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Peer company ETRs: Benchmarking complexity

12 December 2018

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The effective tax rate (ETR) of a peer company may be intuitively thought of as an industry benchmark. This benchmark could traditionally be useful to investors, boards of directors, CFOs and tax departments of multinationals and CFOs. But times are changing.

Effective tax rates are becoming less useful as a benchmarking indicator

The recent tsunamis of tax complexity, including enactment of the US Tax Cuts and Jobs Act of 2017 (TCJA), subjective anti-abuse rules, transfer pricing disputes and an increase in the backlog of competent authority requests have effectively marginalised this ETR comparability tool.

The recent wave of complexity has forced most investors to avoid reasonable interpretations of a public company's tax footnote, thereby focusing more on non-tax operational measures which are, by nature, easier to understand and rationalise.

The TCJA has introduced additional layers of complexity, with code names of GILTI (global low-taxed intangible income), BEAT (base erosion and anti-abuse tax), and FDII (foreign derived intangible income). These new provisions have thousands of pending pages of additional guidance that will attempt to further clarify the new law. The extent to which a US headquartered public company's tax posture could be reasonably interpreted was waning up until 2018, but the TCJA further obliterates any realistic insight.

General anti-avoidance rules (GAARs), coupled with anti-abuse rules, transfer pricing complexities and inefficiencies in tax dispute resolutions, have further escalated the level of incomprehension of a company's ETR, notwithstanding comparability to other peer companies.

Tax accounting has also been left behind in this complexity. US generally accepted accounting principles (GAAP) are very prescriptive for tax reporting, although clinging to former concepts and principles that defy reasoned conclusions. An ETR footnote presentation is somewhat vague and obtuse, as it cannot begin to explain the complexity for all elements that differ from a company's statutory tax rate. Other forms of accounting principles will also be stripped by new tax standards that no longer fit within prescribed rules of reporting. US GAAP and other principles will strive to catch up, although new complexities and interpretations will continue to frustrate those efforts in a no-win situation.

In summarising the above obstacles for understanding a company's ETR, are there better ways to promote comparability, notwithstanding the tax complexities that defy a reporting rationale?

One possible starting point for a global ETR would be the statutory rates multiplied by pre-tax book incomes in all jurisdictions. This starting point would illustrate the basic differences of jurisdictions in which a company conducts business. Naturally, this would be different for every company each year, although the major components of changes leading to the global ETR can then be enumerated.

An alternative form of reporting would use cash taxes as a supplement to the current tax footnote, exclusive of interest, penalties, audits and non-recurring items. Notwithstanding timing issues of cash tax payments, this trend may be useful in understanding the relationship between business operations and taxes more simply.

Conclusion

It is a steep uphill climb to understand a company's ETR to form a comparison with peer companies. The simple task of assembling an ETR, without further explanation, is gone. As a result, ETR benchmarking is not a value-add exercise. The complexity of tax reporting, coupled with recent changes in international tax principles, have led to the erosion of an ETR as a benchmark.

Keith Brockman is the VP Global Tax at Manitowoc Foodservice. His previous role was international tax director at Mars. He is also a lecturer, frequent speaker and the author of the Strategizing Multinational Tax Risks blog. In his regular ITR column he provides a practical analysis of some of the more challenging recent developments for corporate taxpayers, looking at how in-house professionals can mitigate new risks and identify effective solutions in an evolving environment.






International Correspondents