As duty holders of human rights with the responsibility to protect these rights, states have the obligation to vigorously defend their taxing rights.  Developing country states, in particular, should avoid tax standards and practices which legitimize and facilitate the shifting of their tax base to beyond the reach of their domestic authorities.  Well-meaning voluntary efforts in the international arena by private companies often reinforce the Organisation for Economic Co-operation and Development (OECD)’s norms to the detriment of the interests of developing country tax jurisdictions.

I have been asked to discuss Pillar I – the State responsibility to protect human rights – of the United Nations (UN) Guiding Principles (United Nations, 2011) as it relates to corporate taxation. Low- and middle-income countries face enormous challenges in meeting Pillar I because of the nature of the international tax system.

Compared to developed countries, developing countries are twice as dependent on corporate income taxes as a source of revenue.  They are an order of magnitude more obsessed to obtain foreign investment than developed countries, even in the case of the activity to take their own minerals out of the ground so that they can earn foreign exchange.

For the purposes of taxation, multinational companies are enterprises that are operating in multiple tax jurisdictions.

When they decide how much to legally pay in taxes in these jurisdictions, they use the rules governing the allocation of taxing rights between these jurisdictions.

Because the taxes paid by a multinational in one jurisdiction are based on the allocation of taxing rights between jurisdictions, multinational corporate tax actions have an inherently extra-territorial character.

One can appeal to Maastricht Principle 17 (Maastricht, 2011) which provides that the interpretation and application by states of all tax treaties must be consistent with human rights obligations.

One can also appeal to Maastricht Principle 28 (Maastricht, 2011) which provides that states are holders of human rights obligations to create an international enabling environment conducive to the universal fulfilment of economic, social and cultural rights (ESCR).

This is the first aspect.

The second aspect is that because the state is the duty holder in protecting human rights, its tax performance constrains its ability to meet these obligations.  In the ESCR framework, states have the duty to apply “maximum of its available resources” (United Nations General Assembly, 1966, Article 2 (1)).

Referring to the Ruggie (2017) reference in the concept note for this side event, “global value chains” arise from fragmented international production. “Global value chains” are a currently fashionable framework to think about in regards to development, trade and the potentially positive contributions of multinational companies.

In the arena of taxes, however, multinational companies are the enterprises that have subsidiaries and suppliers located - at least legally, even if not necessarily physically - in multiple tax jurisdictions.

While we might be able to potentially celebrate that globalization is made possible by fragmented production, in contrast, the global system of allocating taxing rights is structured to be a fragmented system among tax jurisdictions, mostly to the detriment of the taxing rights of developing countries.

Developing country officials work within a fragmented tax system whose two pillars are an undiluted and unrealistic application of two principles particularly favored by developed countries and abetted by the OECD secretariat, which are:

a. Separate entity principle

b. Arm’s length pricing

The problem with well-meaning efforts by non-governmental organizations (NGOs) and the business sector (such as “The B Team principles” (The B Team, 2018) in promoting responsible tax behavior is that these often reinforce standards of the OECD, standards that do not protect the taxing rights of developing countries.  For example, Principle 2E of the B Team principles state “We use the arm’s length principle, pricing in-line with best practice guidelines issued by the OECD, and apply this consistently across our businesses (contingent on local laws).” 

The B Team (2018) explicitly recognizes OECD guidelines, not those pioneered for example by Brazil or Argentina in regard to pricing of transactions among related companies. There is a fatal flaw when do-gooding private foundations and civil society try to work with the private sector and evade or distrust the participation of the government in issues that concern government policy.  Arm’s length pricing is only one of other proposals by the B Team that are disadvantageous to developing countries’ taxing rights.

A strong adherence to the separate entity principle makes it difficult for developing country authorities to question specific business charges of a local subsidiary which is controlled by a headquarters company.  Is an expense of a subsidiary or its size really a necessary one, or a means of relocating profits out of reach of local authorities?

Under the arm’s length principle, local tax authorities must look for comparable transactions to question prices used by local subsidiaries, even though the domestic economy does not have the variety of enterprises and economic transactions that are present in developed countries to use as comparables.  Thus the application of this principle by developing country authorities is often unrealistic and impractical.

There are quite a few proposals for an alternative tax treatment of related companies and subsidiaries, such as treating multinationals as single entities for tax purposes.  There are also intermediate methods short of a global approach that individual tax jurisdictions could apply.

However, these reforms are not in the interest of developed countries, multinational companies, and the big four accounting firms.  These alternative proposals are resisted by developed countries, multinationals, and the big four accounting firms first of all because these two pillars secure the profitability of global value chains.

Second, these pillars secure the tax base of developed countries where most multinationals are headquartered.  These two pillars facilitate the transfer of income and profits to the headquarters country or to low tax jurisdictions.

OECD’s Base Erosion and Profit Shifting (BEPS) program, while closing some loopholes, has reinforced these two pillars in the fragmented global tax system.

More worrying, because of a dependence on foreign aid and investment and the threat of being classified as a “Non-Cooperative Tax Jurisdiction”, developing country tax authorities are being pressured to cooperate with the BEPS program, unable to overturn its underlying pillars.

This kind of State behavior is questionable under the UN Guiding Principles No. 9 (United Nations, 2011, p. 12) in which States must maintain adequate policy space to maintain their human rights obligations.

The viability of tax havens is very much on dependent on these two pillars.  Tax havens have extraterritorial impact, as in the UN Committee on the Elimination of Discrimination Against Women (CEDAW) case on Switzerland on the impact on women’s rights and substantive equality.

(In November 2016, CEDAW (2016, paragraph 41a) recommended that Switzerland “undertake independent, participatory and periodic impact assessments of the extraterritorial effects of its financial secrecy and corporate tax policies” – facilities often associated with tax havens – on women’s rights and substantive equality.)

These two pillars make it easy to create subsidiaries in multiple tax jurisdictions that are able to carry out transactions among themselves that undermine the tax bases of jurisdictions with higher taxes.

Many of the proposed alternative tax rules and practices by developing countries contradict these principles or adjust their application to be consonant with the nature of the actual economic transaction.

When country authorities try to apply different policies, multinationals complain to the highest level – the country’s finance minister or the president – that the tax authority is not using the “Gold Standard” or the “Best Practice” by which they mean the ONE favored in the OECD model.

Under the Guiding Principles No. 3a (United Nations, 2011, p. 8), States are “periodically to assess the adequacy of such laws” which require business enterprises to respect human rights.

If smaller tax liabilities by subsidiaries unduly reduce overall tax resources below maximum available resources to meet human rights obligations or discriminate against local enterprises unable to shelter their profits abroad, then States must reconsider OECD-based standards and “address any gaps” (United Nations, 2011, p. 8).

As part of their responsibility to protect, under the Guiding Principles, states have the obligations to vigorously defend their taxing rights and abstain from applying unfavorable OECD-mandated norms and practices.

References

Committee on the Elimination of Discrimination Against Women (2016). Concluding observations on the combined fourth and fifth periodic reports of Switzerland. 25 November 2016. CEDAW/C/CHE/CO/4-5.  Available from http://undocs.org/en/CEDAW/C/CHE/CO/4-5 (accessed 28 November 2017).

Maastricht Principles on Extraterritorial Obligations of States in the Area of Economic, Social and Cultural Rights, 28 September 2011.  Available from https://www.etoconsortium.org/nc/en/main-navigation/library/maastricht-principles/?tx_drblob_pi1%5BdownloadUid%5D=23 (accessed 20 September 2018).

Ruggie, John (2017). Making Economic Globalisation Work for All – Speech by Prof. John Ruggie. Available from https://www.ihrb.org/other/supply-chains/making-economic-globalisation-work-for-all-speech-by-prof.-john-ruggie (accessed 20 September 2018).

The B Team (2018). A New Bar for Responsible Tax: The B Team Responsible Tax Principles, 9 February 2018. Available from http://www.bteam.org/announcements/responsibletax-2/ (accessed 14 February 2018).

United Nations General Assembly (1966). International Covenant on Economic, Social and Cultural Rights. Adopted and opened for signature, ratification and accession by General Assembly resolution 2200A (XXI) of 16 December 1966; entry into force on 3 January 1976, in accordance with article 27. Available from https://www.ohchr.org/Documents/ProfessionalInterest/cescr.pdf (accessed 28 November 2012).  

United Nations, Human Rights Council (2011). Report of the Special Representative of the Secretary-General on the issue of human rights and transnational corporations and other business enterprises, John Ruggie. 21 March 2011. A/HRC/17/31. Available from https://www.ohchr.org/Documents/Issues/Business/A-HRC-17-31_AEV.pdf (accessed 28 November 2011).

- Manuel F Montes is Senior Adviser on Finance and Development of The South Centre.

This article is based on Dr Montes’ speech notes for the event entitled “What do “Protect, Respect, Remedy” mean in practice for responsible tax conduct? A special focus on women's rights,” at the annual United Nations Forum on Business and Human Rights, in Geneva on 26 November 2018.  The author is grateful for comments from South Centre colleagues, Kinda Mohamadieh and Daniel Uribe, on an earlier version.  The author is solely responsible for all errors, opinions and analyses.

SOUTHNEWS, No. 240, 20 December 2018

South Centre: www.southcentre.int