International tax: Global warning

Government revenue chiefs from 35 OECD countries met in the South Korean capital in September to “share knowledge… and…[discuss] reforms to meet the challenges of international non-compliance with domestic tax laws.” Their Final Declaration identified two specific challenges.

The first was to improve tax collection administration, tasked as they say they are by their respective governments with an increasing burden of functions. The second was that they face difficulty in enforcing tax collection because of the globalisation of trade and capital and developments in communications technologies.

Therefore, they say, there is a need for them to share best practice and to cooperate to combat those who are non-tax compliant and who may practice or advise on “unacceptable tax minimisation arrangements”. They set out four areas where they will initiate work or intensify what they are already doing:

• Further develop the directory of aggressive tax planning schemes so as to identify trends and measures to counter such schemes.

• Examine the role of tax intermediaries (eg, law and accountancy firms, other tax advisers and financial institutions) in relation to non-compliance and the promotion of unacceptable tax minimisation arrangements with a view to completing a study by the end of 2007.

• Expand the OECD’s 2004 Corporate Governance Guidelines to give greater attention to the linkage between tax and good governance.

• Improve the training of tax officials on international tax issues, including the secondment of officials from one administration to another.

Potential risks

The first and most obvious risk potentially facing businesses is that loopholes and anomalies that might exist because of a lack of coordination between tax authorities could be closed out. This suggests that finance directors, their tax staff and their external advisers should review their arrangements sooner rather than later to assess whether such risk exists for them.

This all sounds straightforward enough. The trouble is that it isn’t and the OECD’s intentions to catch out wrongdoers are underpinned by conflicts and uncertainties. For example, if the “directory of aggressive tax planning schemes” is voluminous and growing then a reference work on government tax incentives and tax competition arrangements – offered to businesses to encourage inward investment – should sit beside it on the shelves of the various tax authorities.

Rates of corporate taxes, sales taxes and value added taxes, property taxes and a raft of grants and incentives differ from place to place and may be subsidised to a greater or lesser degree as part of a worldwide game of tax competition. “I think the governments who’ve signed up for this are running scared of the corporation tax race-to-the-bottom,” says Chas Roy-Chowdhury, head of tax at the Association of Chartered Certified Accountants, “and I think [the declaration agreed upon in Seoul] is their way to combat that.” He goes on to note that tax compliance has become massively complicated, particularly in the UK, and that both tax authorities and corporations are highly distrustful of each other.

Part of the reason for this, says Roy-Chowdhury, is lack of clarity and definition over where the line is drawn when it comes to tax planning.

KPMG’s global managing partner for tax, Loughlin Hickey, believes: “The Seoul Declaration paints a picture of non-compliance as something outside the law – while acknowledging that tax minimisation is legitimate, it brands an undefined part of legitimate planning as unacceptable.” There is a case to be made for restraint in tax planning (through a code of conduct for example) but this cannot proceed in an atmosphere where tax administrations assert that they are the arbiters of what constitutes compliance and acceptability.

“Multinational corporations,” he adds, “are actively shopping around the world for the best deal on taxation and governments that realise this are redrawing their corporate tax systems to encourage inward investment.” The UK, which has developed an aggressive tax regime that has brought it into conflict with companies and their advisers, is taking steps to soften its approach.

Lynne Patmore, former group tax director at Vodafone Group plc and now tax partner at accountants and advisers RSM Robson Rhodes says that the Seoul Declaration reads as if it were composed by the UK tax authorities as an attempt by them to lobby the 34 other countries into following their lead.

Healing the wounds

Notwithstanding this, the recently published Varney review is an initiative to heal the gulf between UK business and the tax authorities and achieve amore consultative and less confrontational relationship. Commentators, including representatives of the Big Four accountancy firms, note that the background to this is thatGordon Brown is very aware that the 30% corporation rate is now looking uncompetitive.

In any event, Patmore notes that measures announced in the declaration are likely to pose greater compliance risk to business.

TimLyford, head of London corporate tax at Smith &Williamson, another of the larger second tier advisory firms, agrees. He says that there is the risk of tax litigation with the Revenue, likely to be longwinded and costly, and the further risk of uncertainty as to the outcome of such disputes.

The second item on the OECD’s work schedule is to investigate the work of tax advisers and their contribution to the “promotion of unacceptable tax minimisation”, a project that the UK’s representation at the OECD’s tax forum has agreed to lead.

To ACCA’s Roy-Chowdhury, exactly what this is intended to mean is unclear.“It sounds like a bunch of words.We need less rhetoric, more simplification and greater clarity about what is acceptable and what is not.”

The risk for business is lack of certainty. RSM Robson Rhodes’ Lyford says that Chancellor Gordon Brown’s recent announcement of advanced tax determinations is to be welcomed, though some are sceptical as to what this will actually mean.

Patmore says that this will probably result in greater scrutiny of tax affairs. However, she adds that governments, especially in the EU, have lost control of their fiscal policy over recent years.

If businesses are free to move to Cyprus,Malta or Ireland, then what are other countries with higher taxation jurisdictions, such as the UK, to do about it?

Fiscal morality

The Seoul Declaration chooses to blur legal tax avoidance practices with those that are illegal. For example, it says, “…businesses of all sizes have created shell companies offshore [legal] to shift profits abroad often taking recourse to over or under valuation of traded goods and services for related party transactions [probably illegal in most jurisdictions] and some multinational enterprises [including financial institutions] have usedmore sophisticated cross-border schemes and/or investment structures [legal] involving the misuse of tax treaties [illegal], the manipulation of transfer pricing [illegal] to artificially shift income into low tax jurisdictions and expenses into high tax jurisdictions which go beyond legitimate tax minimisation arrangements…”

In this way its quest to link tax compliance to the moral behaviour of business has drawn criticism from multinational corporations and from the tax advisory professions as an attempt to gain greater visibility and curry favour with the press and public. Perhaps part of the training of tax officials in international tax matters will include how to handle the media and yoke taxpaying with corporate social responsibility.

Meanwhile, it is important to note that in many western countries, such as the UK, the direct tax on businesses amounts to 8-10% of total tax revenue. It is a fair bet that much of the other 90% or so represents other forms of taxation levied on income that is initially generated by businesses but levied on sales and other personal expenditure.

Creating an environment of additional tax risk and heightened compliance burden for businesses is to scare away the goose that lays the golden egg.

Mr Brown seems to be getting that message now, though not everyone believes what he has been saying lately, and the Seoul Declaration countries risk alienating businesses too if they adopt a UK-like model of aggressive tax collection and confrontation towards the businesses that generate their national wealth.

Double vexation

Double taxation treaties are needed because, in essence, there is a conflict between two fundamental principles of corporate taxation.

• The first is that a business should pay corporation tax on its worldwide earnings.

• The second is that it is liable for tax on earnings in a country where it is established.

So a company with, say, a base in the UK but which has a number of operations constituted and resident for tax purposes in several other countries could be at risk of having the profits of each of its overseas subsidiaries taxed in their respective countries as well as having its worldwide income taxed in the UK.

Double taxation treaties are agreed between countries to avoid such unfair taxation. The UK has double taxation agreements with more than 100 countries including the states of the European Union and the USA which, together, account for a large proportion of the country’s overseas corporate earnings. For this reason such agreements are a crucial part of enjoying the fruits of operating in more than one country.

But things are not as straightforward as all that. Double taxation may affect not only taxes on business profits, but also taxes on capital gains, dividends, withholding taxes on interest in overseas jurisdictions, which may or may not fall under a particular double taxation treaty.

In addition, double taxation may be deducted by one of three methods which result in different amounts of tax payable overall.