By Catherine Magelssen and Ioannis Ioannou
The issue of corporate tax avoidance is often discussed in relative isolation, without really considering the efficiency and effectiveness those funds are used by governments or by the tax avoiding corporates. What “fair taxation” is, of course, may well be a philosophical discussion. Yet the recent EU decision about Apple’s tax ruling raises a number of questions that, in our view, have ramifications well beyond the domain of tax avoidance and competitiveness. These questions remain by and large unanswered in public discourse and hence, reveal large gaps in our broader understanding of tax policy and its societal implications.
First and foremost, we must ask ourselves whether we are overlooking the firm itself? For a complete understanding, we must consider the firm as a whole, as well as the multiple political environments surrounding it. Tax avoidance is an international issue, and as such it is not independent of politics. On the international stage, we are seeing a battle emerge between countries and institutions over the taxable income for multinationals. In terms of its current tax structure, both Ireland and the United States are contesting the EU ruling as a unilateral decision that affronts the multilateral efforts made by global countries to revise the international tax system.
Over the past three years, countries have participated in a multilateral effort to revise the international tax system through the OECD Base Erosion Profit Shifting Project. The ruling by the EU single handedly imposes a tax, counter to the existing international tax system and calling into question international tax treaties. In this political battle, it is easy to lose sight of the actual worldwide taxes paid by firms. In fact, Apple is one of the largest tax payers in the world. Between 2003 and 2014, Apple paid $63.5 billion in taxes, reflecting an average corporate effective tax rate of 26.1%. Apple’s tax bill in 2015 alone was $19.1 billion, which is larger than the GDP of 82 different countries. Looking at the firm as a whole, can put into perspective the true extent to which firms are engaging in tax avoidance.
Second where is value being created? The EU has suggested that European countries can try to claim some of the €13 billion tax assessment - presumably for sales of Apple products in their local jurisdictions. If we believe that profits should be located where value is created, two key questions arise: (1) what are the value generating activities in the business, and (2) where are they located? Apple customers presumably buy the products because of the design and technology, not because a friendly sales person sells them. Nearly all of Apple’s R&D is conducted in the US, which implies that profits should be associated with the US, not the EU member states. It is therefore no surprise that the US is taking action to contest the EU’s decision as it jeopardizes the taxable income for the US. For countries without value creating activities, another key policy question that arises is how to foster such activities by multinational firms in their local jurisdiction?
Third, it seems to us that the issue of taxation should be assessed in conjunction with a firm’s overall societal impacts, both the positives as well as the negatives. Although some may argue that measurement of such total value creation is problematic, and that any discretion allowed in tax policy may eventually be abused by opportunists, the fact remains that some firms are better corporate citizens than others. In this sense, from a societal point of view, there is a strong argument to be made for recognizing, rewarding and even incentivizing socially beneficial corporate behaviors through smart tax policy.
Importantly, the measurement of corporate impacts in environmental and social domains may not be as problematic as some might think. This type of measurement has tremendously improved in recent years; environmental, social and governance (ESG) data are becoming increasingly more reliable, and are already used in public and private equity markets to make investment decisions. Companies around the world are rated and ranked based on such non-financial and non-traditional metrics of performance. Moreover, organizations such as SASB and the GRI, are diligently working towards establishing global reporting and auditing standards for ESG metrics.
Measurement of corporate societal impacts and a broader understanding of value creation - beyond profitability metrics - is on course to become as credible and reliable as financial reporting. Apple is globally recognized as a leader of environmental responsibility with respect to its products, its operations and its massive supply chain. Hence, from a societal point of view, it is hard to argue against incorporating such metrics into a smart tax policy which promotes corporate transparency, responsibility and accountability.
It is for the courts to decide whether the EU’s decision on Apple is right or wrong. What we want to underline in this blog is that any discussion about tax policy (and by extension, tax avoidance) should be smarter and more comprehensive. In many respects, tax rates, as numbers, are meaningless unless first, the firm as a whole is taken into account, second, global politics, against which context tax policy is set, are deeply understood, and third, the totality of societal impacts of a corporate are taken into account.
In recent days, public discourse on tax avoidance in light of the Apple case has been partial, at best. There is no question that incomplete information and partial or politically biased discussions inevitably lead to bad policies, and eventually to decision-making that fails to generate the most beneficial societal outcomes possible.
Catherine Magelssen, Assistant Professor of Strategy and Entrepreneurship and Ioannis Ioannou, Associate Professor of Strategy and Entrepreneurship, London Business School.
