Several decades ago, the idea of corporate social responsibility (“CSR”) was not entirely acceptedby most corporations or legal scholars. Most scholars today, and many corporations, understand that corporations owe special commitments to their stakeholders in addition to their traditional function of maximizing profits for the benefit of their shareholders. It is also accepted that corporations’ commitments go beyond standard regulatory requirements and that corporations should not disregard their impact and influence over the communities in which they operate. Corporations are viewed as both economic and social entities; they depend upon and compensate shareholders and have complex relationships with stakeholders. Under the nexus of contract approach, the corporation is conceptualized as a nexus of explicit and implicit contractual undertakings towards its stakeholders, which are not limited to the corporation’s stockholders and include its bondholders, executives, employees, suppliers, and customers. As such, “translating” such notions to a CSR regulatory framework requires prioritizing these commitments among the corporation’s stakeholders. Such prioritization is complex for corporations that solely operate domestically; however, such prioritization in the cross-border context for multinational corporations (“MNCs”) can be even more challenging. Our research proposes a general framework for CSR and taxation (“CSRT”) in the cross-border context.
Centuries ago, corporations were viewed as creations of a state, which had the exclusive prerogative to issue the charter of incorporation. Following this concept, corporations were expected to act in furtherance of the specific rights and duties issued by the state.
For instance, Queen Elizabeth established the first two MNCs as early as the 17th century to gain access to East India and develop cross-border commerce between England and the Far East. The English East India Corporation and the Dutch United East India Company were viewed as state organs subject to the English Crown. Therefore, they were expected to fulfill the numerous contractual features and undertakings as specified in their charter of incorporation and, in consideration, were awarded certain benefits, including trade monopoly for 15 years, privileges of purchasing land, pleading in English courts, and more. For such privileges, the corporations undertook regular voyages to India using six ships, to deliver their ships to the English navy in times of war, and to pay customs and duties (following a brief period of tax holidays they received upon incorporation).
However, over the years, the complete subordination relationship between the corporation and the state of incorporation has been significantly relaxed as the old grant/charter system was replaced with a free incorporation system. This movement dramatically changed the state’s role in forming corporations from a monopolistic power approach that views the state as holding power to form corporations to a commodification approach that only requires the state’s recognition and allows the founders to “cherry-pick” among states where to incorporate. This change also led to a “race to the bottom” among states that welcomed it. It often incentivized founders to incorporate corporations under the assumption that such incorporation would benefit them, either by using local professional services providers or paying charges, fees, and taxes. These changes eventually led to the increasing powers MNCs have at the expense of state sovereignty and accelerated the new era of economic globalization we currently live in.
According to the World Trade Organization (also known as the WTO) and the United Nations Conference on Trade and Development (also known as UNCTAD), the value of the world merchandise trade in 2020 was approximately $17.6 trillion. The value of world commercial services trade in 2020 was $5.1 trillion. Therefore, the total value of world trade in goods and services in 2020 was approximately $22.7 trillion, approximately 65% of which was generated by Fortune 1000 companies. The Fortune 1000 companies had combined total revenues of approximately $15 trillion in 2020. Even though a portion of such figures did come from domestic sales or other sources, most of them involved multiple parties from all over the world along the supply chain, so attributing trade value to a single company can be difficult. Based on these numbers, transnational corporations carry on most of the world’s trade, and a significant portion is carried within their multinational corporate network (i.e., inter-company transactions).
This new legal and economic reality has challenged what we know about CSR, mostly under environmental, social, and governance initiatives (“ESG”). For example, decades ago, corporate managers had to choose between the contributions of employing people in factories in the state of incorporation and causing local environmental damages (e.g., pollution) or migrating the corporations’ production to developing countries and reducing local environmental damages. However, under the new global reality, corporations and their managers can no longer disregard the environmental damages their activities may cause wherever they operate and conduct business including in developing countries. This equation may seem relatively straightforward (depending on the country and its environmental laws) but is less straightforward regarding employment conditions and redistribution of wealth among countries. Corporations migrate production and manufacturing operations to developing countries to reduce employment and production costs. To the extent that MNCs are expected to pay an absolute minimum wage globally, such production migration may not be worth it anymore, and possibly deteriorate economic conditions in developing countries.
Clearly, the CSR regulatory framework requires prioritization in establishing the minimal domestic standards for corporate governance, environmental protection, product safety production measures, human rights protection and minimal labor conditions, health, and consumer protection. In our context, the CSR regulatory framework also requires adoption of tax-reporting and liability obligations as such tax obligations are viewed as an integral commitment of good citizenship. Accordingly, while prioritization between these different factors has been challenging for policy makers for corporation that solely operate domestically, such prioritization for MNCs may be even more challenging in the cross-border settings.
In other words, while the CSR regulatory framework has been challenging to define and measure for corporations that operate domestically, implementing such a framework in the global and cross-border setting is even more challenging. In addition to prioritize the different factors, it is challenging because it is also difficult to identify the relevant communities in which the MNCs operate and owe special obligations. Even more so, it is difficult to prioritize the MNCs’ obligations among the relevant communities and whether they are obliged to redistribute wealth more fairly while considering the macro-economic conditions and disparities among the countries they operate and owe special obligations.
Despite such complexities, our recent paper offers a general CSR regulatory framework for taxation. Until several decades ago, executives were expected to engage in strategic tax behavior that would reduce corporate tax payments.Under that assumption, leading executives and corporations have been actively involved in abusive tax shelters, which enabled them to dodge corporate income taxes. The collapse and bankruptcy of Enron in 2001 is one of the best examples of how executives believe/d they are expected to operate. In investigating Enron’s collapse, Congress discovered abusive tax practices, including forming 3,500 domestic and offshore entities (441 in the Cayman Islands alone) and dozens of abusive tax shelters, which enabled it to dodge corporate income taxes. Enron continued to generate tax losses even when it became clear that the company was in trouble and it was unclear to what extent such losses could be used in future years. Also, less than a decade ago, Gabriel Zucman found that approximately 55 percent of the foreign profits of U.S. corporations were located outside the United States to reduce their effective corporate tax rates. At the same time, the Tax Justice Network estimated that about a quarter of U.S. corporations’ profits had been moved into jurisdictions where those corporations do not have any meaningful economic activity, and this behavior has led to an annual income tax revenue “saving” of hundreds of billions in U.S. dollars.
However, over the past two decades, it has become apparent that such aggressive tax behavior is undesirable and may undermine states’ abilities to maintain their welfare services. A critical milestone in advancing CSRT is the ratification of the multilateral instrument that characterized double non-taxation (i.e., tax is not being paid in any member state) as an abusive and undesirable practice. Another significant milestone was changing the self-regulation business model from a voluntary basis to a more mandatory basis. This multilateral effort was orchestrated through the OECD member states, heads of G20s, and heads of 137 states. Through their work on this inclusive framework, corporations were recommended to be subject to a minimal effective corporate tax rate of 15% (Pillar 2 of the BEPS Project).
However, in our view, this 15% rate alone is not enough. In an era of globalization, the time has come to develop a new conceptual framework for CSRT in cross-border settings, especially for MNCs. We propose adopting an innovative CSRT framework to establish the suitable contribution MNCs should make to the countries where they operate and generate profits or revenues. This suggested framework begins with a globally applicable minimum effective corporate tax rate (which is nowadays being adopted by countries around the world) while also ensuring equitable distribution of MNCs’ tax payments among the relevant countries (i.e., where the MNC operates meaningfully) and replacing the arm’s length principle for allocating intercompany transactions with a comprehensive new methodology that embraces factors that include the economic or other needs in the relevant countries in which they operate. Therefore, the proposed “transfer pricing” formulas can, in our view, encompass the value added by each relevant jurisdiction and external factors such as infrastructure status, poverty levels, macroeconomic conditions, and more. We also propose strengthening the exchange of information practices in taxation and including special assistance to developing countries struggling to tax foreign income and gains.
Lastly, CSR is an important concept that can positively impact society. In an era of economic globalization, we should not limit CSR to domestic activities alone. It is essential to ensure that cross-border activities create value for all relevant stakeholders and that taxation is integrated with CSR. By doing so, corporations can help create a more sustainable and equitable world. Accordingly, taxation should be seen and considered as a component of CSR, but unlike most CSR components, this one should not be voluntary.
Perhaps another way to look at it is that the “taxation” issue should fall under ESG in the governance component, not the social one. The expectations from MNCs to contribute to society and pay their fair share in taxes is an accepted norm, as we learn from Pillar 2. However, we believe Pillar 2 can also serve as a benchmark for developing a better framework for cross-border CSRT, and we expect a much higher level of transparency from MNCs to ensure they are not abusing the jurisdictions they operate within and contribute their fair share of taxes.
Doron Narotzki is a Professor at the University of Akron’s George A. Daverio School of Accountancy.
Tamir Shanan is a lecturer at the Haim Striks Faculty of Law, where he also served as the Dean.
This post was adapted from their paper, “Cross-Border Corporate Social Responsibility and Taxation: A New Conceptual Framework in an Era of Economic Globalization,” available on SSRN.