By Giancarlo Elia Valori*
The European Treasury, individually as member States or collectively as Union, has so far reached – with a race to the bottom – as many as 72 agreements with large global companies.
Tax competition is still very strong and active. Just think of the US corporate tax that-following the latest reforms- has decreased to a maximum 26% rate, more than one third less than the previous rate, with a US average corporate tax rate which is now below all OECD and G7 levels. Similar approaches, however, are developing in Argentina, Colombia, Luxembourg, Canada and even Japan.
Conversely corporate taxes have increased in Turkey, Portugal and Taiwan, with further increases – albeit slight – also in India. They are selective increases to favour some foreign or national companies compared to others.
At world level we now have as many as eleven jurisdictions –which account for 27% of the total corporate taxes in the world – that are currently increasing corporate taxes, while all the other small and large countries will keep on competing fiercely at tax level with their neighbouring countries.
In short, technology has made all the old tax strategies obsolete.
In fact, currently competition between EU tax systems costs the weakest countries 60 billion euros a year.
It is worth recalling that nine of the twenty companies with the largest capitalization in the world are digital.
The most used corporate tax avoidance strategies to move profits sourced in EU countries to offshore tax havens include the “Dutch sandwich”, the Luxembourg tax rulings-which have recently come to light with the LuxLeaks scandal which hit the headlines – or the specific Irish tax policy, known as the double Irish arrangement.
They rely on the tax loophole that most EU countries allow royalty payments be made to other EU countries without incurring withholding taxes. However, the Dutch tax code allows royalty payments to be made to several offshore tax havens, without incurring Dutch withholding tax.
The Dutch sandwich is based, at first, on the Dutch national rule according to which the dividends and surplus value of a parent company can be transferred to its subsidiaries without paying any tax.
Hence any capital can be transferred to companies based in the Netherlands, thus avoiding all taxation on this liquidity.
Therefore the Dutch sandwich behaves like a “backdoor” out of the EU corporate tax system and into the untaxed non-EU offshore locations.
On the other hand, Luxembourg tends to enter into bilateral agreements with large companies and multinationals, as in a sort of State-company agreement. Everyone tends to do so, but in Luxembourg the transactions and agreements with companies are always particularly beneficial to the private sector.
Ireland imposes a maximum 12.5% corporate tax rate on the total taxable income stated. For purely financial companies said tax rate is only 10%.
Currently the EU tax policy is still based on the destination principle which allows for VAT to be retained by the country where the taxed product is sold.
This is a strategy dating back to the period when the European Union had to deal with the booming phase of Internet sales.
In that case, however, it was a matter of selling traditional goods in a new way. Nowadays brand new goods are sold on the Internet in an even more unusual way.
For IT companies, however, the matter is even more complex, considering they can make turnover and profit anywhere without having any kind of permanent and stable organization where they sell or buy product (or, possibly, produce them).
According to the latest data, with the aforementioned “Dutch sandwich” strategy, in 2016 Google put aside as many as 3.7 billion euros on a total taxable income of 15.9 billion euros.
As all web firms do, it is enough for an Irish subsidiary of the Californian company to sell products globally via royalty schemes to a Dutch company without staff or operations in progress or to another Irish subsidiary also incorporated in Ireland, but managed from an offshore tax haven like Bermuda..
Over a period of three years, the well-known monopolistic Internet firm of California has “saved” approximately 34.2 billion euros, with an annual saving increase of about 7%.
At this juncture, we could only define a universally applicable legal formula of registered office or business organization, in addition to the one of the tangible or intangible place where the tax is generated.
Obviously we also need to imagine the tacit blackmail power of major corporations operating on the Internet, which have very useful databases for all governments and for the US one, in particular. We should also consider to what extent this information and tax asymmetry is useful for the US hegemony over global markets.
This is the geopolitical issue: the tax supremacy of major web firms is an essential and irenouceable factor of the new US hegemony, namely of the New American Century.
With a view to curbing web majors’ tax power, someone has also considered the formula of “meaningful interaction” with users, obtained through widespread digital channels.
It may happen, however, that at least part of the online turnover is produced through peer-to-peer channels between the company and some customer sectors or through a splitting of the IT mediation between small companies, carried out by customer groups.
With the pretext of “dedicated” content, you can avoid taxation and artificially limit the visible invoicing in one single country.
A faster option than “significant interaction” would be to hit only the companies which invoice the intermediate services (advertising, etc.) to the web majors.
Nevertheless, if the web majors bought also these intermediaries, we would go back directly to the Dutch, Irish and Luxembourg tax avoidance schemes and practices.
Furthermore, current data points to a 3% average tax for the companies supplying services to the web majors in Italy and in the rest of the European Union.
In the latter case, the European Commission foresees revenue of only 5 billion euros for the whole EU-27.
However, if we calculate the average of the tax rates currently in force in Europe, the Internet majors pay income tax rates equal to 9.2%, as against the EU average rate of 23.3%.
Is it rational, however, that companies are taxed only on the basis of self-stated annual invoicing?
In essence, with current regulations the sale of data or User Generated Content cannot be taxed properly and profitably.
In this respect, the EU has proposed two different levels of taxation, but considering the digital platform to be a “presence” of company and, therefore, a “permanent and stable organization”.
The criteria under discussion will be the following: exceeding a revenue threshold of 7 million euros in a single EU Member State; the presence of over 100,000 users in one Member State during a single fiscal year; the presence of over 3,000 contracts for digital services concluded between company and users in a single fiscal year.
Hence, with a view to circumventing EU rules, the Internet majors can rely – for their “permanent and stable organization” – also on systems based outside the EU. They can also distribute their users among various micro-companies, not necessarily having a permanent and stable organization in the country using them. Finally they can invoice the 3,000 minimum contracts differently.
A second proposal, still under discussion among the EU leaders, regards the “temporary tax” on digital activities which, moreover, are not currently taxed in any way by the EU.
Hence, according to this proposal, revenues resulting from the sale of advertising space for goods or services other than the means used would be taxed.
Or the revenues resulting from the sale of data based on the information provided, free of charge, by users would be taxed.
Obviously the tax would be collected by the Member States in which the users are located.
Are we sure, however, that an online service can be used without being tracked? This is the rule in what is currently known as the dark web.
If smuggling is the strategy used by all those who do not want to pay taxes on sales, the dark web could become – with some mass IT devices – the new Tortuga of Internet majors.
In Italy, the new Budget Law provides for a tax on digital transactions -as from 2019 – but only relating to the provision of services to subjects resident in Italy both by national companies and through non-resident companies.
In more specific terms, each transaction shall be taxed at 3% net of VAT, thus further loosening the legal connection existing between company’s presence and provision of services, i.e. between “permanent and stable organization” and online commercial activity.
The Italian rule for 2019, however, regards only business to business transactions, thus explicitly excluding both e-commerce ones or the final business to consumer connection.
Much Internet content, however, can easily shift from business to business(B2B) to other types of sales or supply.
Therefore the tax levied should be the withholding tax on revenues, which creates a difference between resident and non-resident companies, which could not suit the EU system.
Hence, again with reference to Italy, the new tax will be neutral with respect to the place of origin of the transaction, but revenues can be subjected not only to the 3% levy, but also to other taxes.
Moreover, it could also be possible to carry out manoeuvres on the prices of the IT supply, with a sort of new dumping on EU or Italian companies by the big Internet majors.
On the other hand, the Italian web tax relies only on self-certification. There will be trouble.
If the web tax and the other taxes on the Internet are VAT modelled, we will face the problem that the VAT transitional regime, defined in Europe until 1997, is still currently in force.
Not to mention the fact that the transfer of capital via the Internet is fully uncontrollable for the States or unions of States and that information gap and asymmetries between States and Companies in this field are such that everything relies on the “good will” of the subjects taxed. Too little.
A solution would be to equip the EU with a stable IT system capable of controlling, at least, a significant part of commercial transactions via the Internet, but this is almost science fiction.
Otherwise, stringent and fast regulations would be needed to definitively close “tax havens” both in the EU and elsewhere but, apart from the unavoidable delays, the result would be that the countries which are currently tax havens would ask for something-indeed, much – in exchange to the other ones which are not tax havens.
Or it could be possibly stated very frankly that the EU market does not accept the free movement of capital in this sector.
However, this would favour the geopolitical areas that would like to use what, in their eyes, would be considered a European weakness.
Nonetheless, here as elsewhere, we should really rethink the architecture of the world economic and financial system.
Said system results from the fully geopolitical irrational anarchy which saw Eurasia yield to the US unipolarity, which currently no longer exists, at least according to the 1990s standards.
Here as elsewhere, we should import the idea of a great liberal and free trader, a disciple of Luigi Einaudi who, in the 1950s, imagined the “army of labour”.
I am referring to Ernesto Rossi who, while assuming a public system using the huge mass of post-war unemployed people, clearly theorized – as a liberal – “a marked integration of Socialist elements into the market economy”.
Abolire la Miseria was written by Ernesto Rossi in 1942, on the island of Ventotene where he had been confined. It was published in 1945 and then re-edited in 1977 after his death.
The Tuscan liberal thinker theorized no “social safety nets”, but rather the creation of an army of labour to be recruited as an alternative to the military service.
The army provided all its members with essential services, with dignity and autonomy, but the “army of labour” had to work both on public infrastructure and on land use and maintenance activities, i.e. all the productive activities that – as Keynes said- could not attract and rely on private capital, which would record no sufficient and quick returns.
What about including clearly Socialist mechanisms in the current financial system, and not only through tax systems, thus rightfully leaving high-income activities to private capitalism?
It would finally be the merger between the two best intellectual and technical lines of Italian democracy, namely social Catholicism and secular Liberal Socialism.
About the author:
Advisory Board Co-chair Honoris Causa Professor Giancarlo Elia Valori is an eminent Italian economist and businessman. He holds prestigious academic distinctions and national orders. Mr Valori has lectured on international affairs and economics at the world’s leading universities such as Peking University, the Hebrew University of Jerusalem and the Yeshiva University in New York. He currently chairs “La Centrale Finanziaria Generale Spa”, he is also the honorary president of Huawei Italy, economic adviser to the Chinese giant HNA Group and member of the Ayan-Holding Board. In 1992 he was appointed Officier de la Légion d’Honneur de la République Francaise, with this motivation: “A man who can see across borders to understand the world” and in 2002 he received the title of “Honorable” of the Académie des Sciences de l’Institut de France.
This article was published by Modern Diplomacy.