Your Taxes: UK Labour Party international tax program analyzed

On October 28, 2019, John McDonnell, Labour’s Shadow Chancellor of the Exchequer (Finance Minister), endorsed a report issued the same day by Public Services International (PSI).

By LEON HARRIS

NOVEMBER 21, 2019 23:41

UK LABOUR leader Jeremy Corbyn speaks in the House (photo credit: Courtesy) — UK LABOUR leader Jeremy Corbyn speaks in the House

(photo credit: Courtesy)

The UK Labour Party is hoping to raise GBP 3 to 6 billion per year, to help finance its spending proposals, by changing the international tax system.

On October 28, 2019, John McDonnell, Labour’s Shadow Chancellor of the Exchequer (Finance Minister), endorsed a report issued the same day by Public Services International (PSI), a global trade union federation of public service employees in 154 countries.

“We welcome this exciting and important report on fair taxation of multinationals,” McDonnell said.

The PSI report dismissed current OECD tax reform measures and advocated moving over to a worldwide “Unitary Basis” of taxation. This means multinational corporations would allocate taxable income between countries according to a formula reflecting labor, capital and sales.

If a Labour government is elected on December 12, would the PSI proposals improve our lot?

Comments on the PSI report:

Missing from the income allocation formula are some important factors: intellectual property (IP) and entrepreneurial risk. So a hi-tech firm from Tel Aviv (or California) which succeeds (around 80% fail) and supplies UK customers may receive zero recognition for its innovative IP and therefore have to pay extra British tax. Other countries’ tax authorities may be reluctant to grant a credit for such extra British tax, resulting in double taxation.

The stated reason for ignoring IP is that it might get parked offshore. That generally no longer works under Israeli and US tax rules. But the proposal would reward less innovative countries.

How would double (or multiple) taxation be avoided? Which country’s accounting rules would apply? Would there be a worldwide tax tribunal system to deal with disputes between taxpayers and the various different tax authorities? The PSI report does not discuss these aspects.

The report also accuses multinational corporations of setting up many affiliated companies for tax reasons. In fact, exporters generally set up local subsidiaries to be closer to customers and to local employ staff who speak the same language and share the same culture. And many start-ups operate online with no foreign affiliates or just a handful. They operate over the Internet.

Moreover, the report rejects the principle of valuing export transactions at market value (“the arm’s-length principle”). This means the report effectively rejects capitalism and national sovereignty.

What happens if many engineers are hired to develop a new application, which subsequently operates automatically? It is unclear when labor is quantified in the PSI income allocation formula.

Furthermore, the report contains no mention of how the unitary system would be implemented. Will US multinationals first report to the US IRS, who would then pass on some of the US tax to the UK and other countries? Or would the US multinational report to each country?

Last but not least, the PSI report only discusses income tax. It ignores VAT and US sales tax, which are also undergoing change to ensure efficient (but complex) ways of taxing online sales. These ways include automated self-assessment and tax withholding by online market places.

What did the OECD propose?

By contrast, the OECD has recently issued proposals based on so-called “pillars.” Pillar one proposes to continue with the present market-based “arm’s-length” basis for transactions within a multinational group. But excess profit above a base-line level would be re-allocated to where customers or users are located. Pillar two proposes that multinationals should pay a minimum tax rate on their global operations.

Comments on the PSI and OECD proposals:

Both sets of proposals are unfinished works in progress. The rates and percentages have not yet been decided, nor have “carve-outs” for deserving special cases. This is like a baking a tax cake for hungry tax authorities where the ingredients are undecided, but the cake needs to be on the table by early 2020.

California has a unitary system of state income tax, but it is possible to file a “water’s edge election” to stop California taxing non-US income. Many other US states apportion corporate income by reference to sales or a three-factor formula: sales, property and payroll. In some states, the three are equally weighted, in other states, sales are given double weight.

What should multinational firms do?

In practice, e-commerce and other international operations that use algorithms as well as people may be penalized under both sets of draft proposals. Specialist advice is needed to assess what is needed, where it’s needed and whether any alternatives should be considered – they exist.

As always, consult experienced tax advisers in each country at an early stage in specific cases.

leon@h2cat.com
The writer is a certified public accountant and tax specialist at Harris Horoviz Consulting & Tax Ltd.