In its manifesto for the forthcoming general election the UK Labour Party has included a commitment to tax multinational enterprises (MNEs) as unitary firms. The commitment adopts recommendations put forward in a report by Danny Bertossa and myself, so naturally we are pleased.

Some have challenged whether this is feasible, and the estimates of the benefits. The report itself provides a full explanation, so anyone interested should read it, which perhaps not all the critics have. Here I will address the two main questions that have been raised: could a UK government do this, and what would be the benefits?

Those who have been following the project on base erosion and profit shifting (BEPS) will know that it is now at a crucial stage. Proposals have been put forward that would radically alter practices that have become normalised over the past 20 years, which have greatly facilitated tax avoidance by multinationals.

These centre on the so-called ‘arm’s length principle’, and the Transfer Pricing Guidelines developed by tax specialists through the Organisation for Economic Cooperation and Development (OECD). Tax treaties specify that the accounts of local affiliates within a multinational corporate group can be adjusted, to ensure that the profits declared and hence taxes paid are similar to those of comparable independent firms. The Guidelines (now some 600 pages) provide details for how this should be done, based on five alternative methods. Tax practitioners have insisted that the adjustment of accounts should be done only by comparing the transactions between the various affiliates within a multinational corporate group with those between independent entities, which they describe as the ‘arm’s length principle’. However, the Guidelines also include a profit-split method, which allows allocation of the aggregate profits of related entities.

In the latest stage of the negotiations, the proposals centre on the use of formulaic methods for the allocation of profits, building on the profit-split method. The aim is to provide simpler administration, as well as certainty for business. It would also dramatically reduce the opportunities for tax avoidance by multinationals, which generally involve the creation of complex corporate structures with often hundreds of affiliates within each group. The OECD estimates that such practices cost countries $100-240 billion in lost revenue annually, the equivalent of 4-10% of global corporate income tax revenue.

In these debates tax advisers have resolutely tried to defend the transactional approach to the arm’s length principle, but this is now clearly a losing battle. At the most recent OECD public consultations on 22-23 November, Grace Perez Navarro (the OECD deputy head of tax) joked that these arguments reminded her of the John Lennon song ‘Give arm’s length a chance’ (the video can be viewed here ­– the remarks were made on day one at 4:28pm). Her comment was: ‘But we can’t go there… you can see that the three proposals the Inclusive Framework approved have all rejected the arm’s length principle. We are looking at a new type of approach that is looking at the whole entity and applying a more formulaic approach’.

The last ditch in this defence is the insistence that formulaic methods could not be introduced without changes to tax treaty rules. This would mean all countries agreeing to revise their treaties, which would make this change impossible. However, the key treaty provisions can reasonably be interpreted to allow adjustment of accounts by any method which ensures that a multinational’s subsidiary declares similar levels of profits to comparable independent firms. Indeed, there is very good evidence that the current rules totally fail to achieve this result. A recent study by a US economist using actual HMRC tax return data showed that over a 14-year period local subsidiaries of foreign multinationals paid on average half the level of tax of comparable independent UK firms.

At the international level this could be done by rewriting the Guidelines. Since they are not legally binding, individual states are free to adopt their own interpretation of the treaty provisions. Such moves may be the best way to persuade reluctant countries to accept reforms, otherwise the international negotiations will move at the pace of the slowest.

Indeed, such unilateral moves have already taken place. The UK itself introduced its Diverted Profits Tax (DPT) in 2015, while the first phase of the BEPS project negotiations was still under way. A prominent target of the DPT has been Glencore, which was hit with a demand from HMRC for $680m. This is being challenged legally, and some consider the DPT to be contrary to tax treaties. The Tory government has also announced that it will follow other countries such as France, and introduce a digital services tax (DST). The US administration has denounced the French tax as discriminatory, and opened an investigation under s. 301 of its Trade Act, which could lead to retaliatory tariffs.

Both the DPT and the DSTs are very blunt weapons, arbitrary and unprincipled. The DST would be a gross tax easily passed on to consumers, and targeted only at digital advertising and platforms. These are unhelpful unilateral measures, which do not lead the way to a better international solution.

In contrast, adoption by a country such as the UK of a policy of moving towards unitary taxation with formula apportionment could accelerate the growing momentum for a more effective and comprehensive international solution. Indeed, earlier this year the Indian government put forward proposals to adopt fractional apportionment unilaterally, explaining how it could be compatible with its tax treaties. Even if not all countries follow, governments bold enough to lead the way could create a new consensus for reform of the rules to make them fit for the 21st century.

There is also considerable evidence that this approach would increase global tax revenues: a recent research paper for the IMF estimates this would be between 3% and 14%. Based on the data in this paper, and in another recent study, our paper estimated increased revenue for the UK of between £6 billion and £14 billion, before adjusting for behavioural response, and at current rates of tax. Hence, the estimate in the Labour Party’s Grey Book of £6.3 billion is conservative.

More important, in my view, would be the enormous benefits from placing taxation of multinationals on a new footing that would provide both fairness and certainty.

This is a bold, visionary plan for taxing multinationals from the Labour Party – but it is also workable and necessary.