity has thus become an urgent matter.

Yet, who is to be held responsible for the erosion of the tax system? Multinationals or states? This question is ultimately a moral one, for taxation is a moral phenomenon. As Thomas Piketty (2014, p. 493) states, ‘without taxes, society has no common destiny, and collective action is impossible’. Indeed, the tax system reflects and protects important values such as liberty, reciprocity, solidarity and distributive justice. Taxes are the main funding for society and for individual liberty to flourish. Moreover, they are an important means to enhance distributive justice.

Why is tax compliance a question of moral responsibility? Multinationals and states make choices that impact the tax system. Both multinationals and states as actors in the tax system enjoy a certain freedom of choice with regard to the design, interpretation, application and use of tax rules. States can devise tax systems in different ways. Corporate (and other) taxpayers can comply with the rules and they can also structure their tax affairs to minimize their tax liability. The choices by these actors may affect, enhance or undermine the integrity of the tax system.

The integrity of the tax system has been hollowed out by both multinational corporations and states. On the one hand, many multinationals are gaming the system. By minimising their tax liability, they erode the integrity of international tax law. They do not pay their share in a system where everyone, both citizens and companies, are expected to contribute to the financing of public expenditure which everyone benefits from. On the other hand, the rules of the game are set by countries competing for multinationals’ investment, by lowering tax rates and introducing tax incentives which lower effective tax rates. Both multinationals and states compete at an international level.

Moral responsibility begins precisely where actions are not completely determined by the tax law. That is, freedom of choice entails responsibility. Multinationals and states are therefore both responsible for the integrity of the tax system. But, if so, are these actors equally responsible?

States have the primary responsibility

States, who set the rules of the game, have the primary responsibility to establish a fair and effective system of taxation. States must act responsibly by cooperating to make better rules which prevent aggressive tax planning. Responsible tax governance requires that states to improve the international tax system, and to abstain from harmful tax competition.

In this regard, the OECD’s Base Erosion and Profit Shifting (BEPS) Project introduced regulatory improvements to ensure more responsible fiscal behaviour from both governments and multinationals, with the goal of bringing to a halt the erosion of the integrity of the (international) tax system. The European Commission followed suit with its Anti-Tax Avoidance Package. Better rules improve the integrity of the international tax system.

Multinationals and their responsibility

Multinational enterprises also have responsibility for the system. Tax legislation should be based on an impartial balancing by the legislature of the different interests involved. Yet, corporate lobbying aimed at protecting multinationals’ interests is often very effective. It may result in tax privileges violating the requirement that tax legislation should be based on an impartial balancing of different interests.

The prevailing political view on taxation as a regulatory tool—for example to attract foreign investment—increases the risk of the introduction of privileges, detrimental to the integrity of the system. As Allison Christians (2017) argues, this governance problem requires improved transparency and accountability in order to restore taxpayer trust.

Lobbying is not the only reason why some taxpayers end up paying less than a fair share. Although the law should be equally applied to all, some taxpayers manage to escape their obligations by searching every nook and cranny of the tax system; hence, paying taxes becomes a matter of choice. With choice comes responsibility: the integrity of the tax system is therefore a matter of shared responsibility, even if asymmetric. The fact that the legislature has to advance the general interest, while taxpayers may seek to advance their own, accounts for this normative asymmetry.

Without taxes, there would be no successful corporations. The state creates the trust on which market transactions depend, through legal enforcement of contracts and (intellectual) property rights, by fixing market failures and taking an active role in managing markets. The ‘state’s very visible hand’ takes on risk by shaping and creating new markets, as Mazzucato (2015) maintains. Governments expect to receive a return on these investments by taxing the resulting profits, and corporations’ aggressive tax planning impedes this goal.

States are cooperating in creating better rules to prevent aggressive tax planning. Nonetheless, a perfect tax system will never be achieved: whatever tax rules are in place, (corporate) taxpayers will always have some choice regarding the applicable tax rules and their interpretation. However, as stated earlier, freedom of choice entails moral responsibility, and using tax rules is inevitably a matter of exercising that responsibility.

Tax planning by multinationals spans many different strategies, and not all of them may seem aggressive. Tax planning can be aimed at avoiding double taxation but it may also entail tax avoidance, with taxpayers arranging their affairs in order to pay less than their due share, disproportionally shifting the tax burden to other taxpayers—the sitting ducks.

Aggressive tax planning is an extreme form of legal engineering: the inconsistencies and loopholes of legal systems are exploited to provide perfectly legal benefits. The phenomenon of ‘stateless income’ (Kleinbard 2013) may be the ultimate example. Aggressive tax planning also takes advantage of the law’s adherence to formality at the expense of the substantive value of distributive justice and, in doing so, ‘it exploits the values of the rule of law itself’ (Prebble & Prebble 2010).

Tax professionals and their responsibility

Tax professionals, including legal and accounting advisors, fulfil an important role in the tax system. However, tax advisers also use the formality of the law as a knife, to minimise the amount of tax paid by their clients or employers. Formalistic legal reasoning may have a serious impact on distributive justice and should therefore be guided by ethical considerations. Tax professionals have choices, and also have a responsibility to protect the tax system.

Companies and tax advisers endorsing corporate social responsibility should avoid acting irresponsibly, and abstain from engaging in aggressive tax planning. Companies may show ethical commitment through corporate social responsibility. The voluntary engagement of multinationals in CSR entails acceptance of ethical obligations beyond the strict compliance with the law. This commitment should be applied to taxation, putting  a stop to narrowing down their obligations to the letter of the law in order to minimise tax liability. The ethical commitment requires multinationals and their professional advisers should avoid irresponsible and profoundly unfair tax planning.

Shared responsibility for the tax system must be taken seriously by both states and multinationals, especially in the framework of corporate social responsibility. They should not pass the responsibility for the integrity of the tax system to the other party.

 

Further reading: Gribnau, H 2017, ‘The Integrity of the Tax System after BEPS: A Shared Responsibility’, Erasmus Law Review, vol. 10, no. 1, pp. 12-28.