Harmful tax competition

The globalization of markets

In the last three decades, the expansionary globalization has deepened its model.

A great growth of transnational transactions was accompanied by the rise of e-commerce. This increased exponentially the types of contracts and the possibility of concluding them between companies and people physically distant from each other. It also allowed the diversification of channels of formalization, instrumentation and ways of payment in commercial operations involving two or more jurisdictions.

To this, the consolidation and proliferation of new economic actors on the scene were added. These were multinational companies, non-governmental organizations and supranational entities with different degrees of development and delegated powers (European Union, Pacto Andino, Mercosur).

Their presence changed forever the concept of economic sovereignty as it existed so far.

The division created by the state borders was relativized and thus emerged corporations with negotiation, investment and fiscal planning capacities not seen until then.

The competition for revenue collection and capital flows

The tax administrations needed to readjust their efforts to the volumes and territorial dispersion of the transnational companies, in order to tax these operations and to solve the increasingly frequent and significant conflicts in the application of the rules, taking into account the multiple hierarchies that were incorporated into regulation.

This complex and changing environment implied for States a deepening of the need to cooperate in the field of information exchange.

However, in return, it opened an unexpected scenario of tax competition between administrations, called harmful, as it was described by the O.E.C.D. in a document on the subject dated in 1998.

Conscious of the resulting economic benefits, some jurisdictions began to implement speculative practices by establishing certain fiscal conditions in their domestic legal systems.

This was an intent to offer certain non-resident investors – originators of very high tax rates – a jurisdiction to settle and tax, through different incentives to such establishment.

Thus, some jurisdictions declared non-adherence to international cooperation in the exchange of information for tax purposes.

They denied the provision of information on holdings in bank accounts, assets or operations of companies or individuals under their jurisdiction.

In this way, they sought to implement a policy of attraction of investments based on the strategic design of their taxation.

The measures included, as well,  a reduction in aliquots and the establishment of non-taxation benefits for investments from abroad. They also resorted to the signing of special agreements, private and reserved, between the State and large capital contributors, where special taxation conditions were agreed upon (ring-fencing).

A global issue

As a result of this, there were emerging calls for attention from organisations such the O.C.D.E. and the U.E. about the consequences of an escalation of this harmful competition between States,  highlighting the effects that such measures could have on local economies and the global market.

Thus came the recommendations for the adoption of the so-called good practices of States and companies (Serrano Palacio, op cit).

Different voices were heard, for and against the discretionary state power to tax operations and the possibility of making it a competitive advantage to attract capital.

But over time, non-collaborative territorial jurisdictions were also unveiled as a haven of assets linked to the most serious issues of International Security.

In part because of this, the majority doctrine reached a new consensus on these non-collaborative jurisdictions. It was accepted that a State could decide sovereignly how much to tax the duty of contribution of its residents but it could not remain opaque in a matter of information exchange. That because the lack of transparency turned them into a refuge of assets from crimes, functional to money laundering and the perpetuation of organized crime structures and terrorist financing.

In reference to those countries that declared themselves transparent in terms of information exchange, the doctrine emphasized the effective fulfillment of the agreements.

That meant such consideration should be given to the effective, and not just the declared, commitment of the duty of collaboration between jurisdictions through the exchange of information.

This, because of certain jurisdictions that had signed agreements and did not comply, in practice, under formal pretexts or delays.

In this way, by the hand of the transformation of the market, the norms of the internal tax law of the States were modified.

This implied the transition from a basically internal model to a markedly regional and international model.

This international system is still under construction and it is experiencing a permanent change that can and should be guided by chosen scenarios, that focus on development, equal opportunity and security.

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Trick or treating

agreement

 

International treaties to avoid double taxation and bilateral agreements on exchange of information on tax matters

In accordance with the evolution of legal doctrine and jurisprudence, the domestic law of the different countries gradually adopted principles on fundamentals, limitations and guarantees in matters of taxation.

In exercise of its sovereign power, each state legislated on the relations between subjects, facts and their territory, defining in this way, when an act was taxed and to what extent the subject had to contribute.

If the relationship had elements involving two or more state jurisdictions, States established rules that included or excluded the operation in question from their power of taxation, based on different points of connection.

However, many times, two States sought to receive a tax for the same taxable event, given that there was a concurrence of some circumstance that linked that operation to its sovereignty. To do so, they considered the territory, the nationality of one of the subjects, the location of the goods or the place of celebration of the acts.

This resulted in a double taxation on the same event, which discouraged the conclusion of cross-border transactions.

On other occasions, it happened that certain facts or acts were not reached by any tax jurisdiction, and the opposite occurred, the phenomenon of non-imposition.

This is considered harmful, from the point of view of the tax administration, because it exempts economic agents from the duty to contribute, generally in a distorting way and without justifiable cause.

These difficulties were resolved through the progressive adaptation of domestic state legislation and the conclusion of conventions to avoid double taxation.

These are international treaties, generally bilateral, where tax administrations conventionally “distribute” tax powers to mitigate the disincentives and inequities that result from double taxation. They refer either to commercial operations or certain civil acts, mainly on direct taxes, to income and wealth.

However, there was a risk that the proliferation of dissimilar agreements, called to solve the need to harmonize and articulate the different legislations, would end up generating a complex normative framework that would complicate the issue even further.

information exchange

That is why the so-called “model conventions” were born. These are typified redactions that share a common scheme of distribution of tax power and that the States can adopt with the modifications that punctually agree to the contrary.

In these model conventions, two trends were reflected, referring to the connection point used to tax the rent – whether based on the source of wealth or on the residence of the owner of the capital. This depended on whether the adopter country was, respectively, importer or exporter of capital.

The first work on a model of an agreement to avoid double taxation in terms of income and wealth, by 1921 and 1928, was carried out by the League of Nations.

Subsequently (1956) published its model treaty the Fiscal Committee of the Organization for European Economic Co-operation (O.E.E.C.) which would be later the O.C.D.E.

Finally, the United Nations Organization further up in 1979 to a model alternative agreement to that first.

The bilateral agreements to which the States acceded thanks to these models, allowed to solve successfully that first challenge in the matter.

These agreements also included, progressively, commitments on the exchange of information between tax administrations for the purposes of their application.

At that time, however, such exchange was limited to the application of those bilateral agreements and was generally conditional upon the prior request of a party and the verification of the concurrence of certain conditions concerning the type of information requested, reciprocity and subsidiarity.

The question of the effective implementation of these agreements until the beginning of the millennium, shared the incipient of the institution. In fact, it was often the case that the legal provisions of many conventions remained a dead letter of the law, without the effective responses being given in a timely manner.

This experience generated the awareness in the international tax community of the importance of moving towards multilateral information exchange agreements, planned with a total view from their original design, and oriented towards automaticity as a principle in committed data traffic ( Coronas Valle, 2015).

Not an easy road

A brief tour to the current concept of taxes as a source of funding for Citizens’ Rights.

lady godiva

Although the current political, legal and social foundation of taxes has Man as the center, this has not always been the case.

Its historical genesis is strongly associated with the financing of the war and other extraordinary expenses of the Administration in times of peace.

These forced contributions, which were not only monetary but extended to personal benefits, were imposed without limits. On the other hand, its system of validation – normative and philosophical – was very different from the current one, even though they were according to the criteria of each period about the legitimation of power and its historical context, in general, related to national defence.

That is why we say that in this matter, it has not been an easy road.

There has always been a clear correlation between the conception of the tribute and its implementation and those norms and needs of the Empire, City-state or State where they belonged, as with any other branch of Law.

Historical references on tax collection go back to the earliest government organizations in Egypt, Mesopotamia and China, about five thousand years ago.

They were applied later in Greece and after a great development in Rome, they remained in the Medieval Cities, until finally arriving at the first governments of the present countries of the world.

The task of the tax collector, because of its historical origins, has always been clearly unpopular, causing adverse manifestations, based on the lack of adequate limits, that generated manifest inequities for the citizens.

Fortunately, much has evolved – ever since – that power of the state. The first advance was given by the requirement of the principle of legality, which establishes that the taxes must have legal basis – generally of a Parliamentary type – that can not be delegated. They must be in accordance with the constitutional principles of the State, which will help to delineate it (O. E. A.,  1998).

Thus, in its political face, the tax becomes a public power to impose, as a regulated obligation to manage the application of tax laws.

Due to the later developments of the doctrine on the acts of government, the tributes become founded: they have as purpose to ensure the sustainability of the management of the common good, according to certain principles, limits and obligations of the parties.

Subsequently, other more complex developments emerged, such as the principle of proportionality (Fernández González, 2000).

This principle consists of assessing the facts demonstrating the contributory capacity of those obligated to pay, that is, the quantum of the obligation to give and proportionately, increase the correlative obligation to contribute.

Other principles were added later, such as equality, which requires equal treatment in equivalent circumstances (Bonell Colmenero, 2005) and the non-confiscation of income principle, as a limit to the measure of state power of taxation (Naveira de Casanova, 1996).

The consideration of progressivity in the application of aliquots was also introduced as a way of redistributing income, adjusting the contribution to the exact scale of the taxpayer’s economy (Barberán Lahuerta, 2006).

It was opportunely stated that the correct application of justice demanded equity in the tax, taking into account special situations or vulnerable sectors that merited a different treatment (Gherardi and Rodríguez Enriquez, 2008) regarding the general rules and principles of taxes.

Finally today, topics such as the admissibility of extra tax purposes in taxation are discussed, that is, what activities should be taxed and why. And there is also controversy over the possibility of taxing unlawful acts, among other issues.

The current view thus departs from the historical paradigm by relying on two key ideas that, with a greater or lesser degree of implementation to date in the different current tax systems, constitute a common aspiration of the same: the sense of tax and the responsibility of the Parts of the obligation.

In relation to the first item, the faculty of taxation is not conceived as a public power of the coercive type, unilateral and based on the supremacy of the State over the individual.

On the contrary, it is understood as a means by supranational States or entities to secure certain economic resources that allow them to properly perform the functions and competences that correspond to them and to which they are bound.

The purpose of the tax is to make it possible to exercise the rights of citizens.

But in addition, it is a bilateral relationship of Public Law, where it is fundamental to understand, on both sides, the importance of its existence and the sense of its magnitude: the State must attend and respond to the needs and opinions of the citizens.

Its nature is that of public service, and as such, it recognizes limits and guarantees that must be respected in its implementation and enforceability.

In turn, the faculty-duty that constitutes its exercise includes diligent and objective (transparent) action, effective, according to the resources it consumes and efficient, in terms of the results to be obtained.

Likewise, it is important to advance the commitment of taxpayers and companies to adopt responsible and ethical practices on tax matters.

These should be based on commitments to the public administration that should be in accordance with their values, as individuals and as corporations.

A current conception of the link between parts, has to aim for a mature relationship, with new spaces for institutions that will generate benefits for both parties – such as self-control, proper introduction of incentives, facilitation of compliance – where voluntary compliance rules and the exception is informality and fraud.

This kind of need is of strategic type, more and more as time passes. Its achievement will have an essential role for the sustainability of administrations in the medium and long term, due to economic, demographic, technological impact in the labor market, urbanization and climate change.

This step will require that the administration can not disengage from the results to which the product of the effort required to the taxpayer should be destined.

On the contrary, in a public service relationship, the State must be accountable for the proceeds and justify the investment and return for the benefit of society, in accordance with the principle of responsibility for government actions.

The tendency today has thus, great differences with the architecture of the thought of the past historical experiences.

We said above that in principle, tribute is conceived as a means for supranational States or entities to secure certain economic resources that enable them to create an environment in which it is possible to adequately guarantee the exercise of citizens’ rights. This is its contributory aspect, the obligation to contribute to the common support of the state apparatus. The management of the public is not possible without sufficient resources. For this reason, the beneficiaries or users of the state structures should contribute to its maintenance.

They must do so to the extent of their ability to contribute or other variables that the laws take into account when measuring and defining a taxable event.

However, other taxes are required on the basis of principles of law that do not finance the operation of the State but serve to other valuable purposes whose fulfillment is in charge of the State: security, defence, equity, the creation of a system with proper incentives,  the preservation of strategic assets, etc.

This is a consequence of the fact that the state function is one. All policies and efforts in cross-cutting issues should be aligned, creating well-planned synergies, so as to be able to effectively fulfill public responsibilities.

We refer to topics such as security, education, health, energy, economic and social development, justice, ecology and culture, science and technology.

The road traveled has led the faculty of taxation to a place that – fortunately – has little to do with its historical background.

This identity has not yet been consolidated, due to the permanent changes resulting from globalization and the evolution of thinking about the interrelationship between International Taxation and Global Development.

In the next article we will see why.