Tax avoidance. Aggressive tax planning. Harmful taxation. Treaty shopping. Rule Shopping. Law Shopping. Abuse of tax treaty. Abuse of tax law. Secrecy jurisdictions. Black money.
If someone had the patience to read the tons of documentation written on tax policy by the Organization for Economic Cooperation and Development (OECD) or other international organizations, such as the International Monetary Fund or the United Nations, he would see how these texts are full of unreadable words, locutions, acronyms, slogans and definitions. All these papers are well-written, very elegant in their sophisticated terminology, convincing.
Nevertheless, going more in depth with the reading, one realizes that they are only empty shells, beautiful words with no meaning.
The rush for increasing the sophistication level of tax policy language is not left to chance but it is a deliberate strategy by policy-makers to corrupt the meaning of words in order to convince governments, politicians and naive citizens that the global economy is unjust, entrepreneurs are evaders, multi-national companies spend time designing tax strategies to minimize the amount of taxes to pay, and so on. Once they have convinced the reader that the world is unequal, the solution comes naturally: fight corruption through anti-avoidance rules, squeeze taxpayers (mostly capital-owners), and give more money to the state so that bureaucrats can increase public spending for welfare programs, for whatever that means.
Nevertheless, these institutions know that, to achieve their goals, they must convince the greatest number of countries to follow their recommendations. Suppose, in fact, only few countries decide to follow them, while all the others do not. The former would lose all tax revenues, thanks to the freedom to move capitals and tax bases to other jurisdictions, and the latter would host all the taxpayers escaped from the jurisdictions which levy high taxes.
This is a typical equilibrium achieved under a Tiebout competition. To achieve it, a co-ordination of tax regimes is required. This is why these organizations launched a campaign against tax competition, preaching the benefits of “tax harmonization,” a semantic trap meaning that all jurisdictions should adopt the same tax policy, tax rates, tax bases and tax rules.
A semantic trap in the tax policy is recognizable by the distorted use of the adjectives associated with nouns. The idea which stands behind the trap’s creator is to transform an adjective having a neutral connotation into one with a negative meaning. For example, the OECD’s “aggressive tax planning locution,” used by the organization to convince governments they have to join an international convention to tackle the fiscal planning made by multinational corporations and wealthy people, an “emerging global issue,” as they call it.
The OECD moves from the assumption that tax competition can be harmful. It does not say that it is harmful per se but that it can be harmful when it becomes detrimental for government’s revenues because it leads to a sub-optimal provision of public goods. This is a subtle but fundamental difference. Professor Michael Devereux (Oxford University), one of the leading OECD economists and a great supporter of tax harmonization, defines “harmful tax competition” as “the uncooperative setting of source-based taxes on corporate income where the country is constrained by the tax setting behavior of other countries.” In a free-market perspective, competition is always and necessarily an uncooperative game, as market forces always constrain players to behave in order to achieve better results than other players but the goodness of competition stays just in this. Otherwise, it would not be a competition. Therefore, it seems quite paradoxical that supporters of “harmful tax competition” transform a good feature into a negative one. The result is that someone is entitled to decide when behaviors of those who harm the competition (the tax planners) become unacceptable from a social perspective. In other words, according to this view, tax competition, theoretically seen as a good, is subjected to a moralization process which ends with the condemnation some behaviors. Almost never the OECD said tax competition can be beneficial for people and companies, while empirical evidence shows that this is true. It has always highlighted, and often created, only the side effects of tax competition. Over time, they have hinted that “harmful tax competition” leads to a race to the bottom, fueled by a continued fall in corporate tax rates to attract tax bases, undertaken by the use of tax planning and profit shifting activities.
According to the OECD, jurisdictions with low tax regimes are not seen as best practice in terms of effective and efficient tax administration, but as pirates that subtract tax revenues from other jurisdictions. But since they realize that defining what harmful tax competition really means is not an easy task, they have been forced to introduce an ad-hoc language to identify the subjects who harm the competition. Categorizing institutions and finding a culprit is always the most effective way to reach the goal. So, the OECD started to group states into categories: country with preferential regimes, tax havens, and non-member economies.
Then, it established criteria for identifying each of them. “Preferential regimes” and “tax havens” are other two semantic traps. Just pay attention to how the OECD’s definition of the word “havens” is used to connote a jurisdiction “characterized by having only nominal or no taxes, impeding the free exchange of information on taxpayers with other governments through administrative practices or laws, non-transparency, and a lack of substantial activities” as the enemy of the poor and the haunt of the world’s criminals. The idea that low taxes, small governments, privacy and private property’s defense could be values worthy to be defended does not deserve to be considered.
Another example of semantic trap is the “tax avoidance” locution. According to the Cambridge dictionary, this term means “the reduction, by legal methods, of the amount of tax that a person or company pays.” Moving from this definition, the OECD believed it was its duty to limit the taxpayers’ freedom to find legal methods to minimize their tax burden. The organization’s website devotes an entire section to the tax avoidance issue, in which it notes that “OECD is at the forefront of efforts to improve international tax co-operation between governments to counter international tax avoidance and evasion.” By doing so, tax avoidance is raised to the same level of tax evasion, among the activities which must be tackled. Not because it is illegal, but because it is considered dangerous for governments’ public finances. This is the contradiction: fighting a legal behavior in order to build a more legal world. This violent incursion into the sphere of taxpayers’ personal rights is not only tolerated by the OECD but, even worse, encouraged.
But how can you convince people that something legal must be punished? Through morality. Morality is not justice or legality. In policy-making, morality is only an arbitrary vision of an issue, through which what is “legal” may become an “undesirable legality” and, for this reason, should be punished. With a sophisticated language used to sweeten the pill, the institution has produced a great deal of papers, presented at many conferences around the world, and paid officials to lobby governments in order to convince that tax legality is undesirable. The “undesirable legality” weakens justice and legality, because it erases one of the main characteristics of the two: certainty. The tax planner who legally takes an action to minimize a tax burden must fears that a tax administration can always decide that this behavior must be punished.
This is pure arbitration. The same is used by the OECD when it compiles the “black list” of what it calls “uncooperative tax havens,” according to some criteria it has freely established. Jurisdictions which do not respect transparency and exchange of information requirements are blacklisted. Financial privacy is not a right for the OECD.
In conclusion, we should always pay attention when we read the policy papers and “recommendations” by international organizations because behind any word there is a hidden intent to achieve a moral goal, which most of the time aims to reduce the economic freedom of individuals.
Most common semantic traps used in tax policy
Tax avoidance: the use of legal methods to modify an individual’s financial situation to lower the amount of income tax owed. This is generally accomplished by claiming the permissible deductions and credits [Investopedia]. It differs from tax evasion, which uses illegal methods, such as underreporting income to avoid paying taxes.
After-tax hedging: taking opposite positions for an amount which takes into account the tax treatment of the results from those positions (gains or losses) so that, on an after-tax basis, the risk associated with one position is neutralized by the results from the opposite position. [OECD]
Tax Planning: Set of planning activities undertaken by a taxpayer to minimize tax liability through the best use of all available allowances, deductions, exclusions, exemptions, etc., to reduce income and/or capital gains.
Aggressive Tax Planning: conceptually elusive
Harmful tax competition: Commission communication “a package to tackle harmful tax competition in the United Europe”, discussion initiated by the Commission at the informal meeting in Verona, 1996. From the reading of the text it appears clearly what EU officials wanted to achieve by introducing the slogan “harmful competition”: a needed “coordinated action at European level to tackle harmful competition in order to help achieve certain objectives such as reducing distortions in the single markets, preventing excessive losses of tax revenue or getting tax structures to develop in a more emplyment friendly way”. [conclusions of the Ecofin Council Meeting on 1 December 1997 concerning taxation policy]
The criteria for identifying potentially harmful measures include:
- an effective level of taxation which is significantly lower than the general level of taxation in the country concerned;
- tax benefits reserved for non-residents;
- tax incentives for activities which are isolated from the domestic economy and therefore have no impact on the national tax base;
- granting of tax advantages even in the absence of any real economic activity;
- the basis of profit determination for companies in a multinational group departs from internationally accepted rules, in particular those approved by the OECD;
- lack of transparency.
In a report of November 1999 the Group identified 66 tax measures with harmful features (40 in EU Member States, 3 in Gibraltar and 23 in dependent or associated territories). Following the 1998 report “Harmful Tax Competition: An Emerging Global Issue” the OECD created the “Forum on Harmful Tax Practices” focussed on three areas: Harmful tax practices in Member Countries; Tax havens; Involving non-OECD economies. In the framework of its work on Base Erosion and Profit Shifting (BEPS) the OECD has agreed on recommendations on a number of issues in October 2015 including: Hybrid mismatch arrangements (Action 2); Transparency of rulings (Action 5); Patent boxes (Action 5)
Treaty Shopping: abusive practice of structuring a multinational business to take advantage of more favorable tax treaties available in certain jurisdictions. The search of the most favorable treaty from the tax regime perspective by the subject who abuses.
Rule Shopping: abusive practice consisting in a behavior finalized to making applicable a provision more favorable to the foreign source income, that would not be applicable, otherwise.
Both the Treaty and Rule Shopping belong to the more general Law Shopping.
Abuse of Tax Treaty: improper behavior by a State to suspend or extinct a treaty (Vienna Convention on the Law of Treaties).
It represents a variant of the Abuse of law semantic trap, meant as a subjective right exerted by a single in a contrary manner with respect to the aim recognized or protected by the law.
Hybrid Mismatch Arrangements: arrangements exploiting differences in the tax treatment of instruments, entities or transfers between two or more countries
Related semantic traps:
Hybrid entities: Entities that are treated as transparent for tax purposes in one country and as non-transparent in another country
Hybrid instruments: Instruments which are treated differently for tax purposes in the countries involved, most prominently as debt in one country and as equity in another country.
Hybrid transfers: Arrangements that are treated as transfer of ownership of an asset for one country’s tax purposes but not for tax purposes of another country, which generally sees a collateralised loan.
(see: OECD, Hybrid Mismatch Arrangements – Tax Policy and Compliance Issues, March 2012)
Base erosion and profit shifting (BEPS): tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations. The BEPS package provides 15 Actions that equip governments with the domestic and international instruments needed to tackle BEPS
Transfer pricing: transactions involving intangibles; contractual arrangements, including the contractual allocation of risks and corresponding profits, which are not supported by the activities actually carried out; the level of return to funding provided by a capital-rich MNE group member, where that return does not correspond to the level of activity undertaken by the funding company; and other high-risk areas. (OECD, Aligning Transfer Pricing Outcomes with Value Creation, Actions 8-10 – 2015 Final Reports)