Assessing BEPS: Origins, Standards, and Responses

If you are an IFA member or are attending IFA this fall, you can now download the full IFA 2017 Cahiers. The general report for Subject 1 on BEPS is co-authored by myself and Stephen Shay and is also available on SSRN. Here is the abstract:

The G20/OECD’s multi-year campaign to combat base erosion and profit shifting (BEPS) marks a critical step in the evolution of the international tax regime and the roles of institutions that guide it. This General Report for Subject 1, IFA Congress 2017, provides a snapshot of the outcomes of the BEPS project by comparing national responses to key mandates, recommendations and best practices through the end of October, 2016 based on National Reports representing the perspectives of 48 countries.  These National Reports reveal that the impact of the BEPS initiative on a particular country corresponds to at least three key factors, namely: (1) the extent to which domestic law is already in substantial compliance with BEPS outcomes; (2) the degree to which implementation of BEPS outcomes appears capable of delivering positive revenue or economic results, or both, relative to a country’s experiences and perceptions prior to BEPS; and (3) the type and degree of involvement of a country in the formative stages of the initiative preceding the release of the final BEPS action plans.  As BEPS continues to unfold, it is difficult to gauge the full extent to which countries in fact will adhere or defect from the rules. However, the BEPS project has witnessed the transition of global tax governance from the OECD countries exclusively to global fora. This leaves open questions regarding agenda-setting for international tax policy going forward. As we conclude this interim snapshot of the origins, standards, and responses to BEPS to date, we look to future IFA congresses for answers to these questions and a final assessment of the BEPS project.

 

Tax Sovereignty in the BEPS Era

Kluwer law has recently published Tax Sovereignty in the BEPS Era, a collection of contributions I co-edited with Sergio Rocha, in which we and a slate of authors from a range of countries explore the impact of the BEPS initiative on "tax sovereignty"--which I take to mean the autonomy that nations seek to exercise over tax policy. Here is the description:

Tax Sovereignty in the BEPS Era focuses on how national tax sovereignty has been impacted by recent developments in international taxation, notably following the OECD/G-20 Base Erosion and Profit Shifting (BEPS) Project. The power of a country to freely design its tax system is generally understood to be an integral feature of sovereignty. However, as an inevitable result of globalization and income mobility, one country’s exercise of tax sovereignty often overlaps, interferes with or even impedes that of another. In this collection of chapters, internationally respected practitioners and academics reveal how the OECD’s BEPS initiative, although a major step in the right direction, is insufficient in resolving the tax sovereignty paradox. Each contribution deals with different facets of a single topic: How tax sovereignty is shaped in a post-BEPS world.

And here is the table of contents:

Part I The Essential Paradox of Tax Sovereignty

• CH 1: BEPS and the Power to Tax, Allison Christians          
• CH 2: Tax Sovereignty and Digital Economy in Post-BEPS Times, Ramon Tomazela Santos & Sergio André Rocha
• CH 3: Justification and Implementation of the International Allocation of Taxing Rights: Can We Take One Thing at a Time?, Luís Eduardo Schoueri & Ricardo André Galendi Júnior
• CH 4: An Essay on BEPS, Sovereignty, and Taxation, Yariv Brauner

Part II    Challenge to the Foundational Principles of Source and Residence

• CH 5: Evaluating BEPS, Reuven S. Avi-Yonah & Haiyan Xu
• CH 6: Jurisdictional Excesses in BEPS’ Times: National Appropriation of an Enhanced Global Tax Basis, Guillermo O. Teijeiro
• CH 7: Taxing the Consumption of Digital Goods, Aleksandra Bal

Part III  Acceptance and Implementation of Consensus by Differently-Situated States

• CH 8: The Birth of a New International Tax Framework and the Role of Developing Countries, Natalia Quiñones
• CH 9: The Other Side of BEPS: “Imperial Taxation” and “International Tax Imperialism”, Sergio André Rocha
• CH 10: Country-by-Country Over-Reporting? National Sovereignty, International Tax Transparency, and the Inclusive Framework on BEPS, Romero J.S. Tavares
• CH 11; How Are We Doing with BEPS Recommendations in the EU?, Tomas Balco & Xeniya Yeroshenko      
• CH 12: U.S. Tax Sovereignty and the BEPS Project, Tracy A. Kaye 

And finally, here is a brief description:

The book unfolds in three parts. The first, The Essential Paradox of Tax Sovereignty, features four chapters.

• In chapter 1, Christians introduces the topic by demonstrating how BEPS arose from the paradox of tax sovereignty and analyzing why multilateral cooperation and soft law consensus became the preferred solutions to a loss of autonomy over national tax policy. The chapter concludes that without meaningful multilateralism in the development of global tax norms, the paradox of tax sovereignty will necessarily continue and worsen, preventing resolution of identified problems for the foreseeable future. 
• Tomazela &; Rocha pick up this thread in chapter 2, where they demonstrate that BEPS addresses the symptoms, but not the problems, of the sovereignty paradox. In their view, the central defining problem of this paradox is an ill-defined jurisdiction concept. The chapter demonstrates why tax policymakers need to change the conventional wisdom on sovereignty in order to incorporate new nexus connections due to the changing nature of trade and commerce. 
•  In chapter 3, Schoueri & Galendi further the inquiry by providing a detailed analysis of the interaction of contemporary cooperation efforts with the sovereignty of states in light of historical claims in economic allegiance, economic neutrality and now cooperation against abusive behaviour. 
• Brauner rounds out this first part in chapter 4, which establishes the evolution of the concept of tax sovereignty. The chapter proposes an instrumental role for sovereignty in the process of improving cooperation and coordination of tax policies among productive (non-tax haven) countries, to balance claims and serve as a safeguard against political (in this case international) chaos. Brauner concludes that such a change to the business of international tax law would ensure at least an opportunity for all participants to succeed on their own terms. 

 Part Two of the book, Challenge to the Foundational Principles of Source and Residence, takes an in depth look at why residence and source continue to be the two essential building blocks of tax sovereignty and the backbone of the international tax system, surviving BEPS but still subject to multiple challenges in theory and practice.

• In chapter 5, Avi-Yonah & Xu argue that BEPS simply cannot succeed in solving the sovereignty paradox because BEPS follows the flawed theory of the benefits principle in assigning the jurisdiction to tax. Avi-Yonah and Xu therefore make a compelling argument that for the international tax regime to flourish in the face of sovereign and autonomous states, countries must commit to full residence-based taxation of active income with a foreign tax credit granted for source-based taxation. 
• In chapter 6, Tejeiro continues the analysis of the fundamental jurisdictional building blocks, demonstrating that by resorting to legal fictions within BEPS and beyond it, states are attempting to enlarge the scope of their personal or economic nexus, or to grasp taxable events and bases beyond their proper reach under well-settled international law rules and principles. 
• Bal furthers the discussion in chapter 7, with an analysis of how digital commerce has upended traditional notions of source and residence. Bal advocates the consumer's usual residence as a good approximation of the place of actual consumption and therefore the best-justified place of taxation. 

Part Three of the book, Acceptance and Implementation by Differently-Situated States, considers tax sovereignty after BEPS from a range of perspectives. Chapters 8 through 10 focus on perspectives from lower income or developing countries, while chapters 11 and 12 review the landscape from the perspective of Europe and the United States, respectively.

• In chapter 8, Quinones explores how developing countries might take advantage of the new international tax architecture, developed for purposes of coordinating the BEPS action plans, to ensure that their voices are truly shaping the standards. She argues that the knowledge gap between developing and developed is getting narrower instead of wider, with major negative impacts expected for the international tax order. 
• Rocha continues this discussion in chapter 9, with a proposal: instead of simply accepting the BEPS Project’s recommendations and their reliance on historical decisions about what constitutes a country’s “fair share of tax”, developing countries should join in the formation of a Developing Countries’ International Tax Regime to focus discourse on the rightful limits of states’ taxing powers. 
• Furthering the theme of autonomous priority-setting, in chapter 10 Tavares focuses in on a key part of the BEPS consensus, exploring whether implementing the CBCR standard, without a deeper transfer pricing reform, should be viewed as a priority in every country. He further questions whether this particular initiative, even if important, is worthy of mobilization of the scarce resources of developing countries. Tavares concludes with an incisive review of the role of the inclusive framework in prioritizing some needs over others. 
• Balco & Yeroshenko then consider BEPS implementation from the very different perspective of the EU in chapter 11. The chapter demonstrates that even within the EU, BEPS implementation is not straightforward, as the interests of member states sometimes conflict and the basic notion of tax sovereignty remains fundamental even while tax coordination and harmonization across the EU expands. However, the authors note that the progress made in the last several years on key cooperation norms, which was largely inspired by BEPS, has been unprecedented. 
• Finally, Kaye provides a capstone to the book in chapter 12, where she makes the convincing case that although some in the United States saw the BEPS Project as a threat to US tax sovereignty, this project was in fact necessary in order for the United States to effectively wield its tax sovereignty. Kaye’s chapter thus ends the book with a clear picture of the ongoing paradox of tax sovereignty in the world after BEPS.

Dagan on International Tax and Global Justice

Tsilly Dagan recently posted this new paper on the limitations of normative tax analysis that constrains itself to the state. Here is the abstract:

Inequality, as well as the scope of the duty of justice to reduce it, has always been a central concern of political justice. Income taxation has been seen as a key tool for redistribution and the state was the arena for discussions of justice. Globalization and the tax competition it fosters among states change the context for the discussion of distributive justice. Given the state’s fading coercive power in taxation and the decreasing power of its citizenry to co-author its collective will due to global competition, we can no longer assume that justice can be realized within the parameters of the state. 

International tax policy in an effort to retain justice often opts for cooperation as a vehicle to support distributive justice. But cooperation among states is more than a way for them to promote their aims through bargaining. Rather, it is a way for states to regain legitimacy by sustaining their very ability to ensure the collective action of their citizens and to treat them with equal respect and concern. The traditional discussion in international taxation seems to endorse a statist position — implicitly assuming that when states bargain for a multilateral deal, justice is completely mediated by the agreement of the states. 

In contrast, this Article argues that such a multilateral regime intended to provide the state with fundamental legitimacy requires independent justification. Contrary to the conventional statist position, I maintain that cooperating states have a duty to ensure that the constituents of all cooperating states are not treated unjustly because of the agreement. I argue that not only cosmopolitanism but political justice too requires that a justiciable cooperative regime must improve (or at least not worsen) the welfare of the least well-off citizens in all cooperating states. I explain that cooperation alone is no guarantee of improved welfare and that certain transfer payments between rich and poor countries might be required to ensure this.

 This is an important and provocative paper, highly recommended reading.

Spiro on Citizenship Overreach

The always excellent Peter Spiro has recently posted this new article on SSRN, of interest. Abstract:

This Article examines international law limitations on the ascription of citizenship in the context of U.S. taxation of non-resident citizens. U.S. citizenship practice is exceptionally generous, extending citizenship to almost all persons in its territory at the moment of birth. At the same time that it is generous at the front end, U.S. citizenship is sticky at the back. Termination of citizenship on the individual’s part involves substantial fees and tax compliance. It is difficult to shed a citizenship one may never have wanted in the first place. 

This stickiness would be inconsequential if few costs were associated with the status. But the United States taxes its citizens on a worldwide basis. The 2010 enactment of the Foreign Account Tax Compliance Act has ramped up historically lax enforcement and imposes substantial administrative burdens on even middle-earner citizens abroad. 

In this frame, U.S. birthright citizenship and expatriation regimes may violate international norms, especially with respect to those "accidental Americans" who departed the United States as children. Even in the context of extremely relaxed historical constraints on state nationality practice, there were acknowledged nineteenth century limitations on the extension of citizenship to individuals with insufficient connection to a state -- citizenship over-claiming, as it were. The article also describes the historical requirement that naturalization be volitional, a norm now appropriately applied in some cases in the context of birthright citizenship.  

To the extent the ascription of U.S. citizenship compromises individual rights, there are tax fixes and there are citizenship fixes. Citizenship fixes include opt-in and opt-out mechanisms for birthright citizenship. The better solution may lie in frictionless exit for those with nominal ties to the national community. Though reform is more likely to be accomplished through the tax regime, the moment highlights the over-inclusiveness of U.S. citizenship and the growing salience of international law to citizenship practices.

I'm less confident than Peter that reform will ever be delivered through the tax regime, but I am very glad to see this important contribution to the growing literature focusing on the citizenship/taxation link.

Update: The Price of Entry: Latest Research plus Infographic

* September update: I've found some more information on Russia's program, which brings it closer to the global averages instead of being a glaring outlier. I've also now uploaded my working paper, Buying in: Residence and Citizenship by Investment, and would welcome comments. Here is the abstract:

States have complex and often conflicted attitudes toward migration and citizenship. These attitudes are not always directly expressed by lawmakers, but they may be reflected quite explicitly in tax regimes: for the world’s most prosperous individuals and their families, multiple states extend a warm welcome. Sometimes prospective migrants are offered fast track to physical residence which can lead to citizenship if the migrant desires it. Others are offered a mere commercial transaction, with citizenship granted to applicants with the right credentials and a willingness to pay. Migrants might seek to obtain residency or citizenship for personal, family, economic, or tax reasons, or some combination of them. For the granting country, the tax significance of obtaining new residents or citizens will vary depending on domestic policy goals. However, the consequences of residence and citizenship by investment programs could be severe for the international tax regime: the jurisdiction to tax and the allocation of taxing rights among countries are commonly based on residence and citizenship factors. This article accordingly surveys contemporary residence and citizenship by investment programs on offer around the world and analyzes their potential impact on international tax policy.

* update: I've found a couple of additional programs (e.g. France has a lower cost program, making it less of an outlier)--thank you twitterverse) and I've corrected a few currency conversion errors. This is still a work in progress as previously noted, and I expect to be revising again in the coming weeks.

----

I've been working on residence and citizenship by investment programs, and thanks to some stellar research assistance by Jake Heyka, have developed a set of data comprising what I believe is a fairly thorough look at the residence and citizenship by investment programs currently on offer around the world. I made the above infographic to show the lowest cost program per country for all countries that offer either residence or citizenship by investment.

The lowest cost residence by investment programs are offered by Panama and Paraguay, each coming in at about USD$5,000, while the most expensive is Russia, at over USD$5 million now Austria, at about $3.3M. The average price for all residence and citizenship by investment programs that we found is about $1 million, but this number isn't perfect because some programs are based on job creation rather than investment (e.g., Portugal, Turkey, UK), some involve having entrepreneur/angel investment support rather than a direct investment (e.g. Australia, Canada), and some involve annual amounts (Italy and Switzerland).

One of the things I wondered about in looking over the programs is the inequality factor at play--that is, how much can richer/larger countries demand in terms of higher prices and more stringent requirements (such as actual residence) for entry, and how much must poorer/smaller countries be satisfied with smaller investments and fewer commitments by the applicant? The answer seems to be that there appears definitely a "rich get richer" quality to the distinctions among programs, but there are lots of details in the programs that require further thought.

The paper itself is still in progress but here is an explanation of what I am looking at:

International law and political theory scholars have long wrestled with the normative implications of commodifying citizenship and access to immigration with pay-to-play visa programs, but the analysis does not typically consider the role the tax system plays or could play in these schemes, nor how such schemes might impact the tax regime in terms of gross revenue or distributional effect.  Yet governments increasingly view their tax systems as a means of potentially increasing the value of residence and citizenship in their countries, whether intrinsically or in relation to the treatment of those who gain such status by other means.  Given the cost involved in reducing revenue from those arguably most able to pay, whether the programs actually produce the predicted outcomes is one obvious question to be asked.  Even if the programs in fact achieve their goals, a second question surely arises regarding the normative justification for using the tax system to lure the wealthy away from other countries in this manner. Does the normative case differ when applied to humans as opposed to companies? Does it differ when the luring state is richer or poorer relative to the countries of origin of prospective immigrants? To sketch out a framework for analyzing these questions requires a sense of the various competing programs on offer. This essay takes the first step by comparing national programs that use their taxing power in some manner in order to attract immigration, and highlights some of the factors that raise normative questions about the appropriate design and uses of a tax system. 

Comments welcome.

Shu Yi Oei: The Offshore Tax Enforcement Dragnet

Shu Yi Oei (Tulane) has posted an important new paper on U.S. offshore tax enforcement, of interest. Here is the abstract:

Taxpayers who hide assets abroad to evade taxes present a serious enforcement challenge for the United States. In response, the U.S. has developed a family of initiatives that punish and rehabilitate non-compliant taxpayers, raise revenues, and require widespread reporting of offshore financial information. Yet, while these initiatives help catch willful tax cheats, they have also adversely affected immigrants, Americans living abroad, and “accidental Americans.”  

This Article critiques the United States’ offshore tax enforcement initiatives, arguing that the U.S. has prioritized two problematic policy commitments in designing enforcement at the expense of competing considerations: First, the U.S. has attempted to equalize enforcement against taxpayers with solely domestic holdings and those with harder-to-detect offshore holdings by imposing harsher reporting requirements and penalties on the latter. But in doing so, it has failed to appropriately distinguish among differently situated taxpayers with offshore holdings. Second, the U.S. has focused on revenue and enforcement, ignoring the significant compliance costs and social harms that its initiatives create.  

The confluence of these two policy commitments risks creating high costs for the wrong taxpayers. While offshore tax enforcement may have been designed to catch high¬-net-worth tax cheats, it may instead impose disproportionate burdens on those immigrants and expatriates who have less ability to complain, comply, or “substitute out” of the law’s grasp. This Article argues that the U.S. should redesign its enforcement approach to minimize these risks and suggests reforms to this end.

The paper provides a thorough review of the panoply of offshore enforcement programs and mechanisms and documents the harms of their dragnet approach, especially on the most vulnerable and least likely targets. A significant contribution to the literature.

Modern Day Robin Hood? Taxpayers as Facilitators of State Level Tax Games

In an interesting twist on contemporary debates about tax planning by multinational companies, Prof. Leandra Lederman recently posted a very interesting column about how one government seems to have benefited from some clever tax planning at the expense of its own national government, with the help of a multinational company that appears to have received nothing for its trouble.

This is the strange case of Volkswagen's tax structuring involving the Spanish provinces of Navarre and Catalonia. What is strange is that, in this particular instance, Volkswagen's structure appears to have created no tax benefit for itself, but resulted in the province of Navarre effectively transferring itself a large pot of revenue from the national coffers.

Prof. Lederman's post explains that Navarre is an "autonomous community", which, unlike Catalonia, independently administers the VAT, and therefore only issues VAT refunds when products are exported from Navarre to a buyer located outside of Spain. (Most of Spain's other provinces have a harmonized VAT system administered at the national level). If products are sold to a buyer outside of Navarre but still in Spain, such as Catalonia, Navarre does not issue a refund because there has been no export. But if the purchasing company in that other province then sells to a subsequent buyer outside of Spain, the Spanish Treasury issues a refund to the company and voilà, Navarre has transferred itself a windfall in the amount of tax it collected and Spain paid back.

Over a period of several years, Navarre reportedly collected approximately 1.5 billion Euros from the Spanish government using Volkswagen in this manner. By routing its export sales through an intermediary in Catalonia rather than directly from Navarre, Volkswagen acted as a conduit to route revenues from the state to the province. Given its own indifference to who, as between Navarre and Spain, refunds the VAT on its exports, using an intermediary in Catalonia appears like an act of pure generosity to the province of Navarre. Prof. Lederman goes through the case that brought this issue to attention and queries: what's in it for Volkswagen? She notes that nothing in the public record suggests that VW received anything in return—"it simply did Navarre a favor." That seems unlikely; certainly, as Lederman points out, Navarre would be capable of having made some other concessions. These would not necessarily be made public.

Absent concessions, is this a modern day Robin Hood story, with VW effectively taking from the state to give to the province? Navarre is not quite at the bottom of Spain's provinces economically (at least according to wikipedia) but neither is it near the top spot in terms of gross regional product (it is, however, near the top in terms of purchasing power parity, as well as in other factors such as employment rates). Should we cheer or disparage the tax trickery that resulted in an ongoing transfer of wealth from Spain to Navarre?

Also curious is why Spain wouldn't have anticipated this problem far in advance of this situation arising. It seems that the government proposes to resolve the issue by renegotiating the Convenio Económico Navarra-Estado (Navarra-State Economic Agreement), which governs the VAT administration among other matters. I am no VAT expert but it seems to me that having designed a destination based VAT system and having agreed to independent administration of that system by one or more of its provinces, the state might have immediately recognized that revenue transfers from itself to the non-harmonized province(s) would be likely unless there was some mechanism requiring the VAT-collecting province to be the VAT-refunding province in the case of ultimate exports.

Like Prof. Lederman, I would be curious to know whether this sort of situation has arisen in other contexts--do sub-national governments routinely look for ways to transfer state revenues to themselves using taxpayers as conduits? Should we liken the province's passively benefiting from a system not solely of its own making as acceptable tax planning or harmful tax competition? Likewise, should we view the taxpayer's willingness to facilitate the transfer (for apparently no reason but its good nature and general willingness to cooperate) as a victory or a failing in the taxpayer-state relationship?

Gribnau & Vording on The Birth of Tax Law as an Academic Discipline

Hans Gribnau and Henk Vording recently posted an interesting paper on SSRN. Here is the introduction:

The academic discipline of tax law as we know it today has its roots in the late nineteenth century. In the Netherlands, it emerged out of a confrontation between (predominantly British) classical political economy and German Staatslehre (theory of the state). This contribution analyses the impact of the relevant ideas on Dutch theorizing about taxes. It is argued that tax law as a legal discipline is heavily indebted to the German tradition. This may help to explain why it has proven difficult to develop meaningful communication between tax lawyers and tax economists.  

The paper focuses on the development of tax doctrine in the Netherlands over the nineteenth century, but the paper's thoughtful analysis of the evolution of tax goals and priorities, the conceptualization of the taxpayer-state relationship, the complex interaction on tax policy of political and economic theory, and the impact of rule of law theory on tax policy are of general interest.

Lederman: Death, Taxes and a Beach Read

Over at Surly Subgroup, Leandra Lederman has posted Death, Taxes, and a Beach Read, a review of a series of novels by Diane Kelly, a former CPA and tax attorney turned romance novelist who "had the pleasure of working with a partner later convicted of tax shelter fraud [and] served a stint as an Assistant Attorney General for the State of Texas under an AG who pled guilty to criminal charges related to the tobacco company lawsuits." Leandra told me about these books last week when I was in Bloomington, and I have never heard of them before, so it is fun to see her write them up. From her post:

It never occurred to me to blog about [the series] until I read the first page of “Death, Taxes, and Cheap Sunglasses” while on a plane, and saw a link with tax issues I frequently write about. The opening paragraph reads:

“I slid my gun into my purse, grabbed my briefcase, and headed out to my car. Yep, tax season was in full swing once again, honest people scrambling to round up their receipts, hoping for a refund or at least to break even. As a taxpayer myself, I felt for them. But as far as tax cheats were concerned, I had no sympathy. The most recent annual report indicated that American individuals and corporations had underpaid their taxes by $450 billion. Not exactly chump change. That’s where I came in.” 

I had just presented my latest tax compliance article, “Does Enforcement Crowd Out Voluntary Tax Compliance?” and here were tax gap figures showing up in a novel! ...

Leandra notes that of course the novel simplifies, referring to “underpaid”taxes: official tax gap measurements by the IRS (see e.g. 2006; 2012) include late payment and filing/reporting failures. Leandra continues:

The heroine of this "romantic mystery series" is CPA Tara Holloway, who's described as "kicking ass, taking social security numbers, and keeping the world safe for honest taxpayers." She's a Special Agent with the IRS's Criminal Investigation Division.... 

Diane Kelly takes a few liberties with what Tara can get away with. The acknowledgments in “Death, Taxes, and Peach Sangria” include the following statement: “To the IRS special agents, thank you for sharing your fascinating world with me and for all you do on behalf of honest taxpayers. Please forgive Tara for being such a naughty agent and breaking the rules.” 

Leandra recommends readers start with the first novel in the series, Death, Taxes, and a French Manicure. But if Tara's mission is to close the tax gap, is it ok to buy the book on Amazon?

Some Recent Scholarship on Tax and Human Rights

I've posted on SSRN a new work in progress and two recently published works on the topic of taxation and human rights:

Human Rights at the Borders of Tax Sovereignty

Tax scholarship typically presumes the state’s power to tax and therefore rarely concerns itself with analyzing which relationships between a government and a potential taxpayer normatively justify taxation, and which do not. This paper presents the case for undertaking such an analysis as a matter of the state’s obligation to observe and protect fundamental human rights. It begins by examining existing frameworks for understanding how a taxpayer population is and ought to be defined. It then analyzes potential harms created by an improperly expansive taxpayer category, and those created by excluding from consideration those beyond the polity even if directly impacted by the tax regime. It concludes that a modified membership principle is a more acceptable framework for normative analysis of the jurisdiction to tax, even while acknowledging the overwhelming weight of existing perceptions about the bounds of the polity and the state-citizen relationship as significant barriers to acceptance.

Taxpayer Rights in Canada

Canada is one of many countries where taxpayer rights are becoming an increasingly common topic of discourse among policymakers, practitioners, and the public. Especially in light of recent developments regarding the global expansion of taxpayer information exchange, the role of taxpayer privacy and confidentiality rights have emerged as significant legal issues. This chapter surveys the contemporary theoretical, legal, and political landscape of taxpayer rights in Canada. Part I outlines the theoretical and legal sources from which taxpayers may be said to have rights. Part II examines Canada’s Taxpayer Bill of Rights and considers some of the historical, legal, and political issues that give rise to their core principles. Part III focuses in on the taxpayer’s right to privacy and confidentiality in the context of evolving global trends surrounding the use and exchange of taxpayer information. The Chapter concludes with some observations about where taxpayer rights may be headed in Canada.

Taxpayer Rights in the United States

Despite abundant sources of legal and quasi-legal protection against abuses of individual rights and freedoms, there are areas of contention regarding respect for taxpayer rights in the United States. This chapter lays out the framework of taxpayer rights and considers their meaning by considering a contemporary case, namely, the recent expansion of citizenship-based taxation through globally enforced financial asset reporting and information exchange. Part I outlines the theoretical and legal sources from which taxpayers may be said to have rights. Part II examines the US Taxpayer Bill of Rights and considers some of the historical, legal, and political issues that give rise to their core principles. Part III focuses in on the taxpayer’s right to be informed in the context of citizenship-based taxation in a globalized world. The Chapter concludes with some observations about where taxpayer rights may be headed in the United States.

Heyka on Tax Treaty Arbitration and A World Tax Court

Last fall I via twitter I shouted out two of my students who won the Tax Analysts Student Writing Competition, in the international category:

Very proud that two of my students @LAWMcGill won this year: @montano_cabezas (2015) and @Heyka14 (2017) https://t.co/XjWV2A66Cj

— Allison Christians (@taxpolblog) July 11, 2016

I posted about the first paper long ago but I inadvertently neglected to post the second.  Correcting that oversight, here it is, available at Tax Analysts: A World Tax Court: The Solution to Tax Treaty Arbitration, by Jake Heyka. Here is the brief abstract by TA:

Jake Heyka examines tax treaty arbitration standards while demonstrating that as a matter of fundamental justice, arbitration should be revamped. He proposes the creation of a world tax court.

Heyka begins by observing that "[t]he institution of international tax treaty arbitration (ITTA) is hotly debated in international business and tax law. While the process is helpful because it pressures governments to resolve contested tax decisions, opponents have called it 'secret and evil.'"
He then makes the provocative observation that "the use of ITTA ultimately frustrates the resolution of tax disputes and should be supplanted by a world tax court." In support of his proposal, Heyka lays out the history and critique of tax treaty arbitration (including by me) and concludes:

Standardizing ITTA will create some procedural certainty but does not guarantee consistent use of those procedures, allow the public to see whether the process is fair, or establish reliable precedent. As Lindencrona and Mattson suggested over 30 years ago, ITTA should be a stepping stone to what the world ultimately needs: a world tax court.

As radical as it may seem, the idea is not far-fetched. World courts exist in many commercial and noncommercial contexts, and those that deal with money rather than crime are followed by many countries and used quite often. Moreover, state authority is regularly ceded to resolve disputes between commercial parties in arbitration courts such as the Permanent Court of Arbitration in The Hague, the London Court of International Arbitration, and many other arbitration institutes. A world tax court would merely serve as a place to resolve tax disputes in a similar manner while sustaining the public nature of tax law.

While I am late to post it, Heyka's article remains timely as the inclusion of arbitration in the recently released MLI is sure to keep the issue front and center in international tax discourse. Congrats Jake, and sorry for the delay in posting your accomplishment.

Idiot's Guide to DBCFT, Ryan Style

I've been fielding several "what is is this DBCFT idea" kinds of questions so I thought it might be helpful to present the six basic features of the DBCFT as proposed (in very general form) by Paul Ryan and a very simple chart to explain how the DBCFT would "work" if it was enacted as described in Ryan's "Better Way" plan.*

Accordingly, based on that proposal, the six main features of the DBCFT would be:

1. domestic sales are included
2. foreign sales are excluded
3. dividends from foreign subsidiaries are exempt
4. all foreign costs are non-deductible
5. net interest is non-deductible
6. allowable domestic costs are immediately deductible (expensed)

Obviously these are oversimplifications and I'm ignoring transition rules and so on, but these are the basic building blocks. The Ryan plan proposes a tax rate of 20%. 

So what happens if these building blocks are put in place via legislation, assuming away all transition issues etc., and that a tax imposed is a tax collected?** If we imagine a product that will sell for $125, and costs $100 to produce (in materials and labour), this is what happens:

Box 1: MAGA ideal: made in America, by Americans, for Americans. Tax will be collected on profits earned by selling goods produced & sold domestically. The DBCFT most resembles an income tax in this scenario (though expensing and non-deductibility of interest still moves it toward a consumption base); it will also be the easiest to collect.

Box 2: Exports. Tax exemption for sales abroad will create (possibly permanent) NOLs to carry forward indefinitely. This will require deciding on loss-shifting policy. This is obviously not an income tax but it not a VAT either.

Box 3: Imports. Sales in the US of goods produced abroad are taxed on a gross basis, more like an excise tax (or yes, a tariff). With an estimated $1.2 trillion trade deficit, this part of the DBCFT is expected to raise the most revenue but the success of that strategy depends to some degree (maybe a large degree) on remote sellers collecting tax (that’s complicated--see Europe).

Box 4: Foreign Sales of Foreign Products. Neither costs nor revenues are counted for goods produced and sold abroad, even if produced and sold by a US-based company. This part of the DBCFT would be more or less consistent with either a VAT or territorial income tax.

That, in a nutshell, is the basic skeleton of the DBCFT as proposed in the Ryan plan. It will be interesting to see what, if any, of this ends up enacted IRL.

* There is absolutely zero chance that the proposal will be enacted as described. Still, it is helpful to understand the basic vision. I do not claim to be an expert on the DBCFT and offer here no analysis or predictions about the incidence of the tax, or the impact such a tax would have on US or world capital flows, investment, consumption, economic growth, or international relations. This paper by Wei Cui, or this one by Wolfgang Schoen are helpful in addressing many of these issues.

** A tax imposed is never a tax collected. There is always a gap between a great idea (or for that matter a not so great idea) and something that can actually be carried out: tax administration is tax policy.

Cockfield on Information Exchange

Arthur Cockfield has posted a paper of interest, entitled How Countries Should Share Tax Information. Here is the abstract:

There are increasing policy concerns that aggressive international tax avoidance and offshore tax evasion significantly reduce government revenues. In particular, for some low income countries the amount of capital flight (where elites move and hide monies offshore in tax havens) exceeds foreign aid. Governments struggle to enforce their tax laws to constrain these actions, but are inhibited by a lack of information concerning international capital flows. The main international policy response to these developments has been to promote global financial transparency through heightened cross-border exchanges of tax information. The paper discusses elements of optimal cross-border tax information exchange laws and policies by focusing on three key challenges: information quality, taxpayer privacy, and enforcement. Relatedly, the paper discusses how the exchange of automatic ‘big tax data’ combined with data analytics can help address the challenges.

Cockfield seeks to find a solution that balances the need of the state for extensive information in order to protect the integrity of the income tax system against the need of the individual for protection from abuse by the state. That is no easy balance to strike. From the paper:

All of [the recent information gathering and exchange] efforts seek to provide governments with more and better tax information, and reduce costs through agreement on underlying EOI rules and principles. The reforms, however, largely do not address how financial secrecy laws subvert global financial transparency initiatives. Nor do they address legal technical complexity that raises transaction costs, and makes it even harder for low and middle income countries to implement and enforce EOI. While the EOI reforms are positive steps, given an environment of high transaction costs it may be difficult to make progress in addressing key policy challenges.... 

Data availability, usefulness and verifiability are three components of high quality information that can help governments pursue their cross-border investigations and audits. In particular, transferred information should be relatable to domestic tax identification measures, and checked against third party reporting, and withholding tax disclosures. Once this is done, governments can conduct analysis to determine audit risk by focusing on issues such as taxpayer segmentation, dealings between the taxpayer and offshore service providers, and cross-indexing tax and financial information against non-tax data (e.g., insurance policy disclosures). 

Against this desire for high quality tax information stands (shrugs?) taxpayer privacy concerns. The apprehensions arise from the varied levels of domestic legal protection afforded to privacy rights, along with the risk of abuse or misuse of transferred information. Accordingly, broader multilateral agreement on privacy protections is likely a prerequisite to effective EOI. This hoped-for cooperation is hindered by the fact that many countries refuse to abolish their financial secrecy laws, which stands as one of the main barriers to optimal reform.

My view is that maintaining the integrity of the income tax system appears to require building the panopticon, and much more besides. The steady decline of support for coherent corporate income taxation makes greater and greater individual surveillance necessary, while also making personal income taxation harder. I am not sure where the point lies at which the costs and risks attendant to building the necessary compliance and enforcement infrastructure exceed the benefits of maintaining personal taxes based on income.

Christians and Ezenagu: Kill Switches in the New US Tax Treaty

Recently published as part of the Brooklyn Law School symposium Reconsidering the Tax Treaty, this article looks at the introduction of new clauses to switch off treaty benefits where the treaty partner adopts certain kinds of tax rate or base reductions.  I think these clauses are interesting because they create a way for one country to control the future tax policy decisions of another. Whether other countries will agree to a treaty with such a provision is another story.

Here is the abstract:

The new US model income tax treaty contains an unusual addition: mechanisms for the parties to unilaterally override the negotiated treaty rates in specified circumstances. Previewed last year in proposed form — a first for Treasury — these new mechanisms work as kill-switches, partially terminating the treaty as to one or both treaty partners. The idea is to forestall a more problematic outcome, such as an enduring breach of one of the parties’ expectations, or the opposite, a complete termination of all the treaty terms in the face of such a breach. Yet embedding a kill-switch in a treaty creates distinct legal, procedural, and political pressures in the tax-treaty relationship that implicate treaty negotiation, ratification, interpretation, and dispute resolution. Kill-switches also communicate a defensive tenor in the tax treaty relationships among many countries. This Article analyzes the new kill-switch provisions and concludes that their introduction in the U.S. Model reflects the steady deterioration of tax treaties from essentially diplomatic documents premised on the good faith of the parties to detailed contracts drafted in anticipation of the opposite.

The Seven Rules for Tax Research, Now Ten

The OECD released the multilateral instrument (MLI) on tax, so (assuming that at least five countries ratify it), we have to revise the old rules for doing tax research. The MLI means that any given tax situation will be impacted by relevant statutes, relevant tax treaties, and the portions of the MLI that are in effect as to those treaties. So here they are, the revised rules for tax research:

You can find the text of the MLI here. The Explanatory Statement, also at that link, is so far only in English.

Three months after five countries ratify, the MLI will be in effect; subsequent accessions will take effect one month after ratification. However, as to optional provisions, no substantive changes take effect until both parties notify which provisions they intend to apply to which of their treaties. 

The OECD has designed three types of provisions and explains how they relate to existing tax treaties. Here are my notes to self:

Much more analysis to do obviously, but my first cut at this is to try to understand the process of integrating the MLI into the existing tax law order. 

Fleming Peroni & Shay on Corporate Tax, Credits, and even Customary International Law

Fleming Peroni & Shay recently posted a new article, of interest as it renews the authors' case, in the wake of BEPS, for both worldwide corporate taxation without deferral (a controversial proposal to say the least) and the foreign tax credit as an appropriate mechanism to allocate tax among home and host countries. As the abstract below indicates, the argument in favour of tax creditability is contra Dan Shaviro, who has argued for foreign taxes to be deductible rather than creditable. The FP&S argument in favour of full current taxation without deferral is contra almost everyone, so it's fun to see FP&S make it, especially in the face of what appears to be a rapidly rising tide of sentiment going in the opposite direction. 

My own view is that a switch to deductibility would increases pressure on capital importing countries to reduce their source-based taxes (a deduction does not fully offset the foreign tax, so it would make such taxes more costly to US firms as compared to fully creditable foreign taxes), and therefore transfer revenues from poor to rich countries. Deferral already places tremendous tax competition pressure on host countries, while ending it might enable some countries (to which US capital is a major source of inbound investment) to increase their source-based taxation (as explained in this paper). Therefore I was happy to see this FP&S paper give additional support to the beleaguered tax credit while still recognizing that there is such a thing as giving too much credit.

I was also intrigued to see FP&S begin their paper by picking up Reuven Avi-Yonah's premise that taxation on the basis of residence and source is customary international law. That is not only a relatively unusual argument to find in a US-authorized tax paper, but it is a potentially controversial perspective, which I am exploring in a paper of my own (making the international law case against citizenship based taxation). So, thank you Fleming, Peroni and Shay, for the additional citation support for my arguments.

It is also worth noting that FP&S include in this paper a defense of the corporate income tax in the form of footnote 200, which spans more than a page in tiny but useful print. It summarizes the main points regarding why corporate tax is necessary as a backstop to individual income taxation, citing to the main arguments for and against, thus serving as a valuable micro treatise on the subject.  

Finally, I note that FP&S only give the FTC two cheers instead of three because they feel that it conflicts with the principle of ability to pay, an argument I have not seen before and that gives me pause. Their argument is that foreign taxes are a cost to individuals attendant to investing abroad, and that crediting these taxes is too generous from the perspective of fairness, that a deduction would sufficiently account for the cost in terms of measuring ability to pay. I can understand that argument where the FTC is itself too generous, allowing cross-crediting and not restricting its application to double taxation. But I do not understand that argument applied to an FTC that restricts itself to a dollar for dollar credit of actual taxes paid, which I believe is the argument being advanced here. That's something to think about a little more.

In any event, abstract below and paper at the link above. Well worth a read.

 Reform of the U.S. international income  taxation system has been a hotly debated topic for many  years. The  principal competing alternatives are a territorial or  exemption system and a worldwide  system.   For reasons  summarized  in  this  Article, we favor worldwide taxation if it is real worldwide  taxation; that  is, a nondeferred U.S. tax is imposed  on all foreign income  of U.S.  residents at  the  time the  income is earned.  However,  this approach  is not  acceptable unless  the resulting double  taxation  is alleviated.    The longstanding U.S. approach for  handling the international  double taxation  problem is a foreign tax credit limited to the U.S. levy  on the taxpayer’s  foreign  income.   Indeed,  the foreign tax credit  is an essential element of the case  for worldwide taxation.  Moreover, territorial systems often apply worldwide taxation with a foreign tax credit to all income of resident individuals as well as the passive income and tax haven income of resident corporations.  Thus, the foreign tax credit also is an important feature of many territorial systems. The foreign tax credit has been subjected to sharp criticisms though, and Professor Daniel Shaviro has recently proposed replacing the credit with a combination of a deduction for foreign taxes and a reduced U.S. tax rate on foreign income.  

In this Article, we respond to the criticisms and argue that the foreign tax credit is a robust and effective device.  Furthermore, we respectfully explain why Professor Shaviro’s proposal is not an adequate substitute.  We also explore an overlooked aspect of the foreign tax credit—its role as an allocator of the international tax base between residence and source countries—and we explain the credit’s effectiveness in carrying out this role.  Nevertheless, we point out that the credit merits only two cheers because it goes beyond the requirements of the ability-to-pay principle that underlies use of an income base for imposing tax (instead of a consumption base). Ultimately, the credit is the preferred approach for mitigating international double taxation of income.

 

How to rob from the poor and give to the rich: Border Tax Equity Act of 2016

In September, Donald Trump started calling for the US to tax imports from Mexico and China etc, on various theories having to do with his vision of what fair trade policy involving the United States would require. Democratic lawmaker Bill Pascrell appears to have seized the moment to re-introduce a bill that has failed multiple times in the U.S. Congress over the years, namely, the so-called Border Tax Equity Act. The idea of this act is simple: tax US consumers on imports and give the money to US companies that export things. If you find it amazing that anyone anywhere could support a tax and redistribute scheme like this, blame it on the pitch: Pascrell (and others) laud this as an answer to what they have characterized as a discriminatory practice, namely the exemption of exported products from value added taxes (VAT) by the 160+ countries that have federal consumption taxes. The argument is that "[t]he disparate treatment of border taxes is arbitrary, inequitable, causes economic distortions based only on the type of tax system used by a country, and is a primary obstacle to more balanced trade relations between the United States and its major trading partners."

This argument is specious and I don't expect the bill to pass but this issue is one that just does not seem like it will go away, I think because it is too easy to pitch the VAT border tax adjustment as "unfair." I had an exchange with trade expert Simon Lester almost ten years ago on this very subject, and re-reading my response today, it seems to cover the bases so I thought I would re-post it. You can see his original post here including a discussion in the comments between myself, Simon, and Sungjoon Cho on the matter. Sungjoon helpfully linked to a GATT working party report from 1970 but his original link is dead, however you can find that report here. Here is what I said (highlights added):

The great fallacy here is that the foreign exporter to the U.S. is somehow subject to no tax while the U.S. exporter is subject to two taxes. This is simply not the case. Other countries, especially our biggest trading partners (e.g. Canada) have both a federal corporate income tax and a federal consumption tax, while the U.S. has only a federal corporate tax. You cannot honestly assess the impact of the VAT in the context of only one country’s corporate income tax, and supporting this legislation this way is dishonest. The Textileworld site you reference conveniently ignores foreign corporate taxes in its analysis—I will leave you to decide for yourself why they might do that.

...I will give a drastically oversimplified example. Assume a U.S. person manufactures a product in the U.S. which it will sell in Canada. The company’s profit on the sale is subject to federal income tax in the U.S., plus VAT in Canada (there called a general sales tax). Let us assume a Canadian company makes a similar product. With the same profit margin as the U.S. company on that product, the big issue here is the different rates of federal corporate taxes each company pays to its home country, because both pay an equal amount of VAT tax in that market. What the export credit in the U.S. would do is lower the U.S . company’s federal income tax burden relative to the Canadian one.

Now flip the scenario, the U.S. manufactures and sells a product in the U.S., where there is no VAT, and the Canadian company manufactures a product in Canada to sell in the U.S. Now each company again will pay its income tax to its home country but what happens to the VAT? Well there is no U.S. federal sales tax, and Canada’s VAT only applies to sales in that market, so the VAT is not imposed on the Canadian product coming in to the U.S.—it is exempt from their VAT. Again, in the U.S. market, there is no price distortion other than the difference in corporate income tax burdens—neither product is subject to VAT. If the U.S. imposes a border tax, I think you might now see that as distortionary (to the extent you believe that a tariff is distortionary in any event). Now you might say yeah, but many states have state sales taxes, wouldn't that equalize the incoming product, exempted from sales (VAT) tax in its foreign country? The answer is, of course, yes. But you don’t see very many people complaining if New York does not impose its sales tax on a product being shipped out of New York for sale in Canada—that is a (much-ignored) direct corollary to the VAT exemption.

I could go on but this argument has been made many times before. I appreciate that tax is complex and there are many alternative taxes and scenarios in which they apply differently, so that it is easy to be swayed by something that “seem unfair.” The bottom line is that people will continue to compare VAT to income taxes when it suits their purposes (i.e., supports protectionist policies like the border tax), and not when it doesn’t (i.e, when they want to pressure a government to lower its corporate tax rate to align with other nations’ corporate tax rate). But don’t be fooled by someone who tries to get you to look at one piece of a complex puzzle and guess what the image is.

Further...

[I]f you seek a level playing field, border taxes and rebates do not achieve that, and in fact, I doubt anyone could ever be confident about how to go about getting it via tax breaks for some and tax penalties for others (I have some ideas about where I would start, but I'll restrain myself). A border tax/rebate does not operate like an inverse VAT or offset an extra cost imposed by a VAT. A border tax is a tariff and a rebate is a subsidy, plain and simple, and I would expect many of our trading partners to oppose it if enacted.

Incidentally, abolishing all income taxes might solve the problem of the income tax competition, but then you have a much different problem. By some estimates, if the U.S. were to abolish the income tax entirely in favor of a sales tax, the rate could be as high as 50%. More likely scenario: we keep the income tax just like it is and ADD a 10-20% federal VAT. This would get rid of the erroneous "VAT as distortion" complaint but I personally would rather keep the debate and take a pass on the VAT.

Today, I am less convinced that the income tax is worth saving and more open to a federal VAT, but that's a discussion for another day. To the above I would only add that in 2009 the US Congressional Research Service undertook a study called International Competitiveness: An Economic Analysis of VAT Border Tax Adjustments, well worth reading--the authors were Maxim Shvedov (now tax policy expert at AARP) and Donald Marples, whose more recent work on inversions with Jane Gravelle is also of interest. Their conclusion:

Economists have long recognized that border tax adjustments have no effect on a nation's competitiveness. Border tax adjustments have been shown to mitigate the double taxation of cross-border transactions and to provide a level playing field for domestic and foreign goods and services. Hence, in the absence of changes to the underlying macroeconomic variables affecting capital flows (for example, interest rates), any changes in the product prices of traded goods and services brought about by border tax adjustments would be immediately offset by exchange-rate adjustments. This is not to say, however, that a nation's tax structure cannot influence patterns of trade or the composition of trade.

In summary: No, taxing at the border for the reasons given does not introduce "equity." It introduces WTO-prohibited tariffs and export subsidies. One could imagine that if the tariffs so raised were used to fund public goods, the possibility for an equitable outcome could be increased. But taking the money out of the pockets of US consumers and putting it in the pocket of US exporters in no way fulfills the stated policy goal.

Kadet and Koontz on an Objective Ethical Framework for MNC Tax Planning

Jeffery M Kadet and David L Koontz have recently posted a two-part article entitled "Profit-Shifting Structures: Making Ethical Judgments Objectively," of interest and available on SSRN: parts one and two. From the abstract:

MNCs and their advisors have seemingly taken ethics out of the mix when considering the profit-shifting tax structures they have so prolifically and enthusiastically implemented over the past several decades. ... Given the strong motivation to implement such structures, a counterweight is needed to balance the unfettered acceptance and adoption of profit-shifting strategies based solely on the mere possibility that they might pass technical tax scrutiny by the government. Greater thought needs to be given to whether these plans are consistent with and serve the long term objectives of the MNC and its many global stakeholders. Stating this proposition more directly, it is time to ask if all of these stakeholders would accept the efficacy of these structures if they were made fully aware of and understood the technical basis, the strained interpretations, the hidden arrangements, the meaningless intercompany agreements, the inconsistent positions, and the lack of change in the business model for the schemes proposed or already implemented.

This article presents an objective ethical benchmark to test the acceptability of certain profit shifting structures. ... In brief, this ethical benchmark requires an examination of the factual situation for each of an MNC’s low or zero taxed foreign group members regarding three factors, which are: 

(a) identification and location of critical value-drivers,(b) location of actual control and decision-making of the foreign group member’s business and operations, and(c) the existence or lack thereof of capable offshore management personnel and a CEO located at an office of the foreign group member ... who has the background and expertise to manage, and does in fact manage, the entity’s business. 

Through this examination, it should be possible to determine whether a foreign group member is recording income that is economically earned through business decisions and activities conducted in the jurisdiction in which it claims to be doing business. ... This benchmark should be used by MNCs with the active participation of board and management members. An MNC could also use this approach to proactively respond to critics or to demonstrate its tax bona-fides. 

The article contributes to an ongoing discourse about how states can tax multinationals effectively, and how tax planning decisions should be assessed, in a world of global capital mobility and flexible commercial structures.

Analysis of Canada's Tax Gap Pre-Study

Further to my last post on the newly released Tax Gap study by the Canada Revenue Agency, the following comes from guest blogger Iain Campbell (ARC, UK):

I hope this comment is not too long but I’ve been following Tax Gap discussions for so long that it’s hard to pass by the chance to comment!

Background

This is an interesting development. Writing from the UK I’m not in regular contact with developments in Canadian tax administration. But I do recall there has been some entertainment over the Tax Gap, with the Parliamentary Budget Officer asking for the CRA to do some work on it - and being rebuffed.

In fact, the CRA has not been keen on preparing a Tax Gap analysis. In 2002 it reported that attempting to estimate overall levels of reporting non-compliance such as the ‘tax gap’ or the total amount of smuggling activity was fraught with difficulty. (CRCA Performance report for the period ending 31 March 2002.) Ten years later the CRA were still not convinced. At the start of 2013 they told the PBO:

The CRA later pointed out “the significant debate about the precision, accuracy and utility of any methodology to calculate the tax gap”. It drew attention to critical comments from the UK Treasury Select Committee, as well as the fact of 52 tax administrations surveyed by the IRS, 33 did not produce one, and the high costs of doing so. (CRA, PBO Information Request IR0102: tax gap estimates, letter 20 March 2013,] and PBO Information Request IR0102: tax gap estimates, letter 1 August 2013.) In 2014 the PBO even threatened to take legal action in order to compel production.

But in the recent election there was a promise to undertake such a study, ending this long standing reluctance to follow the example of other countries, including the USA and UK.  And following the Panama Papers the Revenue Minister said in January a tax gap study would be done. The new Canadian study comprises a 31pp paper on a conceptual study of the Canadian tax gap and an 11pp study on the Canadian GST/HST, which gives a gap of 5.5% in 2000 and 6.5% in 2014. (It explicitly references the decision announced by the Minister of National on 11 April.)

Basis of study – what’s in and what’s out

The conceptual study does, to an outsider, seem to spend a lot of time in not saying a great deal. It seems to add qualification to qualification, caveat after caveat, so that at times I wondered if the CRA really wanted to publish anything at all. Gus O’Donnell is the UK civil servant who wrote the Report that led to the UK Customs and Excise combining with the Inland Revenue to form HM Revenue and Customs. In that Report he surely got it down to a few words: “Making estimates of the tax gap is methodologically and empirically difficult, although easier for indirect taxes where tax can typically be related to consumption. Direct tax gaps are particularly difficult to estimate because the aggregate figures for income, for example, are built on tax data.”

The CRA's conceptual study refers a lot to the HMRC papers and policies on calculating the Tax Gap. But in some of the key areas it dances around what might be difficult decisions e.g., whether to report the gross tax gap, or, as in the UK, the gap after action to tackle non-compliance.

Avoidance

More controversially, the UK includes tax avoidance.  This is a good illustration of its overall approach.

On the other hand, academics and members of the accountancy profession have argued the opposite, that any estimate should not include avoidance as referenced by the “spirit of the law”. For example, during a Treasury Select Committee Hearing on The Administration and Effectiveness of HMRC, Judith Freedman (Professor of Tax Law, Oxford University) commented “I really take issue with the spirit of the law part, because either you have law or you don’t have law and the law has to state what it is.”

The Canadian paper discusses this option and concludes “the appropriate treatment of tax avoidance is less clear”. It seems Canada has decided to not include avoidance in its definition: “In general the CRA’s approach to the tax gap encompasses non-compliance related to non-filing, non-registration (in the case of GST/HST), errors, under-payment, non-payment, and unlawful tax evasion” (p29).  There seems to be no explicit position on avoidance but, although I doubt it will happen, “under-payment” is potentially broad enough to include under-payment via avoidance.

Other “Gaps”

Another area the study did not address is what the IMF and EU call the “tax policy gap”. I agree with this decision (which mirrors the UK). The IMF would widen the definition and use of the Tax Gap approach. It suggests including the effects of policy choices that lead to reduced revenues. In a study on the UK Tax Gap it refers to the impact of compliance issues on revenue as “the compliance gap” and the revenue loss attributable to provisions in tax laws that allow an exemption, a special credit, a preferential rate of tax, or a deferral of tax liability, as the “policy gap” (para 68).  As part of this they recommend tax avoidance schemes deemed legal through litigation should be considered part of the policy gap, not the compliance gap, and this distinction should be made clear.

A similar point was made by an EU report on VAT. They suggested that a possible link between the policy and the compliance gaps, since using the reliefs and allowances intended by policy could make compliance more difficult. “Reducing the policy gap may often be the simplest and most effective way to reduce the compliance gap. “ (p21)

In my view these kinds of proposals are likely to be very complex, perhaps contentious, and hard to administer. It seems a sensible decision to not refer to them or suggest their inclusion.

Then there are the base erosion issues where tax is avoided through the use of legal structures that make use of mismatches between domestic and international tax, e.g. permanent establishments. The Canadian study nods in the direction of BEPS and then passes by.

What’s the point of working out a Tax Gap?

But putting aside these sorts of issues, or whether “top-down” targeting is better than “bottom-up”, does the size of the hidden or “informal” economy predict the level of GST/VAT underpayment (or is it the other way around?), perhaps the  big $64K question is whether any of this means anything. If there is no clear agreement on the numbers, how they are calculated and their reliability, then is there are any point in preparing them?

The very concept of the tax gap is not universally agreed to be a useful analytical or strategic lever. Apart from the earlier Canadian reluctance, the Australians were slow to go down this road. UK Parliamentarians have been less than keen. In 2012 the Treasury Select Committee said they thought it was essentially a waste of time and resources. Worse, they feared it would misdirect HMRC away from ensuring every taxpayer paid the right amount of tax. Such fears have not died. The current TSC is examining UK corporation tax. Their early work involved scoping the problem and they heard some evidence on the tax gap. Andrew Tyrie (the Chair) seemed less than enthused at the very concept.

I think it has merits. But it ought not to be elevated to some shibboleth. It is one high-level measure of how successfully legislation is being applied, use of resources, etc.  The UK Government’s official position is that that “thinking about the tax gap forces the department to focus attention on the need to understand how non-compliance occurs and how the causes can be addressed—whether through tailored assistance, simpler legislation, redesigned processes or targeted interventions. Measuring the tax gap helps us to understand whether increasing returns from compliance activity reflect improved effectiveness or merely a decrease in voluntary compliance.”

The Canadian paper says broadly the same things (pp22-24). It talks of providing insight into the overall health of the tax system, of understanding the composition and scale of non-compliance, but warns of their limitations.

If that is how it used then I think it is a useful aid to policy making and how robust is the assurance being provided by the tax administration.