07 Jun Government taxes, industry policy and the increasing relevance of ICT
Recent noise from the current federal government on various topics is increasingly seen as just that…noise. But that doesn’t mean that some of it is not without relevance and will become more so in the coming years.
I am referring to the discussion on tax minimisation by large corporates and in particular global tech corporates. It is a topic being discussed amongst all major western nations. This includes Australia, the UK and the USA where these tech corporates achieve solid revenue yet are alleged to pay just a fraction of tax in comparison to what would be their apparent profits. Of course their real profits are a lot less than their apparent profits, hence their ability to pay reduced tax.
One way they can achieve these lower real profits is through having to pay for the intellectual property that their products and services utilise. Local expenses include payments for this intellectual property, which is paid to the overseas owner of this intellectual property. The overseas owner of the intellectual property is an overseas entity of the same global corporate, and could reside in a lower taxing nation. Hence, via these payments, which are effectively an internal trading mechanism, they lower their profits in higher taxing nations and increase their profits in low taxing nations achieving a net global tax reduction.
This is not a new concept. It has been used for as long as I have understood such things, and probably a lot longer than that. For instance, Ireland became a hub for a lot of software development activities through the early to mid ’90s. This was due to Ireland’s tax and industry development policies, supporting its plans to grow its local software development industry. Many global, or global aspiring companies took advantage and started building offshore software and intellectual property development capability out of Ireland at that time. This dynamic remains in play today.
What is changing however is the increasing reliance on intellectual property in our everyday lives, reflected via the increasing revenues of companies providing technology products and services. And these companies are now becoming the biggest companies in the world, and have the ability be as innovative with their tax practices as they do with their products and services.
It is a natural role for government to want to protect their revenue base, and perhaps natural from some sides of politics to kick those who are successful, but this ignores the real issues.
Senator John McCain, one time Presidential nominee asked a very valid question of Apple CEO Tim Cook, at a senate committee hearing last month on this very issue, asking “couldn’t one draw the conclusion that you and Apple have an unfair advantage over domestic based corporations and companies, in other words, smaller companies in this country that don’t have the same ability that you do to locate in Ireland or other countries overseas?”
If it does, and I think the answer is obvious, then this issue has implications beyond tax receipts, with implications for those who want an industry policy that support innovation, supports new entrants, by lowering economy of scale impacts, and lowering barriers for growth.
For instance, if a start up is forced to pay 30c in the dollar in tax, and its competitors pay 10c in the dollar, that is an extra 20c in the dollar that can be reinvested into RnD, into marketing, into customer service, and into investor returns, thus attracting more clients and more investors. The formula is simple. The start up has a steeper climb ahead.
The ability for some nations to produce tax policies which attract investment or industry development is not a new phenomena. Michael Porter published The Competitive Advantage of Nations in 1990. In my view this should form compulsory reading for all politicians.
This point seems to be getting missed in the current debate about whether these corporates pay their fair share. In Australia, it is common practice for states to compete for the attraction of head offices through the application of state tax policy, such as payroll tax. Yet, we seem to have forgotten that as a nation, we too compete with other nations, for our share of industry.
And in a world where the global value of technology based products and services are increasing, and where intellectual property forms a larger and larger share of these products and services, then the opportunity to move profits based on internal trading of intellectual property will only increase.
The question for government becomes less one of how do we punish corporates that are successful in navigating the existing regime (although that will always be an easy political play), to how do we construct a tax regime which caters for this new reality.
The new reality is that Intellectual Property has increasing commercial value and importance. And the ability a nation has to create conditions that encourage local development and retention of intellectual property will define its global advantage. Australian government policies have never been good at reflecting this understanding.
What they will understand is that tax revenues will come under more pressure as profit based taxes perform poorly. This will also distort the tax take between those with the means for international structuring from those that do not or cannot structure this way.
This bodes well for increasing the scope and rate for transactional taxes such as the GST to restore both equality and equity to the tax take. And hence rely less on profit based taxes as a result.
Protecting the revenue base is a defensive reaction of the type we are used to our politicians taking. So the above shift in tax policy is a certainty in the next decade.
Taking a proactive leadership role in repositioning industry policy to attract intellectual property development and exploitation is a whole other story. Yet, proactive leadership is what is required in an age when information and communications technology (ICT) is moving rapidly and creating industry and community change just as rapidly.
There are enough corporate corpses over the past few decades to show that being proactive and not reactive to these ICT driven changes is the only thing that gives a shot at survival.
It is this need to take proactive leadership by our politicians that will be a big test for Australia. Lets see how the next 10 years goes.