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Introduction
The
Oxford English Dictionary defines 'fiscal' as: 'of or pertaining
to the treasury of a state or prince'. Thus it covers both the raising
of money and the spending of it. By and large it has been true throughout
recorded history that States or monarchs have had responsibility
for both sides of the equation, although they have typically had
more freedom to spend than to raise money. This is not likely to
change; indeed, from the perspective of the State the situation
is going to get worse, since the globalization of business and increasing
personal mobility will make it ever more difficult to collect tax,
while demands on spending will continue to expand.
The
positive side of this mismatch is that States will be prevented
from encroaching further on individual freedoms, simply because
they won't be able to afford it. In fact, many types of expenditure
which are currently seen as state responsibilities will migrate
into the globalized, private sector where they can become economic
market goods. They should never have become state responsibilities
in the first place. Medical and retirement provision are two clear
examples. People will have a far wider range of choices in a globalized
market for such social goods.
The
likely outcome of the tension between unequal national income and
expenditure streams will be considered in Chapter 8: The Future
of the State. This chapter will describe some of the trends which
are leading towards the globalization of taxation, the main ones
being:
- the
accumulation of assets in 'offshore' or 'lowtax' regimes and the
countervailing emergence of fiscal 'transparency';
- a
long-term trend towards the reduction of corporate tax rates and
the
development of a common corporate tax base and global accounting
standards;
- emergence
of global methodologies and regulations in transfer pricing, 'controlled
foreign company' rules, double tax treaties and 'permanent establishment'
rules;
- the
detaching of individuals' revenues from their physical place of
residence, and probable agreement on an international residence-based,
income-sharing taxation regime.
First,
though, it is necessary to review some aspects of the history and
recent development of taxation, and the regulatory environment in
which it takes place.
The
power to raise taxes is said to be one of the characteristics of
sovereignty, although it is only in modern times that the state
has acquired sufficient knowledge about its citizens, and control
over them in a physical sense, to be able to collect taxes in a
direct way.
In
earlier, less developed societies the monarch tended to raise taxes
through levies on goods - either on importation or production, or
at the point of consumption, through the sale of privileges and
licenses, and through stamp duty or its equivalents on transactions
involving real property of various types.
Rent
rolls compiled by governments, the Church or major landowners have
been a feature of almost all societies, and they are concerned to
list the worth of property holdings; the names of tenants are incidental
to the process. The most famous example is of course the English
Domesday Book.
Income
tax and inheritance tax are more recent additions to the armoury
of tax weapons, since both required knowledge of the existence of
individuals and the ability to contact
and assess them, something that was lacking through most of recorded
history. The first census in the UK was in 1841, with other European
nations and the US following rapidly, so it is no surprise to find
that personal taxes such as income tax and inheritance tax made
their appearance in the late 19th or early 20th centuries.
Since
then, the appetite of governments for control over all features
of life has been limited only by their ability to raise enough money
through taxation or borrowing. Public expenditure as a proportion
of national income has risen inexorably in all developed countries,
and continues to do so, with occasional retrenchments. Between 1800
and 2000, public expenditure in the OECD countries
climbed from about 10% of national income to an average of 42%.
Inevitably, taxes have risen to match.
In the US, for instance, corporation tax was
instituted for the first time in 1909 at the rate of 1% (previously,
corporate profits had been attributed to shareholders). Currently,
it is levied at 35%, although it rose as high as 53% at times during
the 1960s and 1970s.
Until
1900, the level of taxes was not so great that people needed to
develop systematic ways of escaping or reducing them. Of course,
people have always tried to avoid paying taxes, and the tax collector
is one of the most execrated figures in history; but from roughly
1920 onwards, the game played between taxpayers and revenue authorities
took on a more thoroughgoing aspect.
The
last 20 years of the 20th century saw an escalation of the battle,
culminating in a determined attempt by the 'multilaterals' (the
OECD, the FATF, the EU,
the United Nations and the IMF)
to bring a halt to the runaway success of the lowtax
(often 'offshore') jurisdictions in attracting capital and income
flows away from higher-taxing countries.
These
attempts were only partially successful, and in any event it is
important to see them in historical perspective. The battle of taxman
and taxpayer is one of the longest-running sagas of the ongoing
development of human society, and without any doubt it will be continuing
long after the offshore wars of the late 20th and early 21st century
are forgotten about.
One
sure statistic is that, despite all attempts by the multilaterals
and high-taxing countries to restrain 'offshore', low-taxing jurisdictions
have increased their share of total assets and total income streams
over the last 20 years. The total proportion of the world's wealth
that is based 'offshore' is said to be well over 60% - and that
figure is rising, both because existing offshore assets increase
largely without being held back by tax, and because people continue
to take every opportunity to re-direct income streams away from
high-tax areas and into low-tax ones.
By
and large, 'offshore' assets can be said to be 'globalized' assets,
since it is of the essence of offshore that banking, investment
fund or trust assets can be moved around the world without taxation.
By contrast, high-taxing 'onshore' jurisdictions put every imaginable
barrier (usually a tax one) in the way of their resident citizens'
freedom to dispose of their assets as they choose.
Offshore
'Offshore'
And The Common Law Trust
It is fair to say that the beginnings of fiscal globalization, both
for taxers and the taxed, can be dated to the emergence of the offshore
trust as a means of tax avoidance, which led eventually to the wholesale
transfer of capital assets and income from high-taxing jurisdictions
into 'lowtax' areas, usually offshore.
Income
tax was first levied in England at the beginning of the 20th century,
and in many countries had become worth avoiding by mid-century;
but initially at least the best way of avoiding it was to turn income
into capital, which was not so heavily taxed. It was only when capital
taxes of various types became significant that the offshore trust
came into its own. Very rich people had begun to use offshore trusts
in the first half of the century, although at least as much because
of the additional asset protection that they offered, simply by
being in a different jurisdiction, as because they were tax efficient.
The administrative
overhead and other complications of dealing with an offshore location
were initially very great, so that at first only conveniently close-by
islands like Jersey (Channel Isles) for the Brits and the Bahamas
(for Americans) developed as 'offshore' jurisdictions, and then
only for very wealthy people. The first trusts legislation in the
Bahamas, surprisingly, dates from 1893. The great expansion of trusts,
both in terms of number of jurisdictions and volume of business,
came later when telecommunications, air transport and the end of
capital controls opened up the world and gave freedom to average
investors to move their assets around with relative ease.
When
offshore trusts began to be used in a major way, they were usually
set up by professionals in the home jurisdiction of the settlor,
reflecting the lack of professional expertise in the few offshore
jurisdictions that were then available. Eventually the main professional
firms began to set up offices in the jurisdictions, and a gradual
process got under way which has resulted in the emergence of sophisticated,
multi-disciplinary firms offshore. When these firms work for the
corporate sector, they can be referred to as 'corporate service
providers', a term which implies a blend of tax, legal and financial
expertise.
In parallel with the
growth of professional expertise, and sometimes in competition with
it, those jurisdictions which encouraged banking usually saw the
development of 'fiduciary' companies, often run as departments of
banks, which specialised in the setting-up and running of trusts.
The banks, which were and are rapidly developing their private banking
sides, had a ready supply of wealthy clients for a trust business.
By 1980 offshore was
burgeoning in response to horrific onshore tax rates, and tax avoidance
had taken over as the main driver of offshore growth. In this process,
and as more and more countries laid claim to the worldwide income
and assets of individuals during life and at the end of it, the
trust played a key part.
The Cleaning-Up
Of Offshore
Alongside legitimate
investors from high-tax countries, 'offshore' also attracted less
salubrious income streams including laundered drug money, a wave
of 'capital flight' from the economies of the former Soviet Union,
and the proceeds of corruption in dozens of developing economies.
In most jurisdictions, professional competence ran ahead of legislative
controls, and the wall of money that hit offshore from illicit sources
in the '90s may have found it all too easy to burrow unseen into
the layer of anonymous trusts, IBCs (International Business Companies)
and bank accounts that makes up the asset base of offshore.
In the last years of
the 20th century, the rich countries' trade union, the OECD,
decided to take on 'offshore', overtly in order to 'clean it up',
but with an unspoken sub-text aimed at curbing the inroads it was
making into its member states' tax revenues. Aided by the FATF
(Financial Action Task Force) and the FSF (Financial
Stability Forum) on the one side, the introduction by the US
of Qualified Intermediary status as part of new withholding tax
legislation on the other, along with the European
Union's 'Code of Conduct' harmful tax initiative, the result has
been a substantial improvement in supervisory standards offshore.
By now, if a jurisdiction wants to remain on the global financial
circuit, it has to apply 'know your customer' rules, have very effective
banking supervision, and conform to high levels of international
mutual assistance.
The Financial Action
Task Force (FATF) was considerably more effective than the OECD
(of which it is a part, to be fair) in 'cleaning-up' offshore -
and some onshore - jurisdictions through its anti money-laundering
campaign. While countries were able to get off the OECD's list of
transgressors simply by promising to be good, the FATF brought a
tougher-minded approach to its targets, and insisted on real
legislative change before it would de-list a country. Usually that
included extensive improvements in 'know your customer' procedures,
the creation of a Financial Intelligence Unit
with accompanying reporting rules, and enhancement of mutual assistance
legislation, as well as the passing of laws which clearly criminalised
money-laundering and terrorist financing.
The horror of 9/11
of course enormously accelerated this process, and faced with extremely
sharp-toothed US legislation such as the Patriot Act, the major
offshore jurisdictions have raced to become cleaner-than-clean in
terms of their anti-money laundering and anti-terrorist funding
regimes, to the point that many of them are by now far 'cleaner'
than the very OECD countries which began the anti-offshore process
in the mid-90s. More to the point, as regards globalization, they
now largely conform to international standards of regulatory control.
Transparency
'Transparency' is
a buzz-word among international financial regulators, and refers
both to the absence of impenetrable barriers to information flow
between countries, and also to the 'level playing field', ie that
domestic and foreign investors and companies should receive equivalent
regulatory and fiscal treatment.
In one word, this is
what is close to having been achieved internationally in the decade
from 1995 to 2005, at first through the moves to regularize 'offshore',
and then through some more general initiatives applying to regional
groupings of countries or in some cases globally.
In October, 2000 the
EU agreed to step up the fight against money laundering and organised
crime on its territory with tougher penalties and a pledge to abolish
the barriers to criminal investigations posed by banking secrecy
and confidentiality in tax matters.
By
May, 2005, the European Commission was able to welcome the European
Parliament's decision to approve the third money laundering directive
which incorporates into EU law the June 2003 revision of the Forty
Recommendations of the Financial Action Task Force (FATF).
The
directive requires those within the financial services sector, lawyers,
notaries, accountants, real estate agents, casinos, trust and company
service providers and retailers receiving cash payments in excess
of EUR15,000 to:
- Verify
the identity of their customer (or the beneficial owner thereof)
and monitor their business relationship with said customer;
- Report
suspicions of money laundering or terrorist financing to the relevant
authorities; and
- Take
supporting measures, such as ensuring the proper training of personnel
and the establishment of appropriate internal preventative policies
and procedures.
The
Patriot Act and other legislative initiatives in the US achieved
largely similar goals.
In November, 2004,
the
G20 group of major industrialised nations and
emerging economies rubber-stamped an initiative aimed at standardising
the exchange of tax information across national borders by adopting
the standard OECD protocol when exchanging
information on tax matters, a move that then German Finance Minister
Hans Eichel declared was a “big step forward,” in the fight against
'harmful tax practices'.
In addition to the G7 group of nations, the G20 includes Argentina,
Australia, Brazil, China, India, Indonesia, South Korea, Mexico,
Russia, Saudi Arabia, South Africa and Turkey.
By 2007, through the
Egmont Group (which oversees Financial Intelligence
Units or their equivalents in almost all countries), the FATF with
its 40 anti-money-laundering recommendations which have become de
rigeur for any country wishing to host international financial business,
the IMF with its country reviews which focus on financial transparency
alongside economic performance, and the various other international
organizations with quasi-legal powers over individual countries,
the goal of 'transparency' is within sight, and it is reasonable
to say that there is already a globalized financial and information-sharing
regime, with fiscal rate-setting one of the few remaining areas
of national discretion.
Banking Secrecy
Confidentiality isn't
what it used to be, but to some extent is still one of the attractions
of 'offshore'. Along with low tax rates and the achievement of 'transparency',
it was one of the targets of the OECD's anti-offshore campaign;
but of the three goals only transparency has been comprehensively
achieved so far. The OECD's battle for 'harmonized' (= high) tax
rates has probably been lost; but in the end secrecy will have been
substantially weakened if not altogether abolished.
After the initial success
of the fightback by 'offshore' against the OECD, '9/11' seemed at
first as if it would hand back power to the regulators, and it has
certainly increased the level of co-operation between national authorities
both onshore and offshore, particularly in the fight against money-laundering;
but so far it does not seem to have been responsible for a major
shift in the overall legal situation regarding banking secrecy.
However, one of the more important legislative
responses to '9/11' has been the United Nations
Convention
For The Suppression Of The Financing Of Terrorism, which in the
long-term can only tend to weaken banking secrecy.
Between
2002 and 2004 no major new international initiative was launched
against banking secrecy as such, but the cumulative effect of additional
Mutual Assistance Treaties, Tax Information Exchange Agreements
(TIEAs), Financial Intelligence Units and other
bilateral or jurisdictional measures has been to weaken privacy
in many if not most offshore jurisdictions. And of course the EU's
Savings Tax Directive has continued on its cumbersome journey, although
since most of the EU's dependent territories, along with Switzerland,
Liechtenstein, Luxembourg, Belgium and Austria have opted for a
withholding tax rather than information exchange as such, the effect
of the Directive on banking secrecy has not been as dramatic as
once seemed likely.
Corporate
Taxation
Multinationals
- The Ultimate Globalizers
While individual persons
have to live somewhere, and therefore in almost all cases have to
be taxed somewhere (they are dealt with below), the same is not
so true of corporations. A corporation with distributed ownership,
with its holding company in a suitable jurisdiction (eg Denmark),
and with a carefully formed international structure, can reduce
its tax bill to single figures, or even to zero. Press reports abound
of such - usually privately-controlled - companies which have miraculously,
so it seems, managed to escape taxation.
Of
course national tax authorities have fought back against aggressive
corporate tax planning, by banning or penalizing the use of out-and-out
tax havens, and by the use of transfer pricing rules (regulation
which prevents a company from making its profits in a low-tax jurisdiction
when the commercial activity took place in a high-tax jurisdiction).
In
planning international corporate structures, there are two major
sets of legislative measures which need to be taken into account
in addition to transfer pricing rules as such: Double Tax Avoidance
Agreements and Controlled Foreign Company (or Corporation) laws.
DTAAs and CFC laws have come about for almost opposite reasons -
DTAAs are the result of bi-lateral national attempts to create an
investment-friendly tax canvas, while CFCs are aimed at preventing
tax avoidance by international corporations - but both impact heavily
on transnational taxation. In addition, both are intricately involved
with 'offshore'.
Personal
tax planning using 'offshore' has come to be seen as somehow reprehensible,
or at least attackable, but corporate tax planning is still respectable,
for now, within the increasingly complex regulatory framework of
DTAAs, transfer pricing rules and CFC laws. They are described in
more detail in Appendix Four.
Corporate
Taxation: The Future
The
Internet has introduced a permanent shift in the balance of power
between the taxman and his tax-paying corporate targets: countries
are anchored in the physical reality of their territory, while companies
will increasingly be free to locate large parts of their economic
activity in low-tax areas. On the corporation tax level E-commerce
and e-business, especially the offshore variety, offer multiple
possibilities for companies to structure themselves so that a larger
and larger proportion of their profits ends up in a low-tax area.
Corporate
activity, much of it Internet-related, will therefore thrive in
most of the important offshore jurisdictions, which will continue
to offer strong tax competition in the corporate sector to the world's
largest economies.
Eventually,
one of two things will happen: either corporation tax will disappear
altogether; or a global harmonized rate will be agreed. In either
case the massive paraphernalia of DTAAs, CFCs, transfer pricing,
and the gigantic corporate tax optimization industry will shrivel
up. Perhaps the first result is more likely. Two steps on the road
to the simplification of corporation tax are the harmonization
of accounting standards, which is far advanced, as described below,
and harmonized calculation of the corporate tax base, which is an
explicit goal of the European Union, currently
being resisted by the UK and Ireland, but which will surely come
into force within the next ten years over much of the globe. It
is not yet clear which international organization will have the
supervision of a globalized tax base - perhaps a glorified OECD,
given its work on permanent establishments and Internet taxation.
Personal
Taxation
Along
with armies, currencies and legislatures, fiscal power would appear
to be one of the 'red line' characteristics of sovereignty, which
most nation states will give up only under
the most intense pressure. They have more or less lost that power
as regards corporate taxation, as explained above; but they certainly
retain it over the individuals who reside on their territory. There
are other sources of taxation, to be sure, which can sustain a national
revenue stream (in order to pay for the jobs, privileges and pensions
of civil servants and politicians), such as stamp duty, property
taxation and VAT; but modern states would be
very badly off indeed if they were unable to take part of the revenue
and capital (whether during life or at death) of their citizens.
Individual
citizens, except at the highest levels of wealth, are firmly rooted
within the nation state of their birth, due to inertia, language,
family ties and culture, allowing nation states to tax them with
little fear that they will decamp to rival countries. At least,
that is true during their productive (and most tax-generative) years.
In retirement, people have more choices. Recent surveys have shown
that astonishingly high proportions of people in high-taxed countries
such as the UK would leave if they could, and many are preparing
the way by buying properties in countries which they see as being
more welcoming (warmer, less expensive and less taxing).
There
are long term trends which will gradually break down the convenient
access nation states have to the income and assets of their citizens,
including:
-
the ease of tele-working (you can work for
a Berlin company as a consultant while living in Malta);
-
the fleet-footedness of companies, noted
above, which can quickly remove taxable activity from a high-taxing
jurisdiction, making it far harder for the jurisdiction to tax
their residents' income streams from such a company;
- the rapid growth
of virtual (Internet) economic activity (see
Chapter 7 and Appendix 3), which is often hard to attribute to
any particular taxing jurisdiction; and
- the growth in individual
wealth, leading to higher and higher proportions of 'rentier'
income, allowing individuals to base themselves in low-taxing
jurisdictions while providing paid-for services to supplement
income.
It
is not easy to forecast how this combination of trends (and others)
will work out, but it seems unavoidable at least that the taxing
countries will reach an agreed international solution, possibly
based on residence periods. Thus, there could be universal taxation
based on physical residence (you live in the Comoros Islands for
six days in a year, you will pay tax on 6/365 of your global income
to the Comoros, at their rate of income taxation). As suggested
above, there will be no corporate tax ('People pay taxes, not companies'
- Mrs Thatcher, c. 1980), withholding taxes, VAT or double tax treaties
(not needed).
Alongside
some kind of globalisation of personal taxation, it is reasonable
also to expect that there will be a global currency, and world-wide
insurance for health-care, pensions etc,
with such 'social' benefits being provided by global, private companies
rather than by nation states.
There
are some pre-conditions to such a system, however, including (something
inevitable) that individuals will have tamper-proof biometric identification,
that financial flows will be fully transparent, and that language
will have ceased to be a barrier to human interaction (see Chapter
2). These conditions are likely to have been fulfilled by 2030,
as described above and as regards language in Chapter 2, so that
is the probable timescale of personal fiscal globalisation.
Once
it has happened, it will be left to countries only to compete in
terms of what they can offer individuals: the local income taxation
rate, and non-economic goods such as quality of life, law and order,
planning and zoning, and 'culture'.
In the medium term
there may still be national safety nets for individuals and families;
longer-term, they are likely to become part of a globalized welfare
system.
These and other aspects
of the future of the nation state are dealt with in greater depth
in Chapter 8.
Global
Fiscal Organizations
As
described above, it is clear that for financially sophisticated
individuals, and for most international companies, taxation is a
subject that has to be approached on an international, not to say
global level. That's a long way short of saying that taxation has
become global, of course; but there are tendencies in the direction
of such an outcome, eventually.
The
remainder of this chapter will be devoted to a review of those international
or global organizations which are contributing meaningfully to the
generalization or globalization of fiscal affairs. As in other Chapters,
the organizations listed are described in greater detail in Appendix
One.
The
World Trade Organization, which as regards tariffs
is clearly a globalizing force, is however dealt with separately
in Chapter 6.
The
OECD (Organization for Economic Cooperation and Development)
is the most prominent international organization as regards tax.
It was described in Chapter 1, and its involvement in setting rules
for corporate taxation were outlined above.
Although
the OECD has only 30 members, including all of the major economic
powers other than Russia and China, it has acquired much wider influence
in certain subject areas, and especially in taxation, in which it
is the only international body with the credibility to make widely
acceptable rules.
The
OECD's rules and standards on 'permanent establishments', the taxation
of e-commerce, double tax treaties (DTAAs), and transfer pricing
are already de facto global standards.
Among
regional organizations, it is really only the European Union
which can be said at this stage to have established any global hegemony,
or contributed to global standards, as described in Chapters 1 and
3. It is a commonplace that the EU, with a formidable legal apparatus
in the European Court of Justice, has diminished
the capacity for independent action of its member states over a
wide range of economic fields. Its VAT rules
have been widely copied by non-EU jurisdictions when they have introduced
VAT. Although the US remains obstinately a 'sales
tax' jurisdiction, most of the rest of the world now has EU-style
VAT, and it is probably only a matter of time before there is a
global, common VAT regime, with only the rates of tax to distinguish
between nations. In Europe the VAT regime is already 90% harmonized,
and there is a (quite high) minimum VAT rate of 15% across the Union.
It
also seems highly likely that there will come to be a common corporation
tax base in the EU within the next ten years, although rate-setting
itself will remain a national prerogative for a long time to come.
This raises the issue of accounting standards,
vital in terms of corporate reporting and international investment,
with US/European mergers of investment exchanges now becoming a
reality.
The
International Accounting Standards Board
The
ongoing march to universal accounting standards presents one of
the clearest examples of globalization, although to the girl in
the street it is probably one of the dullest subjects imaginable.
The
IASB grew out of a UK standard-setting organization during a 20-year
process that culminated in the 1990s. Its standards, which are now
known as International Financial Reporting Standards (IFRS) have
been adopted by a great majority of non-US countries, including
the European Union, Russia, South Africa, Hong Kong, Australia,
and Singapore. All publicly traded EU companies have to prepare
their consolidated accounts using IFRS as from 2005.
As
in so many areas, it is the US which is the stand-out,
using GAAP standards (Generally Applicable Accounting Procedures)
which differ in some respects from IFRS, particularly as regards
the treatment of goodwill. However, a process or reconciliation
between IFRS and GAAP has been going on for the last few years,
and it is by now highly probable that mutual co-existence will be
agreed on within a few years, if not actual convergence.
Once
this happens, it will be possible to say that there is true global
fiscal harmonization, at least as regards the presentation of company
accounts. Evidently that is something that will have immeasurable
consequences for international investment.
The
International Fiscal Association (IFA) was established
in 1938 with its headquarters in the Netherlands. Its objects are
the study and advancement of international and comparative law in
regard to public finance, specifically international and comparative
fiscal law and the financial and economic aspects of taxation. The
IFA now has more than 11,000 members from 91 countries. In 52 countries
IFA members have established IFA Branches.
Although the operations of the IFA are essentially scientific in
character, the subjects selected take account of current fiscal
developments and changes in local legislation. Since the end of
the second World War IFA has played an essential role both in the
development of certain principles of international taxation and
in providing possible solutions to problems arising in their practical
implementation. It has been able to do so because its membership
consists of high level representatives from both the private and
the public sectors, including the Courts, Universities and international
governmental and non-governmental organizations and because the
Association has maintained over the years high standards in its
debates and conclusions. Thus IFA has offered the necessary forum
to experts belonging to different sectors of society, where opinions
on topics of international taxation can be exchanged with respect
for each other's background and responsibilities.
Summary
Taxation
is not the most popular of topics. Apart from the fact that no-one
likes being taxed, it is a 'dry-as-dust' subject in which humour
or moral uplift are notably absent. Still, it has intrinsic importance
out of proportion to its interest: without taxation, the State
could not exist. While it will be difficult to find many words in
this work in favour of the State, it was and to some extent still
is an inevitable and even beneficial stage in human development;
and as long as people want or need some sort of collective action
to protect, defend, entertain, marry or bury them, that long will
there need to be taxes, in one form or another. What is not true,
though, is that taxation needs to be national, either in definition
or in execution. This Chapter has shown that, as in other fields,
the process of taxation is becoming detached from nation states.
It is better for taxes to be levied under transparent, universal
rules; and these must inevitably be - will be - global.
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