The emergence of tax-related risk
Tax risk is certainly not new, but it has begun to loom much larger over the last few years. The onset of BEPS, which the various countries are gradually transposing into their national legal systems will, paradoxically, only complicate tax management, rather than making it simpler. Simplification, however, was one of its original goals. This is undoubtedly a tax revolution rather than a tax evolution, and will bring pluses and minuses with it. But one thing is certain, the greater complexity of tax management will crystallise this risk while at the same time increasing it. Treasurers will also be involved and severely impacted.
The art of managing tax risk has become more complex than ever before. Keeping control over the risks that come with taxes of all types, both direct and indirect, is indisputably a greater challenge than anyone imagined when the OECD and Mr Saint-Amant published the famous fifteen BEPS (Base Erosion Profit Shifting) Actions. An incredible paradox! They were trying to simplify tax rules that were thought to be too complex and to have too many loopholes, and they end up with the risk of a situation that is even complex than it was before. The old saying "don't over-egg the pudding" would seem to apply to tax, too. The BEPS recommendations have fundamentally changed the approach to tax, which now becomes all-embracing and global, and which advocates total transparency and full and comprehensive reporting. Non-compliance and its consequences, including the possible impact on reputation, make the blood of tax managers and C-level officers in every multinational corporation (MNC) run cold. This development in taxes became necessary as a result of the worldwide financial crisis, bottomless government deficits and the excesses of overly aggressive and creative tax advisers. The digital revolution was the icing on the cake, making it essential to review the historical models to enable taxes to be collected when confronted with the new intangible assets being created.
“The BEPS recommendations have fundamentally changed the approach to tax.”
Seeing tax slip through their fingers
Governments were confronted with the risk of seeing taxes slip through their fingers. The approach to tax now needs to pass through the prism of absolute transparency. If everything is transparent, as if by magic, there will no longer be any artificial structures (or at least fewer of them) set up to evade taxes or mitigate them. This tax risk is still a no-go area, and seeing it come out into the light of day now reminds us of how crucial and complex tax strategy is becoming. The public relations message about it has to be handled with kid gloves, with the overarching aim being not to be held up as an example of malpractice. Reputations are affected, even if no tax fraud is established. And the various cases that the European Commission has singled out reminds us that, when it comes to taxes, for a quiet life you need to keep your head below the parapet, or even better stay completely below the radar. BEPS was intended to simplify taxes (amongst other things) by heaping opprobrium on double non-taxation structures and other hybrid instruments. With transparency, many more companies risk being seen as CFCs (Controlled Foreign Corporations) and of being faced with tax demands from various tax authorities. Each one wants to go right back to the ultimate source, to ensure that tax has indeed been received by the others. In a world of BEPS, corporate tax also becomes a key criterion in choosing the location of treasury management centres, and there is a danger of a "tax war" breaking out between countries, within the European Union itself. Taxes are becoming a maze, an inextricable labyrinth of twists and turns, because everyone wants their fair share and proper slice of the cake.
Nothing will still be as it was before
Transparency, consistency and substance are the watchwords under BEPS. Brexit and the reaction that may be expected from the UK, which will wish to reduce its corporate tax in response, and Trump's tax reforms in the US, will add an additional degree of complexity to the situation, without any doubt. Some companies will be tempted to relocate in an attempt to give more substance to whatever place they claim to operate in. On the other hand, the pseudo-holding companies and "non-permanent establishments" will disappear, as will structures artificially contrived to mitigate taxes. No, it is a certainty that nothing will be the same as it was before. In a digital world, in the throes of change, dematerialisation needs to be addressed to avoid losing control over the taxation of revenues generated in a country (e.g. 2017 VAT changes to intangible rights). BEPS is therefore much more than just a tax issue. It goes far beyond that.
“The approach to tax now needs to pass through the prism of absolute transparency”
Ensuring that people don't start talking about you
Companies have found, in this world of wolves ravening for taxes to plug their deficits, that naming and shaming can do a great deal of harm. The cases that the media have latched onto, such as Google, FIAT, Starbuck, Apple, etc., still leave their mark, even if the companies are not found guilty. Being named in the press for breaking tax rules is very much frowned upon. Stakeholders are putting more pressure than ever on companies to force them to be tax compliant. These days, people take a dim view of those who stray from the straight and narrow. Seeking ways of mitigating taxes has now become dangerous. The tax authorities in every country have become scrupulous, meticulous and meaner. You have to be squeaky clean and explain everything, or at least be able to do so. Transfer pricing, making decisions on the permanent establishment concept, restricting the deductibility of interest, restricting the use of losses carried forward and the prescribed comprehensive documentation, amongst other things, make tax risk a major risk.
There is also a feeling that jurisdictional risk is shifting back to the developed countries. This is due to the adoption by these countries (particularly the G20 countries) of the OECD rules on taxes, and by the requirement for greater budgetary responsibility, which involves additional types of tax and better collection of existing taxes. However, Trump's tax reforms could also have serious consequences given the influence of the USA on the world economy. At this stage, this proposed gargantuan reform gives rise to a barrel-full of uncertainties as to what turmoil it may eventually produce. Treasurers need to keep a very close watch on this matter. The debate on what a fair share of tax might be is continuing to attract a lot of attention and some stakeholders are encouraging MNCs to publish as much information and tax data as possible, country by country and business by business, to be as clear, as transparent and as honest as possible. With a subject that is as off-limits as tax, it really hurts to bring everything out into the light of day, and culturally it is no easy thing for management to deal with this subject in its annual report.
“Preventative tax measures will take over from the former approach of simply reacting after an investigation.”
Over-egging the pudding is self-defeating
As always, trying to achieve too much is self-defeating and the backlash could be dangerous. Moving from a certain degree of opaqueness to absolute transparency is a tricky exercise. The way the public relations message is presented becomes very important. With BEPS, interest will no longer be fully deductible because it will be capped. To achieve the best tax situation for the group, it will be necessary to schedule cash flows and to capitalise subsidiaries appropriately. The number of tax disputes will certainly increase. To avoid or avert them, APAs (Advance Pricing Agreements) will have to be negotiated to keep down future transfer pricing risks. Unfortunately, it takes time to negotiate them and renew them as time goes by. With BEPS, it is also important to build up a greater amount of mutual trust between companies and the tax authorities. The best behaved pupils will be identified quickly and looked after. Virtue in tax and total transparency will benefit those the companies that practice them. But it is reasonable to suppose that we will be paying more tax overall in the future. The mass of documents and sets of forms to be produced will increase disproportionately – for example, the famous country-by-country reporting, or comparative transfer pricing documentation for intercompany loans. Information systems will have to be adapted in response to this so as to produce, easily, the required reports and substantiating documentation supporting and justifying your transfer pricing strategy and intra-group operating margin.
BEPS contains positive points and other less beneficial features
If I had to give advice about a gradual approach, I would suggest starting with: (1) clearly defining the strategy and approach to managing taxes. How are we to prepare ourselves for "more aggressive" and more numerous demands from the tax authorities? What is the reputational risk appetite as regards taxation? This is usually defined as being zero. How are we to oversee and monitor it, and also to produce the data required by the tax authorities? How are we to handle the potential tax disputes that will inevitably arise, and anticipate and mitigate the risks deriving from tax audits and investigations. The tax authorities are themselves also becoming more sophisticated everywhere, and equipping themselves with tools to collect taxes better. We have to adapt and take on staff, particularly treasury staff, and give them adequate training to meet the growing needs. It is vital to keep the C-level properly informed, together with the Board of Directors, to give it the reassurance it looks for (3). The public relations message will be crucial (4) both in content and in form. Politicians and the general public have started to pay very close attention to taxes, showing zero tolerance. There is no longer room for DIY and amateurism. I take the view that we need to adopt a global and coordinated policy on how to handle tax controversies. In a globalised world in which all information is accessible to everyone, even the tax authorities, and spreads like wildfire, it is a good idea to be very cautious and opt for a coordinated approach by a specialist team to prevent any risk. There will be regular tax audits, particularly into financing and treasury management, to identify areas of possible danger. Preventative tax measures will take over from the former approach of simply reacting after an investigation. We can no longer wait and see what happens, we have to be proactive and maintain a continuous watch. After that, the computerised tax authorities and the greater sophistication of tax inspectors will increase the need for appropriate IT tools. These IT applications will be able to compile information, process it, and analyse its potential impact. It will be useful to be able to trace transactions and manage databases of historical data. Then come (5) the Alternative Dispute Resolutions to estimate and evaluate the risks connected with agreements such as APAs, rulings, etc., and how potentially to reduce the risks for the business in the future. It is important to have a strategy on anticipating tax risks and on how to address them during tax investigations. Similarly, it is a good idea to build up mutual trust based on a track record of good relations with the tax authorities. Using mediation might be advisable, for example with MAPs (Mutual Agreement Procedures). Preparing the required reports properly should reduce future risks. And finally (6), it involves deploying people, resources (internal and external), processes and technology. BEPS requires greater staffing to meet the demands. You would be well advised to design regular reports and performance indicators for management and the audit committee to keep them informed of the status of tax matters.
“It is therefore clear that BEPS is much more than just a simple tax issue.”
BEPS, more than just a tax issue…
It is therefore clear that BEPS is much more than just a simple tax issue. As regards the financing aspect and in-house bank transactions, it is the responsibility of the CFO, of tax department and treasury department to ensure they are able to produce the material required to substantiate their tax strategy and their transfer prices. Surely BEPS is just a catalyst, the spark that puts the spotlight back on tax risk? This risk is intensified and returns to centre stage for the CRO (Chief Risk Officer). Over to you to be meticulously prepared. No, in tax matters, it is absolutely certain that nothing will ever again be the same as it used to be. The word "taxes" will cause tax managers and treasurers to lose sleep for a long time to come.