Harmful tax practices

The ‘race to the bottom’ on corporate taxation includes the simple approach of lowering the corporate tax rate, but also more complicated approaches that allow multinational corporations to pay a much lower tax rate than the official one. For example, countries can create ways for corporations to reduce the amount of profit on which they have to pay taxes (the ‘tax base’). Common to these approaches are that they create incentives for corporations to move their profits from the countries where actual business activity takes place, to countries where they pay less tax – in other words, they can be used for aggressive tax planning.

Based on an analysis of more than 98 million corporate entities, researchers have mapped out the world of offshore financial centres and identified two types of offshore jurisdictions. The first, ‘sinks’ are jurisdictions, most of which are small and with a low or zero corporate tax rate, where multinational corporations store capital. The second, ‘conduits’ play a central role as intermediaries, facilitating the movement of capital between sinks and other countries where corporations are doing business.

Examples of policies that can be harmful include:

Patent boxes: Also known as ‘knowledge boxes’, these are a special type of tax incentive offered to corporations for revenues derived from intellectual property. They are also widely known as a practice that creates the risk of corporate tax avoidance. Intellectual property is very difficult to put a monetary value on, and its geographical origin is often difficult to determine since, unlike factories, for example, it is often not tied to a specific location. This has made intellectual property income, and the patent boxes that provide associated low taxation, a potential tool for multinational corporations who wish to reduce their tax payments.

Special purpose entities (“Letterbox companies"): Entities which exist only on paper, and often only consist of a nameplate and a post-box. They are ultimately owned by a corporation in another country and carry out very little, if any, actual economic activity in the country itself, where they also have few or even no employees. The bulk of the financial resources running through the company stems from investments to or from other countries, and these resources are normally subject to very little, if any, tax in the country where the entity is registered.

Secret tax deals: Advance ‘tax agreements’ or ‘tax rulings’, are sometimes referred to as ‘sweetheart deals’, are agreements between tax administrations and specific multinational corporations. Secret tax deals have become increasingly controversial after the LuxLeaks scandal, which showed how such deals can be used by multinational corporations to avoid taxes on a large scale.

The report Tax Games – the Race to the Bottom analyses and rates 18 European countries based on the potential harmfulness of their tax system. The report also rates the European Commission and Parliament based on their positions on the issue.

Click here to see a summary of the ratings.

The criteria for the rating can be found here.

To read the full report (including sources and references) click here.