February 21, 2015

10 reasons managers choose not to invest in a country

There are a number of good business reasons why companies choose to invest or not invest in a particular jurisdiction. These include the usual suspects, ranging from market potential to the regulatory framework. But there are also more personal reasons a manager may choose to invest or not invest in a jurisdiction and we generally don't understand the influence of managerial self-interests well enough.
Andreas Schotter (Thunderbird School of Global Management, U.S.) and Paul Beamish (Ivey Business School, Canada) have identified the following personal considerations, hassle factors, that research shows result in managerial location shunning.
Lodewijk Gelauff, Luxor Hassle Free / cc

1. Local transportation standards and availability

Transportation is critical for many companies to be able to conduct their business. The standards and availability of transportation in a country also impact a manager's experience in the country. When I was trying to establish Kijani Energy in Mozambique and Pakistan, it became clear that I couldn't rely on public transport to meet my needs. We were lucky to have local employees and business partners to drive us around, or our business aspirations might have been dead on arrival.

2. Climate

The authors found the overall pleasantness or unpleasantness of a jurisdiction to influence managerial decision-making. As expected, managers are less likely to find the prospect of spending a significant amount of time in a jurisdiction with unpleasant climate.

3. Business facilitation

Most of us expect our meetings to start and end on time. In many parts of the world, this just doesn't happen. I remember a meeting I had with the then Chairman of Pakistan Agricultural Research Council to discuss our biodiesel project. The one-hour meeting was supposed to begin at 10 AM. I wasn't invited into his office until 10:30 AM; he was constantly interrupted by visitors and phone calls that he picked up without any hesitation; a break was taken for lunch and then for afternoon tea. It was 4 PM before I was finally done. I got everything I was looking for, but it also took every ounce of patience in me, and more.
The difficulty in getting things done, or at least getting them done on time, in certain countries is a common complaint of tax directors I work with. Sometimes, the market opportunity is big enough that a manager may put up with the hassle of different business conduct norms--but that market opportunity needs to be big enough.

4. Health risks and medical standards

The authors found the health hazards of a particular jurisdiction, especially the food and water hygiene standards, have a significant impact on a manager's perception of the jurisdiction. Countries with high health risks (and low medical standards) are known to suffer from lack of tourism, but they also have a harder time attracting business travelers.

5. Risks for female executives

In a number of countries around the world, female executives are still not the norm and often face discrimination, even outright insubordination, and that can impact a manager's perception of a jurisdiction's attractiveness. It is well-known that participation of women in the boardrooms and c-suites results in better decision-making; it apparently also influences a jurisdiction's attractiveness for foreign businesses looking to invest.

6. Personal safety risk

A multinational company I know invested in Pakistan and the tax director had to travel to Islamabad to attend some meetings in 2008 a few weeks after theIslamabad Marriott Hotel bombing. The arrangements made by the local subsidiary for his safety included renting a non-descript house in a residential area and a bulletproof car. The tax director was extremely concerned about traveling to Pakistan and did everything in his power to get out of these meetings.
Is Pakistan so unsafe that foreign multinationals cannot conduct business in the country? Likely not. But the perception of personal safety, or lack thereof, greatly reduces the chances that Pakistan would rank particularly highly on any executive's list of jurisdictions for investment.

7. Visa and entry permits

As a Canadian, I have become used to of traveling often without even thinking about whether I need to get a visa. For most people, however, it isn't as simple. And it turns out that the hassle of getting visas often becomes a reason an executive might refuse to consider a country for investment.

8. Telecommunication access and standards

For the plugged-in executive of today, access to high-speed internet and cellular phone service is critical when traveling--unless you are going on vacation to Cuba to unplug and disconnect from the rest of the world. I believe as businesses begin to rely more and more on cloud computing, the need for telecommunication access will become an important business factor when considering jurisdictions for investment.

9. Business hotel standards

If you must travel for work, it better be comfortable. And the authors of the abovementioned study found that managers do consider their comfort when making investment location decisions and availability of 3-star or higher hotels near the business location becomes an important factor in managerial decision-making.

10. Language

Lastly, even if the business is a multinational that aims to work in all jurisdictions, and even if the product or service being sold does not require the use of English language, I have yet to see a Canadian multinational employ managerial-level staff in its foreign subsidiaries that wasn't conversant in English or French. So it isn't surprising to me that an executive would consider the ability to hire English-speaking managerial staff in a country before investing.
These hassle factors may be viewed as ways managerial decision-making deviates from what is optimal for the firm. In my opinion, these hassle factors need to be explicitly considered in making investment location decisions. Even if these hassle factors don't predict the success of the business, the cost of sacrificed happiness, motivation and engagement of the managers involved needs to be taken into account.
Disclaimer: I wrote this article in my personal capacity. The views expressed are my own and do not necessarily represent the views of any organization that I am affiliated with.

February 6, 2015

The great Canadian tax dodge

Tax has become fashionable. From the OECD and G20, to national newspapers, and now film and documentary producers--everyone seems to have something to say about the tax practices of multinational firms.

The Connaught Building in Ottawa / CC
On February 4, TVO aired the documentary "The Great Canadian Tax Dodge"now available on the TVO website.
Here is what I think about the documentary:
Lacking in balance
The hour long documentary started off fairly balanced, with views of both the Tax Justice Network and lawyers like Al Meghji (who is rightly introduced as the Wayne Gretzky of tax lawyers). However, it quickly takes on a very conspiratorial undertone and goes as far as to suggest that the Canadian government, the Tax Court of Canada, the Supreme Court of Canada, and even the Canada Revenue Agency are somehow complicit in facilitating corporate tax avoidance.
The conspiratorial tone is unhelpful, even for a documentary that is produced to explore the birth of the tax fairness movement in Canada. The implied colluding between the Supreme Court of Canada and the corporate interests is overreaching without any facts to support the supposition (see 39:50 mark of the documentary). It is true that the Supreme Court of Canada has disproportionately sided with the taxpayer on tax avoidance cases. However, the job of both the SCC and the lower courts, including the Tax Court of Canada, is to interpret the law and to apply it correctly. As Al Meghji noted, the courts have done just that.
Focused on only a part of the issue
I don't disagree that corporations engage in at least some tax avoidance. Some more than others. And they are allowed to do that under the Westminster Principle. However, the real issue that needs to be considered is not that corporations choose to take advantage of laws as they exist to structure their affairs in a manner most advantageous to them, but that the laws exist in the first place. The alleged loopholes were, for the most part, created to provide certain advantages to Canadian companies. If the reason a loophole was created is no longer applicable and the loophole no longer advantageous to Canadians, then it should be closed down.
No one seems to have considered whether the loopholes designed to help Canadians actually do continue to help Canadians. Prof. Walid Hejazi of the Rotman School of Business was quoted in the documentary, testifying in front of the Senate, saying that ability to reduce taxes is actually good for the Canadian economy. Elsewhere, Prof. Hejazi also hypothesizes that this tax avoidance by Canadian multinationals is beneficial for Canadian shareholders. This needs to be explored further and this research would add a lot more nuance to the tax fairness debate.
Too focused on an uncertain notion of morality
What is moral and immoral in taxation? As Al Meghji stated in the documentary, the allegation of immorality is not warranted. Every individual has the right to structure their affairs in a manner that saves them money, but for corporations we expect that they will do the opposite. If anything, it could be argued, a corporation that chooses to not take advantage of tax reduction strategies legally available to it, is a corporation failing in its fiduciary duty to its shareholders.
Naive in its approach
Despite being a tax practitioner, I believe the Tax Justice Network is a phenomenal organization that provides some of the checks and balances that we need in any system. However, the Tax Justice Network has a very clear bias and their research and publications would be geared at meeting very specific objectives. In this case, the activists who believe in the great Canadian tax dodge would argue that simply turning off the tap on tax avoidance would result in a $100 billion increase in tax revenues for the Canadian government. While revenues are likely to go up in the short-term, there is a plethora of academic research that suggests a decrease in investments would follow an increase in tax rates (or effective tax rates given inability to take advantages of tax planning). So that $100 billion, over time, is likely to be fairly close to zero.
Concluding thoughts
The increased focus on tax practices of multinational firms is here to stay. We have an increasingly activist population and for the first time in history, large swaths of financial and business information publicly available to anyone with access to the Internet. It is easier than ever to compare, contrast and analyze this information for a wide variety of companies and draw inferences.
So tax practitioners and corporations need to be more vigilant in ensuring they comply with the laws, more diligent in protecting reputation, and more transparent than ever before to help the public draw the correct inferences.

January 26, 2015

Restrictions on intercompany debt reduce investment

The recent OECD paper on BEPS Action Plan 4 focuses on intercompany debt and aims to make sweeping changes to how companies finance their global operations. A key aspect of the draft recommendations is restrictions on intercompany debt--whether it is in the form of thin capitalization rules or other group-rules. And while there might be some validity to OECD's assertion that multinational groups can use intercompany debt as a tax avoidance mechanism (not tax evasion), what is missing from the debate is the impact of proposed restrictions on intercompany debt on foreign investment.

Photo Credit: Lendingmemo.com via Creative Commons

Studies have shown that an increase in effective tax rates of a country reduces investment inflows to the country. More on point, a number of studies show that restrictions on intercompany debt via thin capitalization rules directly affect investment inflows. For example, Buttner, Overesh, Schreiber and Wamserundertook a detailed study of investments into OECD and other European countries over the period between 1996 and 2004. They found that introduction of a thin capitalization rule restricting the amount of intercompany debt is associated with a decline in investment by approximately five percent. Their results are confirmed by a number of other studies as well.
A five percent decrease in investment is significant, but it appears that the OECD members keen on curbing base erosion have not considered the knock-on effects on their economies of these restrictive measures. A global implementation of OECD proposals will likely even the playing field--but that's too ambitious a goal to be realistic. In the mean time, I am looking forward to the public comments on the draft proposals by OECD to see whether the business community shares my concerns.

November 3, 2014

Sovereign reputation and investment location decisions

A question came up at a roundtable discussion I led recently with tax directors of a handful of multinational firms: if your advisor came to you with a tax plan that included a tax haven in the structure, would you consider it?

The answer was an astounding no as almost all of the dozen or so tax directors in the room shook their heads in unison. Given the current environment, setting up a tax structure centred around prominent tax havens was considered a non-starter. Way too BEPSy!

And that got me thinking about sovereign reputation. We normally think about sovereign reputation in terms of debt and credit ratings, but does sovereign reputation impact multinational firms' investment location decisions?

Luxembourg. Photo by Wolfgang Staudt / CC
I believe that sovereign reputation does have an impact on investment location decisions. All else being equal, I expect that a multinational will choose to avoid a jurisdiction that is known for facilitating behaviour that the European Commission and others might find unacceptable.

It is no secret that a tax auditor is likely to take a harder look at your file if your company has a lot of intercompany dealings with tiny Caribbean islands. This isn't to say that having presence on tiny Caribbean islands is by itself problematic-- it is just expected to draw scrutiny. Some countries have taken the extreme step of publishing blacklists of tax haven countries, dealings with which draw extra scrutiny or even taxation of income earned in those tax haven countries. And now with the European Commission publishing its opening decisions in state aid investigations of Ireland and Luxembourg, one can't help but wonder whether these jurisdictions are now, somehow, tainted because of these decisions.

The focus of these state aid investigations has been rulings and agreements between the state and the taxpayers that provided selective advantages or individual concessions to a taxpayer. (You can find more on State aid here; it isn't the point of this post.) These state aid investigations also come at the same time as the OECD proposals on greater transparency and recommendations for disclosure requirements on such rulings and agreements as a part of the transfer pricing documentation master file. I expect that a tax auditor looking at your transfer pricing documentation in a couple of years would know whether you had special rulings and agreements in certain "tainted" jurisdictions, resulting in prolonged, more painful audits. And my hypothesis is that all else being equal, a tax director is likely to avoid these jurisdictions due to this risk of prolonged, more painful audits.

It is therefore no surprise that Ireland has so quickly taken steps to remove the provisions that allowed for Double Irish structures. It isn't just the EU investigations and possible sanctions that motivated Ireland in my view; it is the fear that if Ireland as a jurisdiction becomes tainted, that on its own will drive away foreign investment. That doesn't mean that Ireland will cease to provide incentives for multinationals to locate there, because its economy is dependent on that kind of foreign investment. So Ireland has now focused its attention on patent box regimes, which are likely considered a less risky proposition because larger and more reputable islands like the UK have also introduced such regimes.

Others will follow Ireland's example. The economies of Ireland and Luxembourg are so dependent on activities of the multinational firms that they can't afford to lose them completely. Hence they will find new and creative (and sometimes not so creative) ways to retain their advantage, and their reputation.

In the mean time, if you have operations in jurisdictions with tainted reputations, you should have a plan B in mind.

October 19, 2014

Why is transfer pricing inherently an art?

On a recent episode of the popular TV show, The Good Wife, the main character Alicia Florrick (played by Julianna Margulies) states that she was drawn to the legal profession because the rules meant right and wrong was clear. Being a lawyer afforded her clarity and helped her understand right from wrong without ambiguity.

I like clarity. I like rules that tell me what’s right and what’s wrong. (…) I just wanted to be inside something made sense to me.” (Alicia Florrick, The Good Wife – Season 4, Episode 6)

And while I don’t agree the law is as black and white as Alicia would like to believe, I enjoy transfer pricing precisely because there is no black and white. There is almost never one answer. The right answer is almost always in a range of possibilities. My instinctive first response to most clients when they ask me a seemingly straightforward question is “it depends.”

October 7, 2014

Reputation and corporate taxation

When I started working in transfer pricing, it was rare to find anyone other than my colleagues who knew what transfer pricing was. It was rarer still to find many references to transfer pricing in the media. There were no TV shows starring tax geeks. No movies that explored the intricacies of international taxation.

But it has all changed now thanks to Starbucks, Apple and Amazon. So much so that a movie premiered at the Toronto International Film Festival this past month, exploring whether corporations are paying their fair share of tax. I haven't yet watched The Price We Pay but I do intend to get to it soon. 

The trouble really started as the world media got a whiff of high tech American multinationals' incredibly low effective tax rates in the international markets. The tech companies were the key culprits, using a mixture of Irish, Dutch and Barbados based tax structures (also known as the Double Irish with a Dutch Sandwich) to make their income disappear, tax less.

September 8, 2014

Does internationalization lead to innovation?

Export promotion programs, like EDC, have historically been based on the assumption that internationalization leads to greater innovation, higher productivity and above-average returns. In a recent article, Bill Currie of Deloitte Canada raised all of these arguments and more to encourage Canadian companies to look beyond their domestic markets. I believe he completely missed the mark.

While the statistical data would show that multinational Canadian companies experience higher growth rates and have higher productivity than their purely domestic peers, this is a case of misidentifying cause and effect. The multinational Canadian companies do

September 1, 2014

Why study the impact of taxation on investment location decisions?

The recent economic downturn and deficit challenges have focused political debate on revenue generation, and specifically corporate taxation, making international tax reform one of the most important areas of discussion on public policy. The Occupy movement, an international protest movement that first gained prominence in 2011 for its protests against the alleged corporate greed on Wall Street, has consistently pointed to the relatively low tax rates paid by large corporations as a prime reason for growing inequality and gap between the rich and the poor in the US and elsewhere around the world. In a recent paper on base erosion and profit shifting, OECD (2013) highlights what it considers the low share of corporate taxation in overall governmental revenues, at less than ten percent. Mandated by the Group of Eight (“G8”), Organisation for Economic Co-operation and Development (“OECD”) has expended a significant amount of effort over the last year in proposing recommendations for fixing what it describes as loopholes and gaps in the international tax system. The work done by OECD over the last year has been unprecedented in its scope, multilateral buy-in and the speed at which it is forging ahead to plug gaps that purportedly result in base erosion and profit shifting.