Global tax evasion fight: Why MNCs, HNIs still outsmart regulations

The menace of tax evasion and avoidance by multinational corporations and high-net-worth individuals — by relocating to low-tax jurisdictions and tax havens — has been a matter of serious global concern. This is particularly so in developing countries, as they require the much-needed resources to augment infrastructure and human development, combat environmental challenges, and control deficits and debt for macro-stability, especially in the aftermath of the economic challenges created by the pandemic and international hostilities, which have disrupted global supply chains and adversely impacted production costs and energy prices.

 

In this context, the recent report on global tax evasion by the EU Tax Observatory, hosted by the Paris School of Economics, focusing on international tax evasion and wilful avoidance, requires close attention.

 

Multinationals and high-net-worth individuals (HNIs) dodge taxes in a variety of ways. The most common way for multinationals is through the transfer pricing mechanism, in which a subsidiary in a high-tax country purchases management or financial services from a related entity in a low-tax country at an inflated price, shifting profits to the lower-tax jurisdiction. Another way is to borrow funds in a high-tax country from a related party in low-tax country at high interest rates and transfer profits in the guise of interest payments. Yet another way is to locate the headquarters in tax havens and assign intangible assets such as trademarks, intellectual property rights, and logos, and extract royalties for the user rights on the subsidiaries in high-tax countries.  While a number of multinational companies resort to such practices, the issue is particularly pronounced among multinational digital companies that can easily locate their headquarters to low-tax jurisdictions and evade tax payments.

 

Globalisation and modern technology have only added complexities and created new avenues for HNIs and multinational corporations to evade taxes. The multilateral exchange of financial transaction information, mandated in 2017, has led many HNIs to shift from stashing cash abroad to investing in real estate. While there can be legitimate reasons for owning property in other countries, real estate can also serve as a tool for money laundering. 

 

Based on the recent literature, the report states that about 25 per cent of the offshore wealth held in the form of financial assets earlier may have been converted into real estate to avoid reporting financial transactions.  The report cites the case of Dubai, where cross-border ownership of real estate is large. Interestingly, Indians own about 20 per cent of the properties owned by foreigners in Dubai, and it is suspected that a considerable part of this could be to evade taxes.

 

Tax evasion by multinational corporations and HNIs has drawn considerable attention from global policymakers. Over the past decade, governments have cooperated to launch major initiatives aimed at tackling this challenge.  In 2013, G20 countries entrusted the task of addressing the issue of base erosion and profit shifting (BEPS) to the OECD, resulting in the establishment of the Inclusive Framework on BEPS. As many as 140 countries are working together to implement the 15-point action plan developed by the OECD to tackle tax avoidance, improve coordination in international tax rules, and ensure greater transparency. The Independent Commission for the Reform of International Corporate Taxation (ICRICT) — a coalition of intergovernmental, civil society, and labour organisations — has also been undertaking research and advocacy, highlighting the problem and recommending methods to apportion the profits of multinationals headquartered in low-tax jurisdictions to different countries based on investments, turnovers, or employment so that these earnings are taxed in their respective countries. 

 

However, not much has been achieved in terms of ensuring compliance because international agreements have been elusive.  Nevertheless, the two recent developments have made some notable changes in this landscape: First, the mandatory multilateral exchange of financial information by banks, introduced in 2017, has expanded to over 100 countries as of 2023.  Second, the 2021 international agreement to impose a global minimum tax on multinational corporations—endorsed by more than 140 countries—has marked a step forward. While these measures have made a notable impact, a comprehensive solution to tax evasion remains elusive.

 

The Global Tax Evasion Report presents some important findings that offer lessons for further international cooperation and policy interventions. First, the automatic exchange of bank information agreed upon in 2013 has curbed global bank secrecy, reducing offshore tax evasion by nearly a third over the past decade.  A decade ago, almost 10 per cent of the world’s gross domestic product (GDP) was held in financial assets by households in tax havens. While offshore financial wealth remains at similar levels, only 25 per cent of it is now estimated to evade taxation. Surely some evasion continues, and this could be due to non-compliance by some banks, use of shell banks, high reporting thresholds, non-participation by the United States in the Common Reporting Standard (CRS), potential loopholes in reporting norms, and a lack of administrative capacity in some countries. Second, 140 countries were signatories to the global minimum tax of 15 per cent on multinationals in countries where the actual production takes place and this was expected to increase revenue by 10 per cent.  However, due to loopholes, actual collections have fallen far short of expectations. In fact, the loopholes have expanded over time, as some countries engage in a “race to the bottom” by offering tax incentives.  Third, global billionaires have been successfully using shell companies to reduce their tax payments to less than 0.5 per cent of their wealth.  Fourth, a large amount of profits continues to be shifted to tax havens with almost 40 per cent of this being done by US corporations! The amount is estimated to be close to 10 per cent of the global corporate tax revenues.

 

How can we force compliance on multinationals and HNIs? The report makes recommendations to rework the international agreement to raise the minimum tax to 25 per cent and plug the loopholes to eliminate tax competition. It also advocates a new global minimum tax for the world’s billionaires at 2 per cent of their wealth.  Another proposal is to tax long-term residents moving to low-tax countries. The countries should implement measures unilaterally if the global agreements fail to come through. The moot question is, can countries act unilaterally without a global agreement? Will US multinationals allow such an agreement to come through? Do developing countries have the muscle power to deal with powerful multinational companies and HNIs? The answers to these are not easy to come by, and in the meantime, the struggle will continue.

 

The author is chairman, Karnataka Regional Imbalances Redressal Committee, and former director, NIPFP. The views are personal