Multinational enterprises, financial centres and their implications for external imbalances: a euro area perspective
Published as part of the ECB Economic Bulletin, Issue 2/2020.
This article analyses how the operations of large multinational enterprises (MNEs) affect the external account of the euro area and, in general, financial centres. The increased ease of moving intangible assets, profits and headquarters across borders poses challenges to the current framework of international statistics and economic analysis. First, the article shows how MNE operations are recorded in cross-border statistics, as well as the challenges in measuring such data. Second, the article highlights evidence of the impact that MNEs have on the external account of the euro area – this is most evident in current account balances and foreign direct investment in euro area financial centres, often involving special-purpose entities (SPEs). Third, the article looks at the tendency of financial centres to report current account surpluses that may be tentatively attributed, in part, to the activity of MNEs. Multilateral initiatives could help to improve the transparency of MNE operations and ensure an exchange of information across borders for statistical and tax purposes.
1 Introduction
The rise of large, profitable, global firms and the mobility of intangible assets[1] have increased the relevance of firms’ profit-shifting activities, posing challenges to the current framework of international statistics. The balance sheets of large multinational enterprises (MNEs)[2] have become very sizeable. The assets of the largest listed companies in major advanced economies, amounting to a value of several hundred billions of US dollars, are roughly equal to the gross domestic product of many small open economies. In order to reduce their tax burden, MNEs carry out a range of activities: these include shifting profits to low-tax jurisdictions by manipulating transfer pricing[3] and shifting intra-company positions – often this involves complex financial structures and the creation of SPEs in low-tax, or no-tax, jurisdictions. These activities are extremely difficult to track. The novelty of some activities – in particular the growth in intellectual property products and improved opportunities to strategically choose their location – poses significant challenges for the existing framework of national and international statistics, which is based on the concept of residence[4].
International tax avoidance by MNEs is not a novel phenomenon but its rapid growth increasingly attracts the attention of academics and policy makers.[5] Global firms respond to tax incentives when recording worldwide income among affiliates. A recent survey of this literature finds that a decrease by one percentage point in the statutory corporate tax rate translates into a 1% expansion of before-tax income for global firms.[6] Importantly, this study shows that the estimated impact appears to be increasing over time. Transfer pricing and licensing seem to be the main channels of tax avoidance – these appear to be more important than financial planning.[7] International taxation may also alter the geography of foreign direct investment (FDI): a higher statutory tax rate in a target investment country discourages the acquisition of firms in that country, while lower tax burdens may attract FDI related to profit-shifting activities.[8] Another area of research focuses on the implications of these tax-avoidance activities for the measurement of the external wealth of nations and the diminished ability of governments when it comes to taxing the corporate profits of global firms.[9]
A number of policy initiatives at the international level have been launched to counteract the intensification of tax avoidance. The Organisation for Economic Co-operation and Development (OECD) estimates that 240 billion US dollars in tax revenues are lost globally every year as a result of tax avoidance by MNEs. As a result, the OECD and the G20 sponsored the Base Erosion and Profit Shifting (BEPS) Project, including an action plan that identifies 15 actions intended to limit international tax avoidance.[10] This initiative currently involves over 135 countries, including the European Union (EU) Member States. The EU built on the BEPS Project’s recommendations by adopting two Anti-Tax Avoidance Directives, which entered into force between 2019 and 2020. The EU reform package includes concrete measures to reduce tax avoidance, boost tax transparency and move towards a level playing field for all businesses in the EU, but also new requirements for MNE financial reporting (see Box 1).[11]
Box 1 Tax avoidance and transparency: policy initiatives at the international and EU level
At the international level, the OECD, with the support of the G20, championed work on limiting tax avoidance. The OECD/G20 BEPS Project, finalised in 2015, proposes measures to reduce tax avoidance; it also includes new requirements for MNE financial reporting, in particular for country-by-country reporting by 2025. Many of the recommendations of the OECD/G20 BEPS Project have been transposed at the EU level via the European Commission’s broad Anti-Tax Avoidance Package.[12] This package also includes the revision of the Administrative Cooperation Directive, proposing country-by-country reporting between Member States' tax authorities on key tax-related information concerning multinationals operating in the EU.
Statistical compilers need to closely cooperate internationally to ensure that MNE activities are recorded consistently from country to country. This means that they have to share confidential data on MNEs and their subsidiaries across borders. The GNI pilot project, launched by the European Statistical System Committee in 2018, takes steps in this direction; it aims to jointly assess the consistency of statistical recording among national statistical authorities, using a sample of 25 MNEs in Europe.
Moreover, some national statistical authorities have set up large case units to monitor the activities of MNEs nationally. However, no formal coordination exists yet at the international level. Further development of legal entity identifiers and business registers would also be instrumental in improving national accounts and b.o.p. statistics.[13]
The traces of MNE operations are particularly apparent in the external statistics of financial centres. Since the euro area hosts some significant financial centres, this article discusses the dynamics of their external accounts. We adopt a standard operational definition of financial centres on the basis of the size of their stock of foreign liabilities relative to GDP. These are therefore economies where financial activities tend to dominate domestic economic activity. In particular, financial centres are defined as the ten advanced economies with the largest ratios of foreign liabilities to GDP in a large sample of more than 60 countries. These ten financial centres include six euro area economies (Belgium, Cyprus, Ireland, Luxembourg, Malta and the Netherlands) and four non-euro area economies (Hong Kong SAR, Singapore, Switzerland and the United Kingdom).[14] Chart 1 shows the ratio of foreign liabilities to GDP for three groups of countries: advanced economies (excluding financial centres), financial centres and emerging market economies. In contrast to the effect it had on other advanced economies, the global financial crisis in 2008 does not appear to have dented the rise in the international financial integration of financial centres. In financial centres the median value of foreign liabilities increased, from around seven times GDP before the global financial crisis, to almost 11 times GDP at the end