High-profile investigations and stringent new laws are part of a focus by governments across the world on tax evasion. Reforms to corporation tax and international information-sharing agreements promise to hit tax-evading companies - but the reforms have problems of their own. Nick Kochan reports Too many companies have been looking at their tax liability in the wrong way - and that has to change, regulators say. Pascal Saint-Amans, head of tax at the Organisation for Economic Co-operation and Development (OECD), says tax should not be treated as just another line in the profit and loss account that can be managed to fit in with the best interests of the financial statement. "The behaviour of some multinationals has become too aggressive. This is important and shouldn't be avoided. It is a compliance issue and tax administrations across the OECD have been very clear that they will not tolerate aggressive tax planning that turns into tax evasion and behaviours that go against the spirit of the law. There is probably a need to remind people that tax is something serious, that you cannot deal with as just another line of the P&L," he tells Operational Risk and Regulation. Moves to ratchet back the point where tax avoidance approaches evasion are coupled with efforts by many governments to curtail tax schemes set up by international banks to help wealthy clients minimise tax obligations. Such schemes use their global structure to enable customers to avoid paying tax in their home jurisdiction by putting funds into low tax havens. Tax authorities' efforts to retrieve tax lost to other jurisdictions is being assisted by an unprecedented number of whistleblowers inside banks, feeding lists of clients with offshore accounts to national tax authorities. Most recently, a four-thousand strong list of HSBC clients in Jersey was passed to the UK tax authorities, HM Revenue & Customs, which is investigating them for possible evasion of UK taxes. According to press reports, the clients on the list have a total of £699 million deposited with the bank. This follows HMRC's receipt two years ago of the ‘Lagarde list' of account holders at HSBC's Geneva branch - named after the then French finance minister, Christine Lagarde, now head of the International Monetary Fund, who acquired the list through the French intelligence service from an HSBC employee and handed the list over to international tax ministries. The list became public knowledge when it was leaked and published by a Greek magazine in October 2012. The OECD, a leading influence on global tax policy, has been asked by the G-20 group of leading nations to investigate current structures for corporate taxation and to propose alternatives. The project has been given additional impetus by recent coverage of the low UK tax bills paid by several major companies - Google, Amazon and Vodafone among them - which Saint-Amans cites as evidence of the problem. The OECD initiative, he says, will examine two key issues: tax base erosion and profit shifting to low tax jurisdictions. First it will make a serious analysis of how tax avoidance has been developed, and the problems it causes government Treasuries. Second, it will look at the International Accounting Standard rules and their implementation in various countries; if the rules are too complex the OECD will work to simplify them, Saint-Amans says. Keep it simple The second stage is particularly important, Saint-Amans argues - simplification of the accounting rules would facilitate the work of tax authorities which have the task of scrutinising corporate tax planning, and make it more difficult for companies to exploit complexities and inconsistencies to their advantage. In particular, he says, authorities should revisit rules on transfer pricing, where companies arrange their tax affairs so that profits and losses can be taken in jurisdictions where the tax exposure is smallest. "Transfer pricing rules are very complex. They have the merit of being based on a single standard, which allows for the elimination of double taxation which is absolutely key if you want cross-border investment which is necessary for growth. But the way they are implemented may be too complicated. Maybe we need to go back to basics, to simplify the rules, to adapt them to deal with transfer pricing in the area of intangibles." The Tax Justice Network, a UK-based tax reform campaigning organisation that focuses on tax avoidance and tax havens, has called for changes in the rules on transfer pricing. Executive director John Christensen says: "The rules of the game on taxing multinational companies are simply not fit for purpose. They are based around this idea that the companies should trade between their own subsidiaries on the basis of a world market price for whatever they are trading. This is the so-called ‘arm's length price' rule. But this is intellectually flawed. It is very hard to apply in practice, not least because you are asking companies to produce world market prices which very often don't exist." In many cases, companies can argue in good faith that no comparator exists - but this leaves the way open for them to price internal transfers more or less at will, Christensen argues; and the burden on tax authorities which attempt to call their bluff can be disproportionately large. "It is very common for companies to make up prices when no obvious comparator exists. So national tax authorities have to engage in massive investigations to find out whether or not these prices are anywhere near reasonable. There is a great deal of horse-trading going on around that." In other cases, Christensen says, companies can exploit the system to shift profits around - charging subsidiaries heavy bills for fictitious services in order to move profits from high-tax to low-tax jurisdictions. To avoid this kind of abuse, Christensen argues, national authorities should work together to introduce ‘unitary taxation', addressing multinational companies as a single unit and apportioning the taxation on the basis of economic activity rather than legal entities. He sees tax lawyers making their assessments based on where the company makes its sales, where it employs its people and where it makes its investment. Christensen says: "Forget about the tax havens, because nothing of any substance actually happens there. That is the logical route to follow. [There has been] massive resistance to the unitary tax approach from tax havens, from countries that benefit from them...but this is where we are going. If companies were required to disclose their accounts for every subsidiary in every country where they worked, the tax authorities would have a lot more information about where their profits were actually being created, and what taxes were therefore due." The move towards general acceptance of the International Financial Reporting Standards (IFRS) will have as a side-effect a significant move towards, effectively, unitary taxation, Christensen argues. However, he says: "It is facing fierce resistance from some multinational companies. If they are required to disclose their accounting information at subsidiary or country level, it would be a lot easier for tax authorities to identify where profits are being shifted to tax havens." One particular critic of unitary accounting is Bill Dodwell, chairman of the Chartered Institute of Taxation's Technical Committee and a tax partner at Deloitte. Though the intention is laudable, he says, implementing a truly unitary tax system would be a huge task - and there are fundamental problems with the idea of effectively compelling every country in the world to use the same taxation system. The bones of unitary taxation - a common accounting system and tax base - are already in place in many jurisdictions. The European Commission's proposed Common Consolidated Corporate Tax Base rules involve a similar system to that used by many US states - "a three-part formula of tangible fixed assets, people and sales", Dodwell says. But even this has presented problems with variations between countries and industries: "The EU variant modifies the people segment, by counting both numbers of people as well as their payroll cost... Financial profits are shared, but the formula doesn't work sensibly for financial sector activities; something separate would need to be devised." These problems are central to the whole project of unitary taxation, which requires a uniform situation across countries in order to work. In situations where costs of a similar item, people, property or sales values, vary significantly, unitary taxation is unlikely to work. "Countries with low costs would lose out to those with higher costs," Dodwell says. "Oddly, the less competitive a country became, the higher its share of corporate profit. Swings in exchange rates would alter allocations. Everything would need to be adjusted on to a purchasing power index to end up with fair comparatives. Would it be possible to do this fairly?" Another objection to unitary taxation centres on intangible assets. This important part of commercial activity would need to be reflected in the unitary formula, yet valuation of intangible assets is an inexact science. The final problem is political rather than practical - under a worldwide unitary tax system, countries would lose control over their own tax systems, and inequalities would persist or arise between countries just as they do under current systems. "Instead of being able to design a tax system suited to individual economies, countries just get an allocation of profit - or loss. Ireland could no longer offer a lower than average tax rate to boost employment, since the small size of its economy would mean that insufficient profit would stick there. Comparatively few sales would be made there and the large number of people based elsewhere to service other markets would mean that the people factor wouldn't help. Some countries - particularly large economies - might find that attractive," Dodwell says. "The new system would produce winners and losers. Winners would get a greater slice of profit and so could either reduce the corporate tax rate, or change other taxes. Losers would need to put up corporate rates, or pass the burden more directly to people through increases in income tax or VAT," Dodwell adds. And, he adds, it would not be a panacea for tax avoidance either. "The new system wouldn't be immune from planning. Companies would realise how they could influence their profit allocations by, for example, outsourcing or insourcing activities. Devising an anti-avoidance rule to cater for situations commonly encountered commercially would be difficult." Individual as well as corporate tax evasion is also under intense scrutiny as governments seek to rein in schemes which enable wealth to be redistributed to low-tax and typically secretive jurisdictions. The pursuit of money seeking a secret haven is being advanced by the growing acceptance that countries need to inform the home tax authority as soon as a foreign national moves money into one of their institutions. This denies the individual the opportunity to evade his higher domestic taxes as he seeks to enjoy the benefit of a low-tax jurisdiction. A problem shared... This principle of automatic information sharing has been incorporated in the US in the Foreign Account Tax Compliance Act (Fatca) whose goal is to prevent tax evasion by US citizens who use offshore accounts. The law is directed at foreign financial institutions (FFIs), which must provide information on US accounts to the Internal Revenue Service. An FFI that decides not to sign up will be subject to withholding tax on dividends and interest from US corporations. In practice, Fatca is likely to be implemented in a slightly different form: rather than banks around the world reporting directly to the US authorities, an approach that risks running foul of local privacy and data protection laws, they will report to their national regulators, which will pass the relevant data on to the US under a reciprocal intergovernmental agreement (IGA). IGAs are being drawn up between the US and several other jurisdictions - 50 countries are currently negotiating IGAs with the US authorities. Nor is Fatca the only driver towards automatic information exchange - the 2005 European Union Savings Directive includes such a requirement at European Union level. While the automatic system gathers pace, a number of jurisdictions continue to apply a much weaker system for sharing information. Known as the ‘on-request' system, it only comes into effect when the home tax authority approaches the offshore authority to request information about one of its citizens. The foreign authority will provide information based on the evidence of the requesting country. Christensen is highly critical of the OECD, which has pioneered the ‘on-request' system. "This is a weak system because it requires a smoking gun to trigger the request," he says. "And although hundreds of new Tax Information Exchange Agreements (TIEAs) have been signed since 2001, they have proven to be totally ineffective. They have had neither the deterrent effect, nor do they work in practice because it is so expensive and time-consuming to work up an exchange request. So it is a failure." Saint-Amans rejects the criticism, saying the OECD is fully supportive of the trend towards automatic exchange. "The G-20 is asking for further moves towards automatic exchange of information. We are involved in developing a multilateral platform for automatic exchange of information for countries that have implemented the Fatca agreement. We have put in place the mechanism for exchange of information, and we are involved in the process whereby some countries have decided to automatically exchange information. We support those countries." Not all countries - especially not those with large private wealth management industries - have wholeheartedly supported the automatic exchange system. But an alternative exists in which a jurisdiction makes an agreement to withhold tax from investors of a foreign country without notifying the investor's home taxation authority of the individual's identity or the location of their funds. The withheld tax is subsequently paid to the investor's home jurisdiction. Such an agreement (dubbed the Rubik agreement) has been adopted by the United Kingdom and Switzerland, but Saint-Amans dismisses this as inferior to the Fatca IGAs. "I have no comment on Rubik. But there is another game in town which seems to move faster and this is the Fatca-type intergovernmental agreement. So Switzerland has agreed with the US to exchange information automatically. I observe that Fatca IGA types of agreements are the key area. That is the equivalent to automatic exchange of information."...
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