Fleecing foreigners or blood from a stone?

Andrew Leigh has an op-ed in the Herald Sun talking about thin capitalisation. Mind you – he doesn’t actually use that terminology; that would be a tough gig in the Herald Sun. Instead he gives an example:

There are several tricks that multinational firms use to shift profits out of Australia and into low-tax jurisdictions. For example, they might arrange for their Bermuda arm to sell their Australian arm a paperclip at a cost of $1 million.

The Australian arm claims that as a $1 million tax deduction and the money is effectively shifted offshore.

Thankfully, that particular loophole is closed, but a similar trick can be played with debt. If the Bermuda subsidiary makes a multi-million dollar loan to the Australian arm, a million dollars a year can be shifted out of Australia in the form of interest payments.

The interest payment is a tax deduction in Australia and the profit is moved to Bermuda, where the company tax rate is considerably lower. Same thimbles, different peas. Now you see it, now you don’t.

To be fair – that is the common view. But it is very misleading. First interest expense is deductible for domestic firms and there is no good reason why foreign firms should be excluded from the same business and taxation rules that domestic firms face. Second that debt coming into Australia constitutes foreign investment, the interest being paid on that debt is the return to that foreign investment. The contribution that multinationals make to the Australian economy is well beyond any taxation that they pay to the ATO.

There is the an additional problem that has dogged the ALP over the last few years. Simply declaring a new tax doesn’t actually guarantee the revenue. This is how Andrew Leigh describes the issue:

Yet one of the most disturbing decisions of the government has been to keep a $700 million tax break to multinational companies. In government, Labor’s economic team – particularly former Assistant Treasurer David Bradbury – took careful measures to ensure that multinationals paid their fair share of tax.

Well – okay. But how does the current government explain its decision?

The Coalition will not proceed with Labor’s proposal to deny deductions made under section 25-90 of the Income Tax Assessment Act 1997 because the revenue is essentially unrealisable and it would impose unreasonable compliance costs on Australian businesses.

So the current government doesn’t think the proposal would actually raise the revenue.

If true this was going to be another mining tax debacle. Remember there too the ALP (and its allies) argued that taxes were not being paid essentially by foreigners. At some point the political classes will have to learn that verballing foreigners may be cheap politics but is economically expensive.

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20 Responses to Fleecing foreigners or blood from a stone?

  1. Jock

    As an initial thought, and someone who has dealt with foreign companies in finance planning, it is notable that in the UK, and despite the political moaning and backstabbing, Starbucks , Google etc had not only complied with the law, they had gone to the trouble of putting their structures before HMRC and obtaining what would be tax rulings here. It seems every country wants its fair share, but the point of a competitive tax regime is to be the beneficiary of the business and the employment it brings. If you are a high tax regime then it is likely that, to the extent laws allow, little real income or capital will be kept in your regime to tax. The UK is right next door to Ireland with a lower corporate tax regime. But the UK can hardly call foul when it is loudly calling on rich Frenchmen to defect to Britain to avoid a 75% tax regime in France.

  2. Rabz

    There are several tricks that multinational firms use to shift profits out of Australia and into low-tax jurisdictions.

    Yes, Andy – they do this because they are rational actors and not embarrassing, barking mad clowns such as your good self.

  3. Rabz

    Simply declaring a new tax doesn’t actually guarantee the revenue.

    A certain pack of incompetent idiots learned that lesson the hard way, didn’t they, Goose?

  4. Percy

    Not sure they’ve learnt the lesson Rabz, no matter that it got taught to them good and hard

  5. Rabz

    True, Percy.

    They will have learnt nothing from that little lesson.

  6. Notafan

    I thought companies came to Australia in the expectation of making a profit (though some seem to be here for government handouts) not as Australian benevolent societies.
    Australia has a right to tax those profits and an obligation to ensure that the amount of profit is not artifically reduced by arrangements that mask the economic realities.
    If they have borrowed to fund Aus investments fine, but if they are paying over market interest in non arms length transactions that is another thing.
    Australia does offer a few things that make it more attractive as an investment destination than say, Venezeula ?

  7. Myrddin Seren

    “At some point the political classes will have to learn that verballing foreigners may be cheap politics but is economically expensive.”

    I live in NSW – Australia’s third biggest mining state, and rapidly going backwards.

    Most of the political class of all shades of the spectrum have gained no real life experience past student politics.

    Mining, smelting, refining – anything of scale just has to be swept into the Forgettery as soon as possible because it creates bad press from the ABC, SBS and Fairfax Media; unhappy Doctor’s Wives at branch meetings; and a flow of letters of complaint.

    The loss of jobs, earnings and revenues – oh well, problem for another day.

    The trouble with NSW and similar developed economies is that we aren’t broke enough yet for the political classes to be slapped in the face with the cost of their increasing disconnect. They pay no price when the real economy is thrown onto the funeral pyre. And it is thus never a bad day to stick to The Furriners.

    Until that changes – we will march backwards, like one commentator pointed out yesterday from the ABS stats.

  8. Verballing foreigners is not confined to Labor. There are Liberals who think every foreign owned company is engaging in transfer pricing.

    None of them seem to understand the point that none of this would matter if Australia’s taxes weren’t so high.

  9. Tel

    The trouble with NSW and similar developed economies is that we aren’t broke enough yet for the political classes to be slapped in the face with the cost of their increasing disconnect.

    That’s why I hope people pay attention to what happened in Detroit before it happens here.

    I expect more parts of the USA will run into similar problems…

  10. Rob MW

    David – “Verballing foreigners is not confined to Labor. There are Liberals who think every foreign owned company is engaging in transfer pricing.
    None of them seem to understand the point that none of this would matter if Australia’s taxes weren’t so high.”

    Spot on David. The verballing of business is not confined to foreigners. The law making aristocracy on both sides of the sandpit just love impractical academia justifying all sorts of domestic business verballing that, in often cases, form the ultimate surrogates of ‘Collectivism’. It is that brazen that they don’t even crack a smile while doing the tuga-jig-gig.

    It’s a real pity that you won’t be seated in time to hear the most notable ‘Prescribed’ collective put through their paces and justifying why Government intervention, on behalf of businesses that they have no knowledge of and yet they know best for (big-people’s nannies), is the gold medal of government policy. Your input would have been a breath of fresh air.

    Without boring Cat readers, there is some anti-nanny reading on this over HERE

  11. Thankfully, that particular loophole is closed

    Oh yes. Thank goodness. Or else people might have been making money.

    I love this blog, because when I read articles like Leigh’s, I am dazzled and thrilled by the sheer ingenuity of the human mind, and the way in which human beings can find a way around almost anything.

    Even Andrew Leigh.

  12. Mick

    I must be missing something, because to me there is a big difference between a million dollar paper clip and a million dollar loan. One is not going to pay for additional domestic infrastructure , create extra jobs and earn any extra income, the other ceratinly can.

  13. Token

    There are several tricks that multinational firms use to shift profits out of Australia and into low-tax jurisdictions

    After years of the ATO clamping down on the practice, this process is not as common as the INTELLECTUALLY LAZY Leigh claims.

  14. 2dogs

    there is no good reason why foreign firms should be excluded from the same business and taxation rules that domestic firms face

    But they are excluded. During the GFC, Rudd reduced the tax that foreigners paid on Australian interest, down to 10% in some cases.

  15. I am the Walrus, koo koo k'choo

    Andrew Leigh getting Jessica Irvine to write his op-ed pieces LOL.

    The only danger in this is that some innocent reader might think they might have an idea about what they are writing about.

  16. Andrew

    To these people, even if the tax raised NOTHING (like the RSPT) AND repelled job-creating investment (like the MRRT), it did its job. It’s to show your owners in the union movement, and some low-information Fewfacts-reading voters (but I repeat myself) that unlike Abbott666 you hate the people that employ them.

    To these people, the MRRT was a great reform. Don’t take my word for it:

    A tax which raises nothing AND is still a great achievement? It can ONLY be for its role in advancing the politics of hate and envy. And you’ll probably find if you ran a plebiscite, most people would vote for it.

  17. .

    They use transfer pricing? So what?

    Care to name a member of Parliament who does not minimise their taxes and maximise their expense account?

  18. Gab

    Is transfer pricing illegal in this country?

  19. Casey

    What Andrew Leigh says is fairly shallow. If he had more commercial experience, rather than just academic experience and political religion, he would know a lot more about the practical problems of enforcing thin capitalization type tax laws. But, that aside, it is interesting to see him trying to “muscle-up” on some economic issues. Maybe he will make it on the big stage, but he needs to pick better topics.

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