International tax transparency: Past, present and future

Harm Oortwijn: The call for tax transparency is unstoppable

In their efforts to manage national budgets, politicians are making unpopular choices for the electors they represent. General interest in public financial affairs is historically high, as are the calls for more transparency and measures to combat tax avoidance and tax evasion. This is on the political agenda of the highest international political forums: the G8 and G20.

Almost all tax jurisdictions and institutions have taken, or are taking, measures in response to this public call as voiced in the media and on social media forums. National tax authorities have started collaborating and concluded bilateral and multilateral agreements to exchange information. CEOs, CFOs and tax executives are having a hard time dealing with the current tax developments; previously government-approved tax structures are now being publicly challenged in media and social media, and are being perceived as abusive. Companies are expected to pay their "fair share" of tax in each jurisdiction they are "doing business" in.

The discussion is not as black or white as it may seem to be from most publications and discussions – it is rather a case where all parties involved (that is, the general public, governments and institutional bodies, lobbyists representing businesses in developed countries and lobbyists representing developing countries) are more or less correct on one or a few aspects. This article is intended to contribute to a more balanced discussion of international tax matters of multinationals.

The US Supreme Court already expressed in Thor Power Tool Co vs Commissioner, 439 US 522 (1979) the leading principles of financial accounting and tax compliance: "The primary goal of financial accounting is to provide useful information to management, shareholders, creditors and others properly interested; the major responsibility of the accountant is to protect these parties from being misled. The primary goal of the income tax system, in contrast, is the equitable collection of revenue; the major responsibility of the Internal Revenue Service (IRS) is to protect the public fisc. Given this diversity, even contrariety, of objectives, any presumptive equivalency between tax and financial accounting would be unacceptable".

The first signs of public resistance were already originating in the US in the early 2000s, starting with Enron and the focus on accounting and reporting, and subsequently followed by the implementation of Sarbanes-Oxley. Under Sarbanes-Oxley, compliance, transfer pricing and tax reporting issues were amongst the main reasons for material weakness in US listed companies' financials. Next, the IRS lobbied the Securities and Exchange Commission (SEC) for additional tax disclosure requirements by US taxpayers in SEC financial statements. The IRS increased compliance by adding new tax returns and special reporting requirements (for example, Schedule M3 and Reportable Transactions). This was mainly a response to errors and omissions in filed US tax returns and in response to the application of aggressive tax schemes.

Currently the public's focus is on international transfer pricing and the tax affairs of predominantly US multinationals like Google, Amazon, and so on using the typical (and legitimate) US tax deferral structure. The topic has ultimately become one of the key agenda points of the G8 and G20 meetings in 2013. The increased tax reporting disclosures in financial statements, the press attention on companies' tax issues in combination with governments' choices to remediate budgetary challenges, most likely have fuelled this debate starting in the UK.

The tax debate intensified after the press reported on US multinationals lobbying Congress for full repatriation relief in 2009 through to 2011 – explicitly disclosing how earnings were legitimately held offshore under US international tax legislation. Combining publicly available information of companies and a good income tax reporting knowledge has allowed outsiders to analyse and review the tax structures of multinationals.

In 2004, Congress did enact a one-time break allowing companies to repatriate their earnings at an effective rate of 5.25%. Back then, $362 billion was brought to the US, according to the IRS. Reportedly, though, this incentive did little to boost jobs or investment in 2005; rather it increased share buy-backs – which meant there was no enactment of a permanent relief in 2009 and 2011. Now, US multinationals state that the cost of repatriating foreign earnings is too high and forces them to borrow domestically to fund operations instead. Other US multinationals state their foreign earnings reinvested in US government bonds.

As the debate evolved in 2010, more and more US multinationals' tax information was disclosed, finally ending in a complete overview of how they apply the check-the-box rules in conjunction with the tax deferral technique, and how this interacts with predominantly territorial foreign tax systems and multinational tax treaties. It showed that without breach of any tax law, US multinationals can apply transfer pricing methods to allocate profits to low tax jurisdictions without being subject to US tax.

The public has been calling for US tax reform – changing to a territorial system and changing tax deferral schemes. Max Baucus, Senate Finance Committee Chairman (D-Mont.) and Dave Camp, House Ways and Means Committee Chairman (R-Mich.) opened a website for public input about tax reform (www.taxreform.gov). More than 50 meetings on tax reform were held in the Senate in the past two years. The last tax reform was in 1986. Democrats and Republicans are in agreement that tax reform is required – they disagree about the extent of tax neutrality of such reform. The Obama Administration does not want to wait and prefers to start lowering the corporation tax rate now. Critics oppose lowering the tax rate now without consideration of any other tax aspects currently being investigated, arguing it is too risky as it could lead to a non-coherent tax system.

Outside the US, the tax debate reached its climax in the UK Parliament's Public Accounts Committee holding public hearings which questioned the level of taxes paid in the UK by Google, Amazon and Starbucks, and forcing executives to fully explain the allocation of taxable profits to low tax locations with little or no business activity.

From there on the tax debate spread to the rest of the world. Most of the largest multinationals have taken, or should be taking, internal measures to be prepared for defending its tax affairs in public if requested.

The OECD started the base erosion and profit shifting (BEPS) project to investigate whether, and if so why, the current rules allow for the allocation of taxable profits to locations different from those where the actual business activity takes place. On July 19 2013 it issued a report with an action plan to address BEPS. The plan identifies a series of domestic and international actions to address the problem and sets timelines for their implementation.

During the June 2013 meeting, G8 leaders committed to agree further transparency on the sharing of information and to bring international tax rules into the modern age. They support the OECD to establish the automatic exchange of information between tax authorities as the new global standard and they announced that they will draw up a template for global corporations to report to tax authorities where they make their profits and pay taxes around the world. They claim this will give governments a new tool against tax avoidance by multinationals and will be particularly helpful to governments of developing countries. The G8 will provide support to developing countries to collect the taxes they are owed. The G8 further agreed to publish action plans to require companies to obtain and hold information on who really owns and controls them and to ensure this information is available to tax authorities and law enforcement, including through central registries.

During the July 2013 G20 meeting, the G20 group of industrialised nations commissioned the BEPS initiative. Among the highlights of the plan are:

• Requiring online multinationals with extensive warehousing operations in an overseas country, such as Amazon, to pay local tax on any profits arising from sales in that country;

• Forcing multinationals to disclose to every tax authority a country-by-country breakdown of profits, sales, tax, and other measures of economic activity such as headcount;

• Strict rules to block transfers of high-value and mobile intangible assets, such as brands and intellectual property (IP) rights, to tax havens where there is little or no associated business activity;

• A crackdown on tax regimes found to have too soft an approach to multinationals deploying overseas finance subsidiaries through establishing a new international benchmark for appropriate taxation of controlled foreign companies;

• Wider measures to combat predatory tax competition policies emerging in some financially stretched countries, risking a "race to the bottom" climate on tax;

• A raft of treaty updates to neutralise the tax advantage of complex financial instruments, schemes, and structures, including hybrid capital, interest payment deductions and over-capitalisation;

• A requirement on multinationals to disclose the most aggressive tax planning structures to the authorities that are otherwise often relying on limited, local data that does not show the impact of transnational schemes to lower tax; and

• A new mechanism to fast-track the introduction of OECD recommendations rapidly around the world.

The presidents of the European Council and Commission have strongly endorsed the OECD initiatives recommended by the OECD for tackling tax avoidance and evasion, dealing with BEPS and the Multilateral Convention on Mutual Administrative Assistance in Tax Matters.

The European Commission issued on December 6 2012 a communication to the European Parliament and the Council "An action plan to strengthen the fight against tax fraud and tax evasion". This action plan contains the initiatives the Commission has already taken, new initiatives that will be progressed going forward and other initiatives planned for 2013. The action plan represents a general contribution to the wider international debate on taxation and is aimed at assisting the G20 and the G8 in its continuing work in this field.

In response to the EU Action Plan, in April 2013, the UK, France, Germany, Spain and Italy (G5) signed a multilateral information exchange facility modelled after the US Foreign Account Tax Compliance Act (FATCA). Under the agreement, banks in the G5 will be forced to reveal financial details of foreign clients which will then be handed over to the tax domicile to be checked for evasion. The G5 countries have invited other member states to join this pilot.

The Financial Transparency Coalition (FTC) is an umbrella group including charities such as Christian Aid, Global Witness, Global Financial Integrity, the Tax Justice Network and Transparency International. Some FTC member groups want to explore whether the many hundreds of existing bilateral tax treaties that facilitate global trade should be torn up and replaced with a new model – known as unitary taxation – which they claim would better link the apportionment of taxable profits by multinationals to the territories in which economic activities occur. Among the G20 members there is consensus that unitary taxation is not a feasible solution. The Tax Justice Network is consulting the UN Tax Committee. The UN Tax Committee issued and supports the UN Model Tax Convention, which is different from the OECD model.

The key question is whether every country is benefiting from bilateral tax treaties. Specifically in the case of immovable goods such as, for example the business of extracting natural resources, it is questionable whether a tax treaty would be attracting more foreign investment than would occur without the tax treaty.

The definition of permanent establishment and interpretation of beneficial ownership is in principle governed by tax treaties, but in practice it is differently interpreted for local purposes.

The OECD is often accused of being a "rich country organisation" representing the developed OECD countries, whereas the UN represents the developing countries. The OECD and the UN each have a different version of the tax covenant model. The UN has among its advisers the Tax Justice Network; while the OECD is commissioned by the OECD member countries.

In the BEPS report, the OECD has acknowledged that tax laws have not kept pace with businesses and that developing economies concerns must be addressed equally. Will the implementation of BEPS make the OECD model based treaties effectively more in line with the UN model tax convention?

Under the existing transfer pricing methods based on functional analysis, economic ownership and economic activity, the allocation of low profits is fully compliant with local laws and international tax treaties. More transparency in terms of who the ultimate beneficial owner is will definitely help local tax authorities understand international tax structures and make multinationals require consistent tax supply chain structures. It will not avoid mutual agreement procedures (MAP) but certainly will lead to more equitable tax decisions because of the availability of more information and the existence of an effective framework to closely work together.

German tax authorities have already said the impact of BEPS will not be significant for Germany – since they already have many anti-tax avoidance measures and collaboration arrangements in place. On the contrary, implementing BEPS may have an adverse impact on the current tax procedures and system and could require otherwise unnecessary legislative and organisational changes.

Officials of the IRS have already expressed that they are not likely to accept full disclosure of US taxpayers to foreign tax offices. They will have intergovernmental agreements with a large list of countries for FATCA purposes in place.

The UK's HMRC will be actively helping developing countries in implementing tax information exchange agreements (TIEAs).

BEPS is primarily a response to the public debate about the US multinational tax model starting in the UK – most countries with a territorial system already have one or more anti-avoidance measures in place like a general anti-avoidance rule (GAAR) and TIEAs in place. The debate will likely be ended when the US reforms its CFC tax system of taxing foreign unremitted earnings.

The current tax reporting of US GAAP and IFRS reporting by multinational companies is sufficient – tax disclosures in the financial statements and tax compliance are providing the information to the stakeholders. More often than not, users of financial statements do not sufficiently understand the tax reporting disclosures. In the past year or so there have been many inappropriate responses to the Google and Apple cases in the mainstream media, which were not technically complete and correct.

Tax authorities are having issues attracting and retaining talent because salaries are way below the benchmark of tax professionals in business. Improvements in this area and in recruitment will help raise more tax revenue. With the implementation of horizontal monitoring and system based controls, the idea was that less tax personnel would be needed, which turned out not to be after all. Various governments including the UK (HMRC) have acknowledged this and announced the recruitment of more tax staff in 2013.

Since no tax jurisdiction will want to give up its fiscal autonomy, international cooperation through TIEAs with exchange of information (upon request) is likely to be the way forward. The FATCA type of reporting is becoming more and more popular, evidencing the multilateral information exchange between the UK, France, Germany, Spain and Italy.

This is further evidenced by the fact that on August 27 2013 China was the last G20 country to sign the Multilateral Convention on Mutual Administrative Assistance in Tax Matters in accordance with the commitment it made at the July 2013 G20 summit. That results in 56 countries having signed the convention: Albania, Argentina, Australia, Austria, Azerbaijan, Belgium, Belize, Brazil, Canada, Colombia, Costa Rica, China, Czech Republic, Denmark, Estonia, Finland, France, Georgia, Germany, Ghana, Greece, Guatemala, Iceland, India, Indonesia, Ireland, Italy, Japan, Korea, Latvia, Lithuania, Luxembourg, Malta, Mexico, Moldova, Morocco, Netherlands, New Zealand, Nigeria, Norway, Poland, Portugal, Romania, Russian Federation, Saudi Arabia, Singapore, Slovak Republic, Slovenia, South Africa, Spain, Sweden, Tunisia, Turkey, Ukraine, UK and US.

In a 2005 article published in the Euromoney Global Tax Handbook, I noted that there is a trend of increasing transparency in financial statements to regain trust from shareholders of listed companies in the US and Europe. I also noted that, similarly, there is an increasing trend by tax administrators to increase transparency to combat tax shelters and transfer pricing on a global basis. Those same conclusive statements hold true today.

The views expressed in this article are those of the author and do not necessarily represent the views of his employer.

Further reading

Navigating BEPS with transparency and technology The tax market reacts to G8 Lough Erne Declaration Tax mentions in FTSE 100 annual reports highlight transparency drive