Tax and Tax Incentive Effects on Investment and Policy Implications: ~ How does MNE tax planning factor in?

Transcription

1 Organisation for Economic Co-operation and Development Tax and Tax Incentive Effects on Investment and Policy Implications: ~ How does MNE tax planning factor in? Workshop on Investment Incentives Joint Vienna Institute, January 2010 W. Steven Clark Head, Global Relations and Corporate Tax Unit Centre for Tax Policy and Administration

2 Recent OECD CTPA Analysis of Tax and Tax Incentive Effects on Investment 1. TAX EFFECTS ON FDI Tax Effects on Foreign Direct Investment Recent Evidence and Policy Analysis, OECD Tax Policy Studies No. 17, TAX EFFECTS ON SMEs Taxation of SMEs Key Issues and Policy Considerations, OECD Tax Policy Studies No. 18, TAX EFFECTS ON R&D Roundtable discussion at November 2009 meeting of OECD Working Party No2 (Tax Policy Analysis and Tax Statistics), involving Ministry of Finance tax officials. 2

3 1. TAX EFFECTS ON FDI Tax and FDI project by Working Party No2 of the OECD Committee on Fiscal Affairs three main objectives: review empirical studies of tax effects on FDI. report economic policy considerations in the tax treatment of inbound and outbound FDI. develop framework to consider implications of tax-planning for standard cross-border marginal/average effective tax rate measures. reconsider METR model in Taxing Profits in a Global Economy, OECD, reconsider AETR model of Devereux & Griffith (The Taxation of Discrete Investment Choices, IFS, 1998). Results reported in Tax Effects on Foreign Direct Investment - Recent evidence and policy analysis, OECD Tax Policy Studies No. 17,

4 Assessing the FDI Response to Tax Reform and Tax Planning Reliance on forward-looking effective tax rates to estimate the impact of corporate tax reform on FDI. Standard METR and AETR measures ignore tax-planning: concern when used to assess tax burden on FDI, and to gauge FDI response to tax reform. Standard METR/AETR framework elaborated to highlight effects of various forms of tax-planning: thin-capitalization of high-taxed subs, double-dip financing. use of hybrid securities in place of conventional debt. tax haven finance affiliates, conversion, hybrid structures. Illustrative results to encourage policy analysts to address issue. 4

5 Standard modelling assumptions vs. cross-border tax-planning strategies Fixed financing weights on conventional types of finance, assumed for all countries (and held constant over time) but: Evidence of thin-capitalization of high-tax subsidiaries. Inappropriate to hold constant non-tax factors (e.g. discount rates, B/EQ) when estimating actual tax burdens (appropriate when analyzing differences or changes in tax policies). Use of new financial instruments (e.g. hybrid securities) Typically no account of cross-crediting (FTC) possibilities: Ability to apply excess FTC on high-tax dividends to offset CIT on foreign profit paid out as interest on inter-affiliate loans relevant to parents in countries with relatively low tax rates, dividend credit systems, cross-crediting possibilities (e.g. US). 5

6 Standard modelling assumptions vs. cross-border tax-planning strategies Direct holding structures and immediate profit distribution Significant and growing use of financial intermediaries in tax havens (see next slide). Deferral/avoidance of home country tax on profit paid out as dividends (under dividend credit systems). Avoidance of host/home country tax on profit paid out as interest on inter-affiliate loans (dividend credit and dividend exemption systems). Anti-avoidance (controlled foreign company (CFC))rules in some countries. Varying ability to circumvent CFC rules (e.g. hybrid entities) 6

7 Difficult to gauge cross-border financing developments Existence of financing and repatriation structures to lower host/home country tax on FDI, but key question how prevalent? Limited publicly available information, in part reflecting different treatment in National Accounts of transactions with tax haven finance affiliates ( special purpose vehicles ). Available data suggest the need to address this area. Example - data on the activities of CFCs of U.S. investors, from tax returns filed by U.S. parent companies with foreign operations (reported in Tax Notes International). 7

8 Growth in Activity of CFCs of US Parents in Major Low-Tax Countries ( ) 200% 150% 126% 182% 100% 50% 44% 28% 0% S 1 S 2 S 3 S 4 S1=total pre-tax earnings (all CFCs) S2=earnings of low-tax CFCs in 7 major low-tax countries: Ireland, Singapore, Bermuda, Cayman Islands, Netherlands, Luxembourg, Switzerland S3=total tangible capital (all CFCs) S4=total tangible capital of low-tax CFCs in 5 major holding company low-tax countries: Bermuda, Cayman Islands, Netherlands, Luxembourg, Switzerland Source: Tax Notes International, Vol.41, No.5, 6 February

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11 11 Figure 3

12 12 Figure 4

13 Cross-border METR/AETR model with focus on tax planning effects Analysis of tax-planning effects considers the following cases: 1. retained earnings of parent used to purchase equity shares of foreign sub; 2. retained earnings of parent, used to purchase equity shares and debt of foreign sub (thin capitalization of high-tax subsidiaries in certain cases); 3. third-party debt of parent used to purchase equity shares of foreign sub; 4. third-party debt of parent used to purchase equity shares and debt securities of foreign subsidiary ( double-dip financing) 5. third-party debt of parent used to purchase equity shares and hybrid instruments of foreign sub, and 6. third-party debt of parent used to purchase equity shares of tax haven finance sub investing funds in equity shares and debt securities of foreign subsidiary. Earnings invested offshore indefinitely in passive assets. 13

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15 Implications of results Standard approach may underestimate the FDI response to tax reform in certain cases: AETR adjustment and FDI response may be underestimated, in the case of FDI from investors in high-tax countries operating dividend credit systems (where home country tax is largely avoided). Standard approach may overestimate the FDI response to tax reform in other cases: where actual AETR is significantly lower than estimated AETR due to various forms of profit stripping. Standard AETRs may be subject to significant measurement error use in econometric work could lead to biased estimates of the tax elasticity of FDI. 15

16 Complications in assessing the FDI response to tax reform Complications: degree of tax-planning may vary by type of business activity, by host and home country combination, by year. wide range of possible AETR/METR values depending on financing and repatriation policies at the firm level. even if assume home country taxation of investment returns can be avoided: degree of profit stripping at the host country level (operating subsidiary) is uncertain. cost of finance depends on home tax treatment of interest. even if representative tax-planning strategies are know with some certainty, complications in building into a AETR/METR model. 16

17 Considerations for policy makers Impact of tax reform on AETR/METR and FDI may differ from predictions of standard model. Possibly biased elasticity estimates of the tax sensitivity of FDI. Uncertainty over the level and change of representative AETRs accompanying tax reform. Difficult to assign representative weights to alternative financing and repatriation structures to generate representative results. Estimates of the FDI response to tax reform based on standard models and approaches must be used with caution. 17

18 2. TAX EFFECTS ON SMEs Tax and SME project by Working Party No2 of the OECD Committee on Fiscal Affairs main objectives: Examine possible tax distortions to decision to: Move from dependent employment to establishing a business. Structure a firm in unincorporated or incorporated business form. Take into account corporate and personal income tax, and social security contributions on wage income (self-employed SSC, employee and employer SSC). Examine tax incentives for SMEs Consider arguments for SME tax incentives. Consider arguments against SME tax incentives. Identify main tax incentives for SMEs. Examine SME tax compliance cost and simplification provisions. 18

19 19 Tax and SME project (continued) Arguments for SME tax incentives: Double taxation of corporate profits and cost of capital effects Inability to deduct interest expense (esp. business start-ups) Limited los offset (discouraging to risk-taking) Cross-border tax planning opportunities available to MNEs Relatively high tax compliance burden on SMEs Taxation on sale or inheritance of an SME. Arguments against SME tax incentives: Difficulties with market failure arguments. Possible opportunities and constraints with adjusting basic tax provisions. Tax planning opportunities for SMEs Efficiency and revenue considerations with the use of tax incentives Results reported Taxation of SMEs Key Issues and Policy Considerations, OECD Tax Policy Studies No. 18, 2009.

20 3. TAX EFFECTS ON R&D Roundtable discussion of tax effects on R&D at November 2009 OECD (WP2) meeting input to Innovation Strategy project. Structure of discussion: Conceptual framework Rationale for tax incentives for R&D Tax incentives for R&D (types / design features) Tax policy indicators for R&D (B-index, standard METR, revised (knowledge capital) METR) Evaluation of R&D tax incentives Profit vs. expenditure-based tax relief - R&D tax relief typically targeted at R&D expenditure. - Important to also address tax rate on returns to R&D. 20

21 Conceptual framework Chart 1 Illustration of R&D Firm A skilled labour L physical capital K Stage 1 Stage 2 Basic/applied research activity (R) Use of factor inputs (L, K) to produce new knowledge Q Knowledge capital Q License (non-exclusive right to use Q) skilled labour L physical capital K Development activity (D) Use of inputs (L, K, Q) to produce new product/process New product or process Used by Firm A, licensed, or sold Firm B Knowledge capital Q skilled labour L physical capital K Development activity (D) Use of inputs (L, K, Q) to produce new product/process New product or process Used by Firm B, licensed, or sold 21

22 Analysis of tax effects on R&D 22 Common approach analyzes tax effects on R&D using same framework used to analyze tax effects on physical capital. Policy interest in modelling knowledge capital separately, as an intermediate output help identify range of policy options. Empirical work uses R&D tax burden (user cost) measures that assume returns on R&D are taxed at basic CIT rates ignores: Reduced tax rates on royalty income. Implications of cross-border tax planning involving geographically mobile intangibles. How important is the bias in empirical work? Assessments of tax relief for R&D need to be broadened to address R&D expenditures and tax rates on income from R&D.

23 Chart 1 Simple domestic structure Organisation for Economic Co-operation and Development R&D costs to develop Q (knowledge): - wages (fraction x of costs): --- current tax deduction at CIT rate u. --- investment tax credit at rate c. - capital costs (fraction (1-x) of costs): --- tax depreciation at rate α --- investment tax credit at rate c. PCo Own use of Q - revenue taxed at basic CIT rate u. B=[1-xu-(1-x)uz-c]/[1-u] where: u=basic CIT rate. z= PDV tax depreciation on 1 capital investment = α/(r+α) c=investment tax credit rate. License of Q (e.g. patent) Royalty income on license of Q: - royalty taxed at basic CIT rate=u OpCo Centre for Tax Policy and Administration

24 Organisation for Economic Co-operation and Development Chart 2 Simple cross-border structure R&D costs to develop Q: - As per Chart 1. PCo (Country A) B=[1-xu-(1-x)uz-c]/[1-u * ] where: u, z, c as per Chart 1. License of Q (e.g. patent) OpCo (Country B) Royalty income on license of Q: Case 1: royalty taxed at basic CIT rate (u * =u), with credit for withholding tax. Case 2: royalty taxed at reduced CIT rate (u * <u), with credit for withholding tax. Withholding tax at rate w R on deductible royalty payment Centre for Tax Policy and Administration

25 Organisation for Economic Co-operation and Development Chart 3 Triangular structure, no anti-deferral rules R&D costs to develop Q - as per Chart1. PCo (Country A) R&D tax deductions, credits. Deductible interest payments to Q HoldCo on loans ffrom Q HoldCo. Indefinite CIT deferral, sheltering of foreign profits. Cost-sharing agreement (Q) interest loans License of Q (e.g. patent) Q HoldCo (Country C) OpCo (Country B) B=[1-xu-(1-x)uz-c]/[1-w R ] where: z, R as per Chart 1 (depends on R&D cost allocation). Royalty income on license of Q -received free of CIT (no anti-deferral rules in Country A). - royalty taxed at foreign withholding tax rate (w R << u). Withholding tax at rate w R on deductible royalty payment to Q HoldCo Centre for Tax Policy and Administration

26 Organisation for Economic Co-operation and Development Chart 4 Hybrid structure, avoidance of anti-deferral rules R&D costs to develop Q - as per Chart1. PCo (Country A) Cost-sharing agreement (Q) interest loans Q HoldCo (Country C) B=[1-xu-(1-x)uz-c]/[1-w R ] where: z, R as per Chart 1 (depends on R&D cost allocation). R&D tax deductions, credits. Deductible interest payments to Q HoldCo on loans from Q HoldCo. Anti-deferral rules in place but avoided, indefinite CIT deferral, sheltering of foreign profits. License of Q (e.g. patent) OpCo (operating subsidiary): - branch of Q HoldCo, for Country A tax purposes. - subsidiary of Q HoldCo, for Country B tax purposes. OpCo (Country B) Royalty income on license of Q: -royalty received free of CIT (avoidance of anti-deferral rules in Country A). - royalty taxed at foreign withholding tax rate (w R << u). Withholding tax at rate w R on deductible royalty payment to Q HoldCo Centre for Tax Policy and Administration