International Tax Planning for Companies
By Lowtax Editorial
30 January, 2014
The management of tax cost is one of the main preoccupations for companies doing business across national borders, and without adequate planning and forethought, taxes can be a significant drain on resources, financially and in terms of time spent on compliance.
There are plenty of ways in which a company can reduce its exposure to tax while staying well within the law. Indeed, most governments actually encourage businesses to pay less tax by offering them various tax breaks and incentives to remain in the country or invest in certain economic sectors. Examples include special rates of tax for small companies; accelerated depreciation and expensing rules allowing companies to offset capital investments against tax; loss carry back and carry forward rules allowing losses to be offset against prior- and future-year profits; special tax incentive schemes targeting companies in certain sectors, carrying out certain activities, or based in specific geographical areas; “green” tax schemes encouraging investment in environmentally-friendly technology and energy efficiency – the list goes on.
At the same time however, with tax authorities being given the task of increasing tax revenue by their indebted governments, the pressure on taxpayers in many countries to comply with the law has never been higher. Add to this the public clamour for retribution against taxpayers adjudged to be paying not enough tax, whipped up by politicians adding a moral dimension to the tax avoidance debate, and the tax landscape suddenly looks very tricky for a company trying to minimise tax while staying on the right side of the law.
The line between “acceptable” and “unacceptable” tax planning has always been something of a moveable feast; in the current climate however, the line seems ever more indistinguishable. In the remainder of this article, we look at some of the issues feeding into the tax avoidance debate.
Cultural Issues In Tax Planning
What is considered an "acceptable" approach to tax planning in one country may be deemed objectionable in another.
Therefore, companies are advised to tread carefully in their tax dealings in foreign jurisdictions, according to UK tax and advisory firm Crowe Clark Whitehill.
“The calls by fund managers for US companies to be ‘less aggressive’ in their UK tax planning highlight some of the cultural issues surrounding global tax planning,” the firm stated in a January 2014 news release. “What US companies consider to be routine tax planning may be viewed as inappropriate in another jurisdiction. This is partly due to differing tax systems and partly the results of evolving public perceptions on how large companies interact with the tax system in different territories.”
The firm points to the increasing scrutiny of multinationals' tax bills, and stresses that if "companies don't begin to speak openly about tax, the agenda will be driven by the media, politicians and the public."
Worse still, the debate will be "based on misunderstandings and easy headlines." To avoid the trap of becoming "headline fodder," businesses are urged to "explain to their customers and stakeholders the tax principles that they will use."
Moreover, there can be disagreement within broader political units, such as the European Union, as to what constitutes an appropriate tax break. The UK is currently under investigation for its Patent Box regime, described by the EU as too generous and likely to distort competition within the single market.
Businesses must therefore "be sensitive to the cultural and political debates going on in the countries in which they operate," Crowe Clark Whitehill advises.
Businesses Seek More Tax Guidance
Since it is becoming harder for companies to judge what is acceptable in terms of tax planning from one country to another, it comes as no surprise that businesses all over the world are calling for more helpful guidance from tax authorities.
Grant Thornton’s International Business Report suggested that the majority of the 3,000 chief executive officers, managing directors, chairmen and other senior executives it interviewed for the report would appreciate additional guidance on tax issues. However, there was a marked divergence between regions. Eurozone and Latin American companies lead the way, with 75 percent and 85 percent calling for change, respectively. On the other hand, in the case of North American executives, just 54 percent answered in the affirmative, with 67 percent of Asia-Pacific respondents agreeing.
Concerns were raised about the aims of current tax regimes. Only 31 percent of all those asked regarded their local tax laws and policies as geared to stimulate economic growth. The worst results came from southern Europe, at a mere 11 percent, and Latin America, at 23 percent. Nearly half of all business leaders believe that tax regimes do not bring enough economic participants into the tax base, although that sentiment was less marked lower among BRIC respondents than their G7 counterparts.
The BRIC/G7 divide was also seen in the inclination to make businesses' tax affairs more transparent.
Legitimate Tax Planning on the Rise
While aggressive campaigns against unacceptable tax avoidance might be reducing the use of abusive avoidance schemes, figures from the UK suggest that they merely increased the use of legitimate schemes.
The number of UK businesses using tax planning schemes to reduce their tax bill rose by over one third in the year to October 2012, according to research by the law firm Pinsent Masons. The research is based on the number of UK corporates declaring their use of corporate tax avoidance schemes to HM Revenue and Customs (HMRC). The use of 1,862 such schemes was disclosed to HMRC in the year ending March 31, 2012. This figure is 36% higher than the 1,371 schemes declared in the 2010/11 financial year. It is also more than five times higher than the 351 schemes declared in 2007-8.
As Ray McCann, Director at Pinsent Masons, explained: “The Directors of UK corporates have a fiduciary obligation to their shareholders to ensure that they are not paying more tax than is legally due, and in difficult trading conditions chief executives and financial teams are under lots of pressure from shareholders to boost post-tax profits. Reducing the effective tax rate is often seen as part of this.”
McCann added that many of the schemes reported to HMRC are likely to be legitimate, and legal, tax planning arrangements. He believes that there has been a decline in the use of abusive avoidance schemes because companies are aware that HMRC will challenge them on such activity, with the full support of the courts. Pinsent Masons's research also found that the number of tax avoidance schemes blocked by legislation had fallen to just nine in 2010-11, from 18 in 2009-10 and 173 in 2006-7.
“When it comes to avoidance, very many businesses are making sure they do everything completely by the book even if it means over-reporting. In the long-term this could cause problems for HMRC if more and more taxpayers disclose a substantial number of everyday tax planning arrangements that HMRC would not be expected to challenge," McCann concluded.
Governments are also turning to general anti-avoidance rules (GAARs) in a bid to root out unacceptable forms of tax planning, but they are controversial and by no means a panacea.
The main issue with GAARs is where the line between acceptable and unacceptable schemes is drawn. The United Kingdom, one of the latest jurisdictions to introduce a GAAR, claims to have given its new general anti-abuse rule (a name selected to emphasise its targeted approach) narrow application so that only the most abusive forms of tax planning are caught. Whether the legislation achieves this goal has been subject to much debate, however.
Last April, ahead of the introduction of the UK GAAR on July 17, 2013, guidance was published by HMRC which courts will be required to take into account when considering cases brought in relation to the rule. The guidance, which is supposedly written "in layperson's language," summarizes what the GAAR is designed to achieve and how HMRC intends to achieve it. However, the document explicitly rejects an approach seen in past court judgments, in which tax avoidance within the letter of the law was allowed to stand, and cautions that: "Taxation is not to be treated as a game where taxpayers can indulge in any ingenious scheme in order to eliminate or reduce their tax liability." Instead, there is now a statutory limit that is reached "when the arrangements put in place by the taxpayer... go beyond anything which could reasonably be regarded as a reasonable course of action."
However, it is this so-called “double reasonableness” test, central to the UK anti-abuse rule, that is causing the most concern in the tax advisory community, because, given the current climate of hostility towards tax planning, what is seen as “reasonable” in the context of tax planning today is possibly a lot different to what it was a few years ago.
On the other hand, some contend that the GAAR does not go nearly far enough, especially as tax planning by multinational corporations was left out of the scope of the rule.
A very similar kind of debate has delayed the introduction of a GAAR in India. Drafted in the wake of a major court victory for Vodafone in its long-running dispute with the Indian tax authorities, the GAAR was primarily designed to prevent the use aggressive tax avoidance techniques by multinational corporations. However, the rule was put on hold following concerns that it gave too much discretion to the tax authorities, was retrospective in effect and would be used to generate revenue rather than as a deterrent to aggressive tax avoidance. Some significant changes have therefore been recommended by a committee set up to examine the proposals, including that the burden of proof be placed on the tax authorities, not the taxpayer.
The perennially delayed GAAR looks set to finally enter into force in India from April, 2016 according to a government notification issued in September 2013. Finance Minister P. Chidambaram has said that the "basic thrust and purpose" of the GAAR will mean that "impermissible tax avoidance arrangements will be subjected to tax after a determination is made through a well laid-out procedure involving an assessing officer and an Approving Panel headed by a judge."
Importantly, the GAAR will not be applied to investments made by foreign investors prior to August, 2010, or to business arrangements where the arising tax benefit for all parties does not exceed INR30m (approx. USD475,000). Foreign institutional investors who have availed of the provisions of one of India's double taxation avoidance agreements or the double tax rules set out in the Income Tax Act will also be exempted from the GAAR.
GAARs are supposed to generate more tax certainty by providing a single interpretation of what constitutes unacceptable tax planning. Both the UK and Indian examples demonstrate however that they often create more uncertainty rather than less.
Survey after survey of company tax and finance executives shows that transfer pricing is considered the greatest tax risk facing multinational companies, and it is true that tax authorities the world over are scrutinizing intra-company transactions as never before.
Ernst and Young's 2013 Global Transfer Pricing Survey corroborated these findings, with the results showing that companies are experiencing a significant increase in unresolved transfer pricing examinations and facing increased penalties and interest when tax authorities formulate assessments.
Nearly half of the survey respondents (47%) reported experiencing double taxation as a result of a transfer pricing audit. Twenty-four percent of parent companies reported being subject to tax penalties in the past three years, in comparison with 19% in the 2010 survey and 15% in a 2007 edition of the survey. Sixty percent of parent companies are also paying interest charges as a result of transfer pricing adjustments.
E&Y’s findings were echoed by a KPMG survey carried out during its recent 2013 Tax Summit in Orlando, Florida, which indicated that the major global concerns of United States tax professionals are corporate tax reform and the rigorous pursuit of transfer pricing adjustments by foreign countries.
"It's clear from our survey that tax department leaders are focused on how to manage in the persistent and active regulatory environment in transfer pricing and are also devoting increasing attention to how changes in US tax legislation will affect their global operational decisions," said Jeffrey LeSage, vice chairman of KPMG's US Tax practice. "We believe that these and other key tax issues will present US companies with challenges and opportunities as the global business landscape continues to evolve."
Meanwhile, national transfer pricing rules have been firmed up in some countries, while others are considering changes to regulations, usually with the aim of tightening up existing transfer pricing frameworks.
In its latest report, the French General Inspectorate of Finance (IGF) has put forward a raft of recommendations aimed at strengthening existing transfer pricing rules applicable to international groups in France, to better combat tax optimization and avoidance by multinational companies.
The IGF was tasked with comparing international practices used to prevent tax optimization and avoidance via intra-group financial and economic transfers. On the basis of its analysis of regulations currently in place in the US, the UK, Germany, and the Netherlands, the IGF advocated a series of measures to reinforce the French Tax Administration's own arsenal in the area of transfer pricing.
In September 2013, the Indian Government unveiled the final version of its new transfer pricing safe harbour rules, just one month after the Finance Ministry launched a consultation on draft proposals.
This rapid progress is in contrast to the more protracted process of reforming India's transfer pricing rules that has been underway since 2009. That year's Finance Act stipulated that the calculation of an arm's length price was to be subject to safe harbour rules. No agreement could be reached on what shape the new regime was to take, and eventually a committee was established in 2012 to draw up provisions.
The committee drafted safe harbours for the IT and ITES sectors, contract research and development (R&D) in the IT and pharmaceutical sectors, financial transactions involving corporate guarantees and outbound loans, and auto ancillary equipment manufacturers. The Government said last month that it had accepted the majority of the committee's recommendations.
Following the consultation, which closed on August 26, the Government has confirmed that the rules will be applicable for the five assessment years beginning in 2013-14. A taxpayer will be able to opt to use the regime for a period of their choice, providing that this does not exceed five assessment years.
From October 1, 2013, new laws will come into effect in Costa Rica regulating the prices of goods and services traded between related companies.
The new regulations apply to all Costa Rican companies buying or selling goods or services to related parties both at home and abroad.
Companies are expected to calculate which of their transactions need to be modified before filing their tax declarations for 2013, and next year all companies must conduct a formal study of all their transfer prices, the new laws state.
In reply to a recent question in the Legislative Council, Secretary for Financial Services and the Treasury, Professor K C Chan, confirmed that Hong Kong's Inland Revenue Department (IRD) has no imminent plans to change its current practices with regard to base erosion and profit shifting (BEPS) and transfer pricing.
Chan said that the IRD's current methodologies and practices adopted for dealing with transfer pricing issues follow the guiding principles provided in the OECD Transfer Pricing Guidelines, and that the regime has been operating well since implementation in 2009.
IRD, he confirmed, has therefore no plan at this juncture to change the current practices, but it will closely monitor international development in this respect, including OECD's discussions, with a view to assessing the need for introducing corresponding measures and consulting local stakeholders in due course.
One piece of good news for taxpayers with UK operations at least is that the duration of transfer pricing audits seems to be shortening.
HMRC’s latest transfer pricing statistics, covering up to the 2012/2013 tax year, show that on March 31, 2008, open enquiries were 32 months old on average (38 months for settled enquiries). On March 31, 2013, this was reduced to 18.6 and 24.6 months respectively. 98% percent of all cases open at the beginning of the 2009/2010 tax year had been settled by March 31, 2013.
One surprising aspect of the figures, given the growing awareness of transfer pricing issues, was the fact that the number of Mutual Assistance Procedures between HMRC and foreign tax authorities had not risen. Data also shows that some MAPs are much trickier than others. In 2012/2013, 50 percent of all MAP applications were resolved within 13 months. Overall, this figure rises to 21 months however. This shows how hard it can be to reconcile tax authorities when they disagree on transfer pricing matters.
Regarding new Advance Pricing Agreements (APAs), their number generally oscillates around 30 per year. Last year's data shows that 50 percent of all APAs were agreed within 15 months. Given that the average time needed to reach an APA was 26 months, a small number of complex APA cases could still take more than three years. Hence HMRC still recommends that UK businesses discuss APAs informally before making an official APA application.
The international aspect of corporate tax planning, of which transfer pricing is but one part, is of course a huge issue at the moment, and has been near the top of the agenda at recent meetings of the G20 nations.
In a report prepared for the G20 by the OECD in February 2013 entitled Addressing Base Erosion and Profit Shifting (BEPS), it was concluded that due to imperfect interaction between nations' tax regimes, and their extensive networks of double tax agreements, the global tax system has failed to keep pace with the changing needs of the 21st century in terms of mitigating corporate tax avoidance. These inadequacies, it concludes, have allowed multinationals to legitimately structure their tax affairs using profit-shifting arrangements to pay tax on their profits at rates as low as 5%, against the corporate tax rates of around 30% in place on fiscally immobile businesses in OECD member states.
The corporations that are the target of the anti-BEPS campaign of course have a duty to their shareholders to maximise profits and therefore minimise costs, of which tax is one. Still, some might disagree with the OECD’s assertion that they are paying single-digit tax rates. Indeed, a recent study by the US Government Accountability Office concluded that the effective tax rate paid by large US multinationals averaged 22.7% on 2010 income when state and local taxes, and unprofitable firms were included in the calculations. Large corporations also like to point out that they make substantial indirect contributions to national treasuries because of taxes paid by their employees.
Nevertheless, while the debate about how much multinationals should and do pay in tax could go on for a very long time, the fact is that the BEPS project isn’t going away. In July 2013, the OECD published its BEPS Action Plan, which is designed to "provide countries with domestic and international instruments that will better align rights to tax with economic activity." The OECD contends that the process of globalization, while beneficial to domestic economies, has opened up a number of opportunities for multinational enterprises to "greatly minimize their tax burden." The result is a "tense situation in which citizens have become more sensitive to tax fairness issues." In turn, governments are now required to "cope with less revenue and a higher cost to ensure compliance." The Plan therefore identifies 15 specific actions that supposedly should give governments the domestic and international mechanisms to prevent corporations from paying little or no tax. Particular emphasis is however being placed on the digital economy, transfer pricing, and “hybrid mismatch arrangements.”
The timetable that the OECD has set itself to achieve the goals of its Action Plan – 18 months to two years from the launch of the project – seems unrealistic given the amount of work involved, which will require legislative changes in many countries as well as new international conventions. Therefore, many observers doubt whether it is achievable. Nevertheless, it doesn’t alter the fact that in general, the tax planning landscape is changing, and the tension between government policies which, on the one hand, use tax breaks to lure multinationals, while on the other, encourage tax authorities to increase revenue at all costs, is creating a great deal of uncertainty. Regardless of this, the imperative for companies to minimize tax remains. These factors will ensure that adequate tax planning will be an even higher priority than usual in the future.
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