The Changing Global Tax Landscape

By Geri Westphal

Audit intensity is likely to increase as global tax authorities look to drum up revenue; companies must take precautionary steps.  

MNC tax structures have come under increasing review—if not outright attack—by tax authorities worldwide. A variety of tax and transfer-pricing initiatives, including most significantly the Organization for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) project, point to a changing global tax landscape that is evolving rapidly in a direction that will be disruptive to global treasury platforms. Are you ready for these changes?

In a recent discussion as part of the Spring 2015 T30-2 meeting, members heard from experts on the latest status of the OECD’s Action Plan and what treasurers should be focused on as their top priorities.

Action plan

As mandated by the G20, the OECD has created a 15-step action plan aimed at addressing many of the perceived issues with current international taxation rules. World governments are under fiscal pressure as a consequence of the fallout from the global financial crisis, and that, combined with the increased public and media focus on tax practices of US multinationals has triggered a call for action.

The OECD project is not so much about enforcement as it is about the general view that rules need to be refreshed and that the current international standards are outdated and do not adequately address modern business models in the digital age. The 15-step action plan is designed to provide concrete solutions to realign many of the existing international standards that today are perceived to facilitate profit shifting, allow “double non-taxation” and contribute to the erosion of domestic tax bases. These rule changes are being made now in real time and will take effect very soon, with the new country-by-country report most likely to have the earliest (and perhaps largest) impact on US MNCs.

Item 13 of the plan (see chart below), “A re-examination of transfer pricing documentation,” tackles country-by-country reporting and may be the most impactful. According to experts at the T30-2 meeting, it is the action item moving the fastest and may have the broadest adoption; and it almost certainly will have a very significant impact operationally and in terms of driving tax authorities’ risk assessment and audit behavior. “And it could impact many of the other changes coming up,” one expert at the meeting said.

This is because it will require global multinationals to report very detailed financial statistics on each of their foreign entities. For US MNCs this report will initially be sent to the IRS for further distribution to the appropriate taxing authority. According to one expert at the meeting, “You need to prepare. You need to do several dry runs and not just for the compliance piece but also for your supporting narrative in every jurisdiction. Everything must be aligned.”

Seems like a ways off

The OECD’s aim is to see the guidelines implemented for accounting periods in 2016, with reporting by the end of 2017. This means from a planning standpoint, it’s fast approaching and will require potential changes to any systems that gather information and report it to the IRS. The US announced it plans to implement this regulatory action for the 2016 tax year.

There’s some skepticism the deadline can be met. However, the consensus now leans strongly toward country-by-country reporting as all but inevitable, as well as other BEPS action points, including the re-examination of transfer-pricing documentation, limiting interest deductions, and developing a multilateral instrument.

On the reporting front there have been numerous efforts in the last five to 10 years by governments to increase the transparency of country-by-country reporting metrics such as revenues and profits, to determine more accurately just how much of MNCs’ taxable income is generated in their countries. And now the OECD’s BEPS plan is looking to work out these issues.

Transfer pricing has traditionally been the mechanism used to make that determination. It is the setting of the price for goods and services, as with third-party customers or suppliers, that are bought and sold between a parent company’s subsidiaries. Governments have voiced concerns that MNCs manipulate transfer pricing to allocate profits to jurisdictions with the lowest taxes. A country’s tax authority may see 20 percent of an MNC’s revenues and employees in its jurisdiction but only 5 percent of the taxable profits, prompting it to question the imbalance. Tax authorities, especially in developing countries have used information found in 10Ks to find those imbalances and spark audits, and the reporting stemming from BEPS could provide another source of such information.

Doesn’t look good either

The main factors prompting the BEPS initiative were the ultra-low tax rates paid by multinationals’ and governments’ search for tax revenues in the wake of the financial crisis. The BEPS initiative seeks to curtail government’s independent efforts to increase those revenues, and the complications and costs that accompany having to follow multiple tax regimes, by offering a common solution.

The US government has also had an interest in limiting “base erosion,” or the reduction of the national tax base through tax avoidance schemes. It has permitted US-based multinationalsto defer taxes on overseas profits, but it still views that tax revenue as its own, and it wants to limit other governments’ role in determining how they are taxed.

In the end, experts at the T30-2 meeting said the US saw it couldn’t prevent other countries from requiring this type of reporting, so it was better to play an integral role in the BEPS initiative, to ensure controls over the reporting and provide greater confidentiality and reduce the operational burden.

The original template, for example, had at least 19 reporting items and a lot of questionable relevance to the tax administrator and one expert at the meeting added that Treasury “pushed back hard” on that proposal “and what we ended up with was a template with seven items, provided by the parent company to the tax authority in its jurisdiction.”

Those items include an MNC’s revenue and earnings before taxes by country, the number of employees in the country, as well as assets, retained earnings and capital. US companies will provide the information to the IRS, which through its network of treaties and tax information exchange agreements will provide it to the countries in which a company has operations.

Although that information is supposed to remain confidential and be used only for risk assessment purposes, the tax experts agreed that foreign governments are likely to use it as fodder to prompt audits, and MNCs’ taxes abroad are likely to increase. One precaution suggested to members of the T30-2: make sure that an MNC’s operations in a country align with the transfer pricing documentation, to be as prepared as possible to challenge audits or adjustments.

unilateral movers

Meantime, companies should be aware that while the OECD is moving as fast as it can to rectify the inconsistencies in global taxation, many individual countries are moving ahead with some of the rules the OECD is working on and in some cases are far from consensus. These tax threats, often done or promoted in the heat of an election cycle in some countries, could lead to a balkanization of the global tax landscape.

As Pam Olson, US Deputy Tax Leader & Washington National Tax Services Leader at PricewaterhouseCoopers LLP, said in recent testimony before the US Senate Finance Committee, that “many governments have not waited for the BEPS process to play out and consensus rules to emerge.” If this continues, it will lead to chaos, Ms. Olson added.

“Harsh political rhetoric accompanying the effort has prompted some taxing authorities to seek an immediate increase in the tax paid by US companies through audit adjustment,” Ms. Olson said. “Others are using the BEPS project to advance a domestic tax agenda and to claim their ‘fair share’ of corporate tax revenues.

The risk inherent in this trend is that as soon as one country moves ahead of the OECD consensus process, others are spurred to action, not wanting to be left behind. As a result, the danger of ‘global tax chaos marked by the massive re-emergence of double taxation,’ of which the OECD Action Plan itself warned, may have markedly increased.”

with friends like these

In her testimony Ms. Olson pointed out that even US ally. the United Kingdom, is getting in the act of front-running the OECD. The UK has proposed “diverted profits tax” which was scheduled to go into effect in April 2015. Under the proposal, a 25 percent tax, which is 5 percentage points higher than the UK corporate rate, would be imposed on profits that are “considered to be artificially diverted from the United Kingdom.”

The DPT is something the OECD has been struggling with as it attempts to work out the details of the BEPS Plan. According to Ernst & Young, Australia says it intends to pursue a similar measure and several other countries may follow suit. Meanwhile, France is taking aim at e-commerce and Germany, Poland, Russia, Spain, Australia, Japan, India, Mexico, and Chile, have begun unilateral actions in the past year ahead of any formal consensus agreements under the OECD BEPS initiative.

So, as the OECD continues to roll out its Action Plan, US MNCs should pay attention to these parallel tax developments; and as far as the OECD plan goes, focus on the proposals that have already gained significant traction, including those deemed harmful to US competitiveness, like scrutiny of Patent Box regimes (see box below), hybrid mismatches that currently treat taxability differently (i.e., deduction/non-inclusion and double deduction), artificial avoidance of permanent establishment and interest deductibility.