Legal reform is sole weapon in war against tax avoidance

Barack Obama’s belated crackdown on inversions reflects a fundamental truth in the perennial controversy over corporate tax avoidance and disquiet this week over the Panama leak. No matter what way you look at it, the solution (or otherwise) is in the hands of lawmakers.

The catalyst for the White House intervention was Pfizer’s audacious attempt to recast itself as an Irish organisation, for tax purposes, via a $160 billion (€140 billion) merger with Dublin-based Allergan. This mammoth scheme was but the latest in a long line of Irish inversions but its very scale – and the resulting political backdraft, in the year of a presidential election campaign – led to the US president’s move to make inversions much less attractive.

Certain non-US groups are displeased. Yet the manoeuvre marks a rare deployment of political power in Washington to subvert excessive tax ploys.

Washington rules

This is crucial, for the US itself and American business groups are at the very epicentre of the global corporate tax debate. True, Ireland continually pops up in international headlines. But such headlines invariably relate to the activities of US firms and, as the inversion affair shows, whatever they do here relates as much to tax rules set in Washington as in Dublin. The same goes for the activities of US groups in Britain, which is reducing its corporate tax rate, and any other international market you might care to mention.

When it comes to American firms, the US code is on the flip side of any elaborate strategem in other jurisdictions – onshore or offshore – to cut the tax due on profits. Inversions are spectacular, but they’re only one kind of scheme among many. Remember, inversions take place in the open because public action is required to elicit shareholder approval for a change of headquarters. Most other schemes are executed in the shadows, yet the principles are the same.

More action might have been expected from Obama. When he won the 2008 election, he set out plans in his manifesto to make it a good deal more difficult for American firms to shelter overseas profits from the US tax authority and to incentivise job creation in the US. The aim was to boost public finances and stimulate economic activity on the ground, all of it in keeping with an effort to reverse the downside in the US from globalisation.

All very straightforward, but deceptively so. Nothing much seemed to happen. There was plenty of handwringing in public debate, plenty of finger-jabbing and plenty of political noise about the Irish tax regime, but not a whole pile of action.

The file is in the command of the Organisation for Economic Co-operation and Development in Paris, which received a global mandate three years ago to develop a plan to curtail base erosion and profit shifting by big firms. Yet this remains a work in progress.

Last year, the Republican leaders of the two tax-writing committees in the US Congress wrote to treasury secretary Jacob Lew saying they were troubled by the Obama administration’s response to the OECD.This cuts to the core of the matter, for political gridlock in Washington greatly limits the scope of any overhaul of the US corporate tax code and all that flows from it.

The political dimension is crucial, and is subject to change. It was before a committee of the US Congress that the most exotic elements of Apple’s tax arrangements in Ireland became public. In the furore that followed, Dublin moved to eliminate a kink in Irish law which enabled a large part of the Apple empire to declare itself “stateless” for tax purposes.

US-EU tensions

The affair ultimately led to a long state-aid inquiry by the European Commission, under way for years without any sign of closure. Dublin insists everything was always in order, and so too does Apple. In January the affair took a new twist when a senate committee called for penalty taxes in the US against European companies if the commission directs Apple to pay back-taxes in Ireland. That this came on top of complaints by the US treasury about the conduct of the inquiry points to high tension between Washington and Brussels.

This is the prism through which the Panama disclosures can be viewed. At issue, as Obama noted, is the fact many of the shady offshore activities are wholly legal. It is clear only lawmakers have the power to do anything. But whether they rise to the challenge is another matter.