Corporate tax avoidance is perhaps the emblematic failure of the current epoch of globalisation; a triumph of complexity and secrecy over transparency and accountability. But as pressure builds, there is hope for change, writes Alex Cobham. 

Corporate tax avoidance is perhaps the emblematic failure of the current epoch of globalisation; a triumph of complexity and secrecy over transparency and accountability. But as pressure builds, there is hope for change.

The first globalisation wave (PDF) began in the early nineteen century and ran until the First World War, bound up as it was with the imperial ambitions of nation states. The current wave, in contrast, has been characterised by the ambitions of the private sector, with multinational enterprises (MNEs) organising themselves in order to benefit from the possibilities of international economic activity.

There can be serious advantages to integrating production processes (think, for example, of the many countries involved in the process of producing a single car); or of expanding the provision of services internationally.

In addition, it turns out, MNEs are often able to arrange their affairs so that in various countries they pay less tax than a purely domestic competitor. So much so in fact, that no less an authority than the Financial Times has described their payment of any tax at all as “largely voluntary”:

Current practice has turned tax into a largely voluntary gesture for such businesses. It is all too easy to shuffle income off to low-tax jurisdictions through intra-group debt financing and the transfer pricing of intangibles such as intellectual property.

The FT here names two important methods of corporate tax avoidance, each of which revolve around ways to make profits appear somewhere other than the place that the underlying economic activity occurred.

The first involves loading up a (profitable) subsidiary with debt, owed to another subsidiary of the same MNE. Repayments allow the first subsidiary to declare zero profit (and hence pay zero corporate tax). Meanwhile, the repayments are received by the second subsidiary, happily established in a low- or zero-tax jurisdiction.

The second method referred to by the FT is transfer pricing. This is the prices that subsidiaries of the same MNE pay to each other for goods and services; and while these should in theory be the same as unrelated companies would pay each other, in practice there is significant scope for abuse.

The graphic in Christian Aid’s report Hungry for Justice (PDF), based on earlier investigative work by Tax Justice Network, gives an example of how profits can be stripped out along an MNE supply chain – ensuring little or no profit is made, or tax paid, in the primary country of operation.

At its simplest, as the Why Poverty film Stealing Africa shows, under-paying for natural resources from developing countries has been a highly lucrative way to exploit that scope. And where intangibles such as a company’s brand or intellectual property are involved, even the most sophisticated tax authorities can struggle to prevent abuse.

Some MNEs have taken their structures further, such as the “Double Irish with Dutch sandwich” of which the New York Times identified Apple as the pioneer but which they found to be used by “hundreds of corporations”.

Profit-shifting by multinationals has been shown to exceed 10% (PDF) of this tax base in a country with the impressive administrative capacity of Germany. The lost revenue costs of trade mispricing alone for developing countries have been estimated, repeatedly (PDF), to exceed the total of aid received.

In the second part of this story, we show how the development damage goes far beyond lost revenues – and explore what can be done to bring about real change.

Alex Cobham is a development economist who appears in Stealing Africa. Here he is writing purely in a personal capacity.