THE messy subject of tax avoidance has become as much the bane of companies’ lives as governments in recent years, and over the past few months, the plot has thickened after the OECD released a raft of recommendations to curb the practice.
And it’s not before time, either. The US has, over the course of 2014, become increasingly intolerant of creative tax provisions made by its multinationals, with so-called ‘inversions’ the key target.
The technique sees US companies seek mergers and acquisitions abroad in a bid to redomicile their tax base overseas and thereby cut tax costs. It was the method undertaken by Pfizer in its ill-fated attempt to acquire AstraZeneca, and has since been considered by hedge fund Marcato Capital in its move for Intercontinental Hotels.
The root of the problem lies in the fact that there is a huge disparity between the US’s high 35% corporate rate and the UK’s imminent 20% rate, which will be brought in by the coalition government in order to attract additional business to the UK. The current rate is 21%.
Then there’s more exotic techniques, such as the one used by Apple, whereby the company’s corporate structure includes three Ireland-based subsidiaries, which do not appear to be tax-resident anywhere in the world.
As advisers have noted, there has been little in the way of watering-down in the OECD’s seven-pronged attack on the practice, neatly divided into seven rather hefty reports (in all, they reach 736 pages).
Not only that, but as several in the tax sector have acknowledged, it’s impressive that the base erosions and profit shifting (BEPS) project has made the progress it has, within the original timeframe and in such deep detail.
Chief among the suggestions – one that relates to the digital economy – is to deny treaty benefits to businesses that are taking advantage of double taxation arrangements, which can result in the precise opposite – what the OECD is calling double non-taxation.
Similarly, the OECD is proposing to prevent “hybrid mismatch arrangements” – whereby the difference in the tax treatment of an entity under the laws of two or more jurisdictions is exploited to drive down tax bills – by adopting a “linking rule” between the payer’s jurisdiction and payee’s, aligning their tax outcomes and eliminating any mismatch.
In all, the recommendations have been set out in seven separate reports pertaining to, respectively: the digital economy, hybrid mismatch arrangements, harmful tax practices, tax treaty abuse, transfer pricing and intangibles, transfer pricing documentation and country-by-country reporting, and the feasibility of developing a multilateral instrument on base erosion and profit-shifting.
Part of that entails shifting corporate tax from a tax on profits to one on something less transient, such as where the sales are made or where the employees and executives are.
Something that is likely to draw the approval of tax justice campaigners is the move towards country-by-country reporting put forward by the OECD.
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However, tax justice campaigners will also be dismayed to discover that such requirements won’t be public.
Instead, businesses are going to be compelled to make country-by-country disclosures to the tax authorities, but they only need to make that information public if they wish to.
Given the reputational kudos that could accompany such disclosures, it perhaps comes as no surprise that Barclays chose to do just that with its first unitary report – which was part a strategy to improve its standing in the public esteem following a string of scandals.
The move follows Europe-wide regulatory requirements for banks to publish 2013 turnover and employee numbers for all countries in which they operate, with further expected disclosure requirements in subsequent years.
Similar rules already exist in the extractive industries within Europe. Companies dealing with oil, gas, minerals and logging from primary forests report payments such as taxes on profits, royalties and licence fees on a country and project basis, which will provide best-practice examples for affected companies.
For CFOs and their finance teams, candour is the imperative that comes out of the recommendations.
“Chief financial officers and finance directors are going to need to be prepared to justify and explain their tax position – perhaps in public,” explains the Institute of Directors’ head of tax policy Stephen Herring. “Hoping that you won’t have to won’t work. They’re going to have to be more upfront, before they’re asked.”
Engaging in the process is key too, Herring says. For him, businesses “should look to lead reform of corporation tax, not resist proposals”.
“Seeking and finding a more reliable, auditable, broader-based tax – one that’s less open to perceived manipulation – is paramount,” he says.
But practically, for those who are operating multinationals’ finance functions or who are considering entering new markets, the proposals need not represent a significant threat, according to Strahan Wilson, chief financial officer of food-on-the-go chain EAT.
Instead, he says that benign financial structures are likely to be affected, particularly in the case of UK-headquartered businesses.
“The reality is that the tax advantage of international brands are those which aren’t headquartered in the UK,” says Wilson. “The majority of the tax gain – as I know from experience – comes from being able to create a royalty stream which goes offshore.”
Costa Coffee, for example, cannot take advantage of the tax avoidance measures put in place by some of its well-known rivals due to the fact that it is based in the UK, Wilson explains.
“For us, it’s less about tax and more around market penetration, internationally,” the EAT chief financial officer notes.
“Clearly, if you’re competing with someone like Starbucks – which is in our sector and clearly takes advantage of paying lower tax in the UK by routing it through the Netherlands – is that a level playing field? If I was going into a country first of all knowing they could pay less – would that be fair? No, it wouldn’t. You take it into consideration, but the reality is that you would only go into a country if you believe the custom is there and they’re willing to pay for your proposition.”
On potential legislative change that may follow the OECD’s recommendations, Wilson suggests that any alterations “would only be in our favour”.
“Currently, our structure is very simple and straightforward, but when our growth plans come to fruition and we eventually move into new markets, it would be relatively easy to comply,” he says.
Of course, for businesses that are already multinational, it may not be so straightforward and it is likely that there would be a need for at least some amount of restructuring.
To that end, in order to comply with requirements, hybrid mismatch agreements may seem like the answer at least initially. But there are some who harbour concerns that the need for individual bilateral agreements between business entities will persist, which many warn could be a return to treaties and discrepancies between different jurisdictions. Some form of oversight is likely be required in order to ensure the rule is applied consistently.
Preparing for a shift
Shifting a European tax base to a nation with a higher rate may also be necessary, as Starbucks did following the hefty criticism of its tax practices. The move to the UK would see it pay more tax in what the company described as its fastest-growing European market. Following the relocation, Starbucks expects to open a further 100 shops, creating 1,000 new jobs. Senior executives, meanwhile, have transferred to its head office in Chiswick.
Bowing to such pressure, according to chairman of international tax practice network Taxand Frédéric Donnedieu, “legitimises the aggressiveness we have already seen from tax authorities towards taxpayers, particularly in areas such as transfer pricing”, and as such businesses should prepare for this scenario.
Of course, obtaining broad international agreement will not happen easily, as many countries fight to maintain their competitive advantage to attract both employment and investment, but the landscape is shifting, and it would be a naïve company that does not heed this. ?
1. neutralise hybrid mismatch arrangements through new model treaty provisions;
2. realign taxation and relevant substance to prevent the abuse of tax treaties;
3. ensure that transfer pricing outcomes are in line with value creation, especially in the key area of intangibles;
4. increase transparency for tax administrations and certainty for taxpayers through improved transfer pricing documentation and country-by-country reporting;
5. address the challenges of the digital economy;
6. facilitate implementation of the BEPS actions through a report on the feasibility of developing a multilateral instrument to amend bilateral tax treaties; and
7. counter harmful tax practices.