Beware the Tax Man: How to Deal With New Global Rules and Audits in 2015

It’s not as if CFOs and tax directors don’t have enough to do. Over the next year or so, the OECD and G20 countries – their ranks include Australia, China, India, Indonesia, Japan, Korea, the US and European Union – will be requiring companies to report profits, taxes paid, number of employees and other data in every country where they conduct business.

“The concept of the country-by-country template,” reports Jess Martin, International Tax Senior Manager at Ernst & Young, “has been agreed by 44 of the G20 and OECD countries, which represent 90% of the world economy.”

There is a perception, whether that’s right or wrong, that large multinational companies operating across the globe have not been paying the right levels of tax

That’s just the half of it. The new and enormous paperwork is challenging enough, particularly for enterprises that still rely on spreadsheets to store financial data. More seriously, some corporations may find themselves having to pay higher taxes – and potentially back taxes and penalties as well.

That’s because the OECD/G20 initiative, known as the OECD/G20 Base Erosion and Profit Shifting Project or BEPS, aims to neutralize hybrid mismatches, address treaty shopping and other forms of treaty abuse, and minimize abuse of transfer-pricing rules.

Not that companies are necessarily deliberately underpaying or evading taxes, cautions Tony Cooper, who is an International Tax Partner at Ernst & Young. “We shouldn’t assume that they’re not paying the right amount of tax – this is something to be tested,” he says.

“It may well be that for many organizations with a robust business model, they are paying the right amount of tax in the right place. But we can’t speculate at the moment. History will show whether that’s correct or not, when we get through this process [of uniform country-by-country financial reporting] and the tax audits that will follow over the next three, four or five years.”

Cooper and Martin spoke to CFO Innovation’s Cesar Bacani on the progress of the BEPs project, the implications on companies in Asia and elsewhere, and advice on how CFOs can prepare their organizations for the challenges ahead. Edited excerpts:

Why are the OECD and G20 folks talking about ‘base erosion and profit shifting’?

Tony Cooper: There is a perception, whether that’s right or wrong, that large multinational companies operating across the globe have not been paying the right levels of tax. So revenue authorities want a set of rules that fit the modern age, so that they can be satisfied that they are getting the appropriate amount of tax paid.

It may be more than what’s being paid currently, or it may not be. At the moment, one of the issues is they don’t have confidence in the global tax rules, because they are rules that were created in an industrial age.

Is there basis for that suspicion?

Tony Cooper: That’s something we can’t really speculate on. What we do know is that one of the important things coming out of BEPS is that revenue authorities are seeking automatic exchange of information and price transparency on the taxes of multinational businesses, so they can understand the global value chain more fully.

And then they will develop a test to see whether the right amount of tax is being paid in the right countries. It may well be that for many organizations with a robust business model, they are paying the right amount of tax in the right place. But we can’t speculate at the moment. 

History will show whether that’s correct or not when we get through this process [of uniform country-by-country financial reporting], and the tax audits that will follow over the next three, four or five years.

We shouldn’t assume that they’re not paying the right amount of tax – this is something to be tested. One of the things the revenue authorities want is the tools to do that, and the information exchange will help them.

What the revenue authorities are looking for are more efficient audit selection to make targeted audits, gain a better picture of the global value chain of companies, and bring in more tax payments

Are there any practical effects on companies in Asia and elsewhere at this time?

Jess Martin: While the OECD does not make law, the concept of the country-by-country template, which requires multinationals to report profits, taxes paid, number of employees and so on in every country where they conduct business, has been agreed by 44 of the G20 and OECD countries, which represent 90% of the world economy.

So it’s expected that countries will act and adopt the country-by-country reporting recommendation.

Companies should evaluate whether they are in a position to provide the information requested in the country-by-country reporting. There is significant challenge associated with that in terms of compliance.

Many organizations are still relying on Excel spreadsheets to store their financial data and don’t have streamlined financial accounting software across the jurisdictions in which they operate. This is across the board from larger businesses to smaller companies.

Performing an analysis of how to extract and record the information required by country-by-country reporting is definitely an area that companies should focus on.

Have any of these 44 countries that have in principle accepted the template started requiring companies to report?

Jess Martin: So far [none of the countries] have changed their domestic law to adopt [the BEPS recommendations]. There are a couple of countries that have announced their intention to do so outside of Asia Pacific region, but so far no one has imposed these obligations yet.

Some countries have announced perhaps in 2015, others in 2016.

Legislation is needed for this? Can’t the tax authorities simply send out an administrative order requiring multinationals to submit a report?

Tony Cooper: If I think of the requirements in a country like Australia, it might not need an Act of Parliament, but you would need regulations, definitely.

At the end of the day, it’s a form-filling exercise and it’s similar to a schedule in a tax return. So at the very least it needs to be enacted by some form of regulation, some form of publication in a gazette.

Even if it’s not superior legislation, there will be some need for local recognition of the rules, so that they can be enforced against taxpayers.

Will each tax jurisdiction gain access to the country-by-country reports?

Tony Cooper: It’s for the revenue authorities to determine a mechanism to exchange information. Most of them are doing that under the provisions of double tax agreements. They will agree a framework to mutually exchange the information.

What the revenue authorities really are looking for from this is probably two things. They want more efficient audit selection, so that they can have more targeted audits and use their own resources better to get better audit outcomes. So not necessarily more audits, but certainly better audits.

And then through better audit selection, they hope that the extent of the information they get will give them a better picture of the global value chain of these companies.

As to whether, at the end of the day, that brings in more tax, that would depend on whether these businesses have [a robust or a weak] model.

Jess Martin: The exchange of information on tax matters has been endorsed by all 34-member countries [of the OECD], and in terms of Asia Pacific countries, include China, India, Malaysia and Singapore. It has been agreed that the information will be exchanged with tax administrations only, and will not be made available to the general public. 

If the exercise shows that companies are, in fact, paying the rights taxes across borders and therefore the tax take will not increase, what happens next?

Tony Cooper: It may be that [tax authorities] do many of these audits and get full information, and there still is not a lot of extra tax being paid. In which case, they may come back and change the law. And that is a valid response.

If companies are considering new investments or have business plans for the future, the tax assumptions need to be built around what the BEPS environment is going to look like, not what obtains today

Obviously, a consistent response by many of these taxpayers is that they are operating within the law in each of these jurisdictions that they do business. And many of these companies have advance pricing agreements in place with the revenue authorities.

So these things are going to be tested. If, at the end of the day, there still is not enough tax coming in, all that will be left will be to change the rules.

What else can companies do now to prepare for these things going forward? I know Jess has previously referenced the need for companies to make sure they have all the information required.

Jess Martin: They should also closely monitor the BEPS action plan, which can change the way they conduct their business, and the progress of changing the domestic law. It’s important that companies are proactively engaged with the OECD and the domestic government as these rules are adopted and developed.

In an era of increased transparency, which we are heading towards, the company should take [a consistent] approach in communicating tax-related information to external stakeholders. They should stay closely aligned with all the areas in their organization to make sure that they are delivering that consistent message in terms of their tax strategy and aligning with the business strategy.

Tony Cooper: The other thing that companies can do is to have an eye to the future. These BEPS recommendations do represent a real move to change. So companies with an eye to the future will review their current tax structure against their business model, which is also evolving because businesses and economies evolve. They're going to be reviewing their tax structure and seeing if it is fit for purpose for the future.

Some of the clearest messages out of BEPS are that there’s going to be changes in relations across borders in financing. So if companies are considering new investments now or they’ve got business plans for the future, the tax assumptions in those business plans need to be built around the BEPS environment.

They need to prepare for what it’s going to look like in future, rather than a snapshot of what we’re doing now. Some of the more pro-active companies are already doing that.

Do you anticipate that some companies may change their investment and business plans because of the changes from BEPS?

Tony Cooper: I think that’s not really a BEPS discussion. Business will always be located where it’s most competitive to operate, and and tax is only one of the costs of doing business.

If you look at what happened in the European Union when all those new countries joined, companies moved manufacturing, finance and so on because of a better regulatory regime, competition rules, employment law. Tax was just part of the mix.

I don’t think this is any different. Certainly no one’s going to be making radical decisions at the back of BEPS because at the end of the day they've got a business to run.

It will be more administratively burdensome to be doing all this reporting, though.

Tony Cooper: I don’t think there’s any question that this kind of activity creates compliance burden on these businesses, just in the annual compliance [with regards to country-by-country reporting] and also the audit activity that we’re going to see in the next five years. That is a cost that these businesses will have to bear.

The OECD thinks that the inappropriate use of financial instruments and tax treaties has created a risk of double non-taxation of income, but it also wants to make sure that it does not create a situation where companies suffer double taxation

But will the transparency that results as well as the uniformity of rules help simplify the way tax management is done in the companies themselves?

Tony Cooper: We hope so, eventually. Certainly, one of the goals of thee revenue authorities is to have more efficient tax audits and more efficient audit selections. It’s not really in their interest to make things harder for themselves to actually conduct these audits.

But there will be a lot of learning along the way. It will be harder before it gets better, that’s usually the case.

Jess Martin: There could be more activity in the tax controversy area. Some economies are beefing up their talent pool in their respective fiscal authorities and are also automating their collection and evaluation of company data.

EY conducted a 2014 global survey on VAT [value-added tax] and GST [goods and services tax] electronic filing and data extraction. The 69 countries reported that their tax administration extracted this data electronically from taxpayers’ ERP system to conduct audit and identify errors. So there is an investment not only on the talent pool but also on the technology side to make the [government] audits more efficient.

The BEPS report says that with the adoption of the first set of deliverables, “hybrid mismatches will be neutralized; treaty shopping and other forms of treaty abuses will be addressed; abuse of transfer pricing rules in the key areas of intangibles will be greatly minimized.” Are companies really doing all these unsavory things?

Tony Cooper: That’s a really interesting question. We had Pascal Saint-Amans talk in our tax symposium yesterday – he’s the Director of the OECD’s Center for Tax Policy and Administration and the driver behind this [BEPS] project.

He highlighted that the inappropriate use of financial instruments and tax treaties has created this risk of double non-taxation of income. But he was pretty clear that countries address this mainly through Action Points Two and Six [in the BEPS plan], they must also ensure that they do not create a situation of double taxation.

The global tax system is a network of separate tax systems and economies and that leads to these mismatches and inconsistent tax treatments across borders. The BEPS project seeks to address the misuse of these inconsistencies, but equally, Pascal was really clear that they do not want to create situations of double taxation that could arise because of the same inconsistencies.

So if I am a company that deliberately takes advantage of the inconsistencies to not pay tax, I should probably think twice about continuing this going forward because I’ll get caught.

Tony Cooper: I don’t know if it’s a question of being caught. At the end of the day, these businesses are all very transparent. But obviously, they got structures, and these structures in place are complying with the tax laws of the country they’re operating in.

And they’ll be tested. If they can no longer fit for the purpose for the future, they’ll change.

There’s no question of any lack of disclosure here or lack of transparency or evasion. This is just about governments not being happy with the operation of the current tax rules and the need to change. 

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