By Alison Jackson
As globalization has changed the way business is conducted, it has also generated tax risks for organizations.
Macro factors such as globalization, sweeping changes to financial reporting regulations and media scrutiny have elevated the profile of tax risk to the board and stakeholder level. As a result, tax authorities and other international taxation stakeholder groups around the world have been collaborating on issues of increasing relevance for global multinational organizations. With the recent base erosion and profit shifting (BEPS) initiative championed by the OECD, tax functions around the world are beginning to predict their new reality and consider their next steps.
In 2003, an article on globalization in The Economist predicted that multinational businesses would continue to shift key business functions from head offices, outsourcing key business processes to the developing world and integrating global resources more effectively. Ten years later, these predictions are a reality, resulting in significant changes to the way business is conducted. Global tax functions have responded well to these changes, both in terms of aligning with business to support growth in new jurisdictions and identifying tax planning opportunities related to these changes. However, working with emerging tax regimes, managing the dispersion of key business functions and keeping up with changes in business models have generated tax risk within global organizations.
As globalization was changing the way business was conducted around the world, financial reporting regulators were addressing business risks by mandating common approaches to risk management and increasing reporting requirements. The Sarbanes-Oxley Act was introduced in the US in 2002, FASB Interpretation No. 48 was issued in 2007 and senior accounting officer sign-off rules were adopted in the UK in 2009. Again, tax functions rose to the challenge of increased reporting requirements, inventorying tax risks and communicating directly with stakeholders about those risks. But the shadow of tax risk continued to grow. In 2010, media carried stories about “unfair” advantages enjoyed by corporate taxpayers and tax risk moved to the forefront. By naming the corporate taxpayers who enjoyed these “unfair” advantages, tax risk was aligned with reputation risk and elevated for even further discussion at the board level.
But corporate tax functions have not been alone in their response to the momentum behind tax risk. For many years, tax authorities worldwide have been communicating more frequently and collaborating on issues of increasing relevance for global multinational organizations. In July 2002, the Forum on Tax Administration was established, bringing together tax commissioners from more than 40 OECD and non-OECD countries to share information and experience and to identify international good practices for resolving particular administration issues. In 2004, the Joint International Tax Shelter Information Centre was formed by the tax commissioners of Australia, Canada, the UK and the US to deter promotion of, and investment in, abusive tax schemes with the exchange of information and knowledge. In 2009, the OECD announced an Information Exchange Peer Review mechanism, and the Global Forum on Exchange of Information and Transparency for Tax Purposes started to monitor the implementation of a standard through peer reviews. Also in 2009, G20 leaders pledged to take action against tax havens as part of a package of measures to respond to the financial crisis and the OECD secretariat provided a report on progress by world financial centres toward implementation of an internationally agreed standard on exchange of information for tax purposes. Prior to the G20 meeting in April 2009, a total of 44 tax information exchange agreements (TIEA) had been signed. Since then, the number of TIEAs continues to rise, with almost 800 in effect today.
In September 2010, the OECD’s Forum on Tax Administration published a communiqué discussing ways in which two or more tax administrations could construct a joint audit of a single company or individual with interests in multiple countries. In December 2010, the Council of the European Union in Brussels agreed to an expansion on exchange of tax information, allowing member states to make administrative inquiries on tax in the territory of another member state and removing the option for a member state to refuse a request for information on the basis of bank secrecy. In June 2011, the OECD announced that the Multilateral Convention on Mutual Administrative Assistance in Tax Matters was open to all countries, thus creating an international framework for cooperation among countries in countering international tax avoidance and evasion, and reflecting the growing recognition that tax administrators are increasingly viewing global companies through a global lens to be more effective in their enforcement efforts.
On Feb. 12, the OECD published its widely anticipated initial report on BEPS by multinational enterprises. The BEPS project is being driven by governments of key OECD member countries, including France, Germany, the UK and US, and it is strongly endorsed by the G8 and G20. On July 19, the OECD released its BEPS action plan, laying out 15 focus areas for the next phase of its BEPS project. The 15 areas include tax challenges of the digital economy; hybrid mismatch arrangements; controlled foreign corporation rules; deductibility of interest and other financial payments; harmful tax practices; treaty abuse; artificial avoidance of permanent establishment status; transfer pricing for intangibles; transfer pricing for risks and capital; transfer pricing for other high-risk transactions; development of data on BEPS and actions addressing it; disclosure of aggressive tax planning arrangements; transfer pricing documentation; effectiveness of treaty dispute mechanisms; and development of a multilateral instrument for amending bilateral tax treaties.
The action plan includes deadlines that range from September 2014 through December 2015. A communiqué issued from the G20 finance ministers meeting on July 20 states, “We fully endorse the ambitious and comprehensive Action Plan submitted at the request of the G20 by the OECD aimed at addressing base erosion and profit shifting … and commit to take the necessary individual and collective action with the paradigm of sovereignty taken into consideration.”
While there is much debate over the extent to which the objectives of the plan will come to fruition, one thing is certain: the future of international tax is changing. To address the tax risks created by the plan and other global changes, leading global organizations are focusing on the following four areas:
Reviewing risks and communicating with stakeholders — based on the breadth of action items in the plan and the trend toward increased global coordination among tax authorities, the risk profile of many traditional international tax planning arrangements may be changing. Global tax functions need to articulate what will happen to their tax accounts if these changes become a reality. To do this, leading tax functions are undertaking a review of risks to identify the aspects of the plan that have the greatest potential impact on their business and their existing tax planning arrangements. With this information, leading tax functions are also working to develop insightful interaction with the CFO, setting the stage for sharing tax risk management issues globally and in real time. With the support of the CFO, leading tax functions are also taking the lead to engage with the board on a two-way exploration of risk factors and best practice alternatives related to the plan and other global trends.
With the heightened sensitivity to tax risk, an opportunity also exists for the tax function to lead the audit committee through its risk assessment of the tax function, including communications about the company’s tax strategy and propensity for risk; tax processes and controls that enable the company to effectively meet its tax compliance and reporting obligations; summaries of all taxes paid by the company; the level of tax paid in all jurisdictions and the extent to which it is in line with business results; the extent of reliance on professional service providers; the extent and use of the company’s internal tax resources; the actions being taken to develop or improve relationships with tax authorities; and the procedures taken to ensure that external information about the company’s tax position is appropriate and consistent, not only in the annual report but also on the company’s website, in press releases, in recruitment advertising and in other communications.
Investigating reporting options — risk reviews related to the plan will often predict additional tax costs. While tax functions may minimize the plan’s impact with additional planning when the parameters of the plan are more fully developed, the results of the risk review will undoubtedly attract attention and leading tax functions want to understand how to effectively communicate with stakeholders about tax costs. Integrated reporting (IR) or stand-alone reporting are options to consider.
Similar to tax risk, IR is gathering momentum on the global stage. An integrated report is a concise communication about how an organization’s strategy, governance, performance and prospects lead to the creation of value over the short, medium and long term. The first corporate integrated report was produced in 2002 and there has been much discussion since then on a global framework for IR.
In 2010, the International Integrated Reporting Council was convened to help businesses and investors adopt IR. In 2011, feedback from a discussion paper issued by the council demonstrated overwhelming support for IR and endorsed the development of a global framework. Currently, companies are considering ways to use IR to provide stakeholders with critical information about the company’s economic and social contributions, including investments in the community, impact on small businesses, volunteer contributions, educational programs, environmental stewardship and taxes paid.
The most prominent example of stand-alone tax reporting is Rio Tinto’s annual Taxes paid — A report on the economic contribution made by Rio Tinto to public finances. As part of its commitment to transparency, the report brings together information on payments the company makes to governments in the countries it operates in, as well as the taxes and net earnings of business units and other tax information.
The report discloses total cash taxes paid, advocates for companies to make effective disclosures voluntarily and advocates for governments to work together to adopt a global approach to transparency initiatives.
Both IR and stand-alone reporting are emerging trends. Leading global tax functions should consider communicating with stakeholders about both options and developing a plan for supplemental tax reporting that is right for the organization.
Embracing transfer pricing strategy to drive competitive advantage — if certain aspects of the plan move ahead as contemplated, transfer pricing strategy and other business-driven tax planning initiatives will drive competitive advantage from a tax perspective in the future. In the past, tax functions have strived to align with business activities, educating stakeholders as necessary and providing support where possible. In order to be successful in the new paradigm, leading tax functions may strive to more fully integrate the tax function with business activities, beginning with education to build the “halo” tax function in all areas of the business, developing communication protocols to identify opportunities as they arise, and hiring or developing the right resources to drive value from these new opportunities.
Aligning the tax risk management framework with global trends — taking into account the BEPS initiative and current trends around transparency among global jurisdictions, leading tax functions are finding new ways to monitor global developments relevant to their risk framework and synthesize results of their monitoring activities with global risk assessments, including communicating with stakeholders about significant changes. Leading tax functions are also investigating ways to participate effectively in discussions regarding international tax policy issues, both with the OECD and with policymakers in the countries they operate or invest in. In order to do these things, leading tax functions are aligning more strategically with globally integrated service providers and articulating the value proposition associated with this alignment more frequently in terms of risk management. In particular, leading tax functions are looking to global service providers who can conduct initial comprehensive risk reviews, take shared responsibility for monitoring global trends and interpreting their implications on existing planning arrangements, and enhance collaboration with tax authorities in the countries where they operate or invest.
Like global demographics, transparency and global collaboration related to taxation appear to be irreversible trends, adding significant tax risk to global organizations. Leading tax functions must act now to respond effectively to these changes in terms of tax planning, tax risk management and related communications with stakeholders.
Alison Jackson is partner, tax, with EY in Calgary
Technical editor: Jay Hutchison, tax managing partner, Canada, EY
This article was originally published in the December issue of CAmagazine.