Introduction
Global expansion prompts companies to manipulate taxes through profit shifting, straining economies. G-20’s efforts falter as profit shifting endures, draining funds for vital services. Lowering corporate tax rates, while tempting, invites financial instability. Embracing ESG principles, tax strategies reveal a moral stance, demanding inclusive financial guidance. Is it time to redefine tax ethics for corporate citizenship?
One of the biggest changes companies expanding globally will experience is likely to be in the way they account for and pay their taxes.
They will likely face pressure to do as their multinational competitors so often do and reduce their international corporate tax burdens through profit shifting, the practice of accounting for profits in countries with lower tax rates. At the extreme end of the scale, we call these jurisdictions tax havens.
Profits shifted to tax havens by multinational companies increased from less than two per cent in the 1970s to 37 per cent in 2019, according to research published last November.
Over the same period, global corporate tax revenue as a proportion of global income should have increased by about a third. Instead, due to profit shifting, it declined by about the same proportion, researchers Ludvig Wier and Gabriel Zucman of the United Nations University World Institute for Development Economics Research found.
As a result, the G-20 group of countries made a concerted attempt in the second half of the last decade to curb such profit shifting.
In an effort to increase transparency in the international tax system, for instance, OECD and G20 countries moved towards country-by-country financial reporting to local tax authorities and to counter tax base erosion and profit shifting.
A few years on, the impact of these efforts remains questionable. Weir and Zucman found corporations shifted nearly US$1 trillion in profits earned outside of their home countries to tax havens in 2019, up from US$616 billion in 2015.
The effect of profit shifting is erosion of the tax base. Governments lose tax revenues that could be spent on essential services such as education, health care, infrastructure or benefits, the OECD has said. Citizens must either foot the bill through higher taxes or go without services.
One of the key tools some nations have used to curb profit shifting is to cut their own corporate tax rates. Again, that can be fiscally challenging.
Domestic businesses can also find themselves struggling to compete against multinationals that can lower their own tax bills to bank larger profits or to invest harder in R&D, marketing or further expansion.
Businesses expanding from domestic to international markets can strategically organize their operations to reduce tax liabilities. However, as numerous organizations embrace frameworks like Environmental, Social, and Governance (ESG), this approach becomes more intricate. As PwC tax leaders Will Morris and Edwin Visser wrote, a company’s approach to tax is no longer just a question of compliance.
“In the context of the environmental, social and governance (ESG) imperative, it is becoming a powerful indicator of how a business views its role in society and its commitment to its purpose. It’s a critical element of a business’s social contribution—part of the “S” in ESG.”
Clearly, international businesses need good financial and tax advice, but if they aspire to be good corporate citizens, they may need to invite an ESG perspective into those discussions as well.
