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OECD Proposes Plan for Crackdown on Companies’ Tax Avoidance

Photographer: Paul McErlane/Bloomberg

The Google Inc. European headquarters are seen in Barrow Street, Dublin, Ireland. Close

The Google Inc. European headquarters are seen in Barrow Street, Dublin, Ireland.

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Photographer: Paul McErlane/Bloomberg

The Google Inc. European headquarters are seen in Barrow Street, Dublin, Ireland.

The Organization for Economic Cooperation and Development proposed a blueprint for cracking down on tax-dodging strategies used by companies such as Google Inc. (GOOG), Apple Inc. (AAPL) and Yahoo! Inc. (YHOO)

German Finance Minister Wolfgang Schaeuble called the OECD’s plan a “major step.” The proposal aims to develop rules over the next two years preventing companies from escaping taxes by putting patent rights into shell companies, taking interest deductions in one country without reporting taxable profit in another, and forcing them to disclose to regulators where they report their income around the world.

“It’s a matter of justice and fairness that multinational companies pay their fair contribution” to national budgets, Schaeuble told reporters today before a meeting of Group of 20 finance chiefs and central bankers in Moscow. Without “fair burden sharing, in the end we will destroy even a global, open economy,” he said.

The 40-page report will complement efforts by deficit-laden governments to increase revenue they collect from profitable enterprises. It follows hearings in the U.S. and U.K. revealing how companies avoided billions in taxes by attributing profits to mailbox subsidiaries in places like Bermuda and the Cayman Islands.

The U.K. Parliament has held three hearings since November on corporate tax dodging -- examining strategies used by Google, Amazon and Starbucks Corp. (SBUX) In May, the U.S. Senate held a hearing on Apple’s offshore tax strategies. The companies all say they’ve complied with international tax laws.

Intellectual Property

“It is clear multinational companies have developed an unprecedented know-how for minimizing their worldwide tax pressure,” French Finance Minister Pierre Moscovici said in Moscow. “These situations are literally impossible to explain to our fellow citizens.”

A pair of the OECD proposals calls for rules to make it harder to shift profits by assigning intellectual property, such as patent rights, to offshore units. Under current law, such offshore subsidiaries can take credit for profits arising from patents developed in countries like the U.S. and U.K. -- generally with cash the parent companies provided to them in the first place.

Mountain View, Calfornia-based Google, for example, has avoided as much as $2 billion in worldwide income taxes annually by attributing profits to a subsidiary in Bermuda that holds the rights to its intellectual property for sales outside the U.S., as reported by Bloomberg News in December.

Economic Activity

Though there is no real economic activity going on in Bermuda “all the returns are in Bermuda,” said Pascal Saint-Amans, director of the Center for Tax Policy and Administration for the Paris-based OECD, not referring specifically to Google. “This is wrong, we need to fix it.”

The OECD is a government-funded think tank that was charged by the G-20 to tackle the issue.

The plan contrasts with the OECD’s previous approach that critics say enabled corporate-profit shifting and resisted reform efforts. As reported by Bloomberg News in March, the agency has seen a revolving door between the top tax officials that write its guidelines and law firms that advise companies on manipulating those rules to avoid taxes.

“For an OECD document this is a really strong report,” said Stephen E. Shay, former deputy assistant secretary for international-tax affairs at the U.S. Treasury Department under President Barack Obama and now a professor at Harvard Law School. “It’s proposing what could be important and positive changes to international tax rules. Whether the member countries can get there, that’s an open question.”

OECD Objectives

Achieving the plan’s objectives may be hamstrung by the role that several European countries -- including Ireland, the Netherlands and Luxembourg -- play in enabling the avoidance, said Sol Picciotto, an emeritus professor of law at Lancaster University in the U.K. and a senior adviser to the Tax Justice Network advocacy group.

“It depends on governments willing to take measures and the OECD doesn’t have any power to compel any governments to do anything,” he said.

The OECD rejected a fundamental overhaul. Under current law in most developed countries, companies allocate corporate income for tax purposes based on paper transactions between units under “arm’s-length” prices, or the amounts that would be paid between unrelated parties. That has let subsidiaries in tax havens pay low prices for patent rights, moving profits offshore.

‘Piecemeal Patches’

A competing approach, considered by the European Union since 2004, would allocate companies’ profit between countries based on measures such as sales in each country.

The OECD plan said moving to this system, known as “formulary apportionment,” is not viable.

The Tax Justice Network, a non-profit group that has pressured government agencies to work on these issues, called the OECD plan “a series of piecemeal patches. These patches are generally to be welcomed, as immediate remedies to the gaping holes in the broken international tax system.”

The group further criticized the OECD for not opening the door to formulary apportionment, which it said would tax companies based on the “genuine economic substance of what they do and where they do it.” Instead, the agency has “for years stubbornly clung to the outdated principles of a system devised 80 years ago.”

‘Realistic Assessment’

Last month, the International Monetary Fund issued a report saying that the possibility of switching to a formulary system based on actual economic activities such as sales in a given country deserves “a more thorough and realistic assessment.”

Meanwhile, a coalition of development agencies, including Oxfam and Christian Aid, criticized the plan for not adequately including developing countries that are not members of the OECD.

“International tax rules affect everyone and it is often the poorest countries that suffer the greatest losses due to tax abuse,” said Oxfam’s senior policy advisor Claire Godfrey. The groups called on the OECD to adjust its proposal to require companies to tell regulators in each country where they report their profits so that such disclosures would be made public. That way “we can see exactly how much profit they are parking in tax havens.”

U.K. Prime Minister David Cameron said the OECD report “shows how taxpayers, governments and businesses all suffer when some companies manipulate the tax system to avoid paying their fair share of taxes. And it highlights how much we still have to do to bring the international tax system, conceived back in the 1920s, into the 21st century.”

Although the U.K. has been accelerating its own efforts to help multinationals avoid taxes, Cameron said in a statement that he would highlight the OECD plan at the G-20 Summit in St. Petersburg in September. “I will call on fellow leaders to get behind this action plan to ensure that we break down the walls of corporate secrecy, once and for all, and that all companies pay their fair share.”

To contact the reporters on this story: Jesse Drucker in New York at jdrucker4@bloomberg.net; Rainer Buergin in Moscow at rbuergin1@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net

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