Ernst & Young’s European Tax Symposium: highlights – part 2February 4, 2013
Lisbon, Portugal — 14 June 2012
Our panelists discuss the dramatic rise in tax enforcement, with the focus now on perceived aggressive tax planning by corporations.
This article was first published in the Ernst & Young Global Tax Policy and Controversy Briefing, Issue 11, December 2012 (pdf, 4.26 MB)
About our panel
- Stephan Kuhn (moderator) is Ernst & Young’s Europe, Middle East, India and Africa Tax Leader.
- Chris Sanger is Ernst & Young’s Global and EMEIA Tax Policy Leader.
- Jeffrey Owens is senior policy advisor to Ernst & Young’s Global Vice-Chair of Tax Services.
- Debbie Nolan is Ernst & Young’s Americas Tax Controversy Leader.
- Klaus von Brocke is Ernst & Young’s EU Direct Tax Leader.
Digging into territoriality
Stephan Kuhn: Chris, you mentioned territoriality. This is also a clear trend and I think, if I understand you correctly, you say “of course every country wants to tax whatever they can and it’s becoming less and less possible to do this.” Of major countries, only the US, China and Korea are still maintaining worldwide taxation. How long can we expect that to last and will there be a continuing trend to territoriality?
Chris Sanger: I guess this one comes back down to that argument that if a company has to be headquartered in a country, then ultimately you can afford to tax the world. But as we’ve seen with globalization there’s a much greater mobility of corporates and they are increasingly moving headquarters locations.
The international, non-territorial, worldwide system basically encourages you to only do activity in that country. What we’ve seen with Japan’s partial exemption and the UK full exemption, all is that if a country is going to be attractive and want to be the gateway, such as the UK into Europe, or Japan into Asia Pacific, it needs to make sure that it is imposing a cost that is commensurate with the benefits it brings. That means you’ve got to move to a territorial regime.
But what is territorial? You’ve got the question of dividends coming in. That’s fine. But all the moves we are seeing around interest deductibility and CFC’s are all part of this too. So there’s a much bigger story, I think than just whether you are in a worldwide system or just taxing on an exemption basis.
Jeffrey Owens: It’s a question of “where do you want to be on the spectrum?” It’s not a choice of pure territorial or pure worldwide. It’s where do you want to be, in the middle? To the left side or to the right?
Chris Sanger: And I think if we look to the CFC’s legislation, the UK is basically saying, “I’m going to protect my borders, but I’m going to release everything else.” And that’s all intended to make people want to come to the UK. But the big thing that’s going as a counter-trend to this, I think, is interest deductibility. The European master plan for a corporate tax system, the CCCTB, is now being proposed to have some restrictions on interest deductibility, very much akin to the ones we see in Germany.
That’s designed to make sure that you are only getting relief for interest against your activities that are undertaking in country. So it fits very much with the territorial regime. But the UK approach is actually completely the opposite. One of the Ministers said he wants to make the tax system once again an asset to draw businesses to the UK, so the UK on interest deductibility is saying, “We can have your whole global interest deduction in the UK, even if it’s funding activities outside of the UK”.
So we are seeing two very different trends play out. We’ve now got many European countries looking at a kind of austerity package, trying to control the deduction, perhaps using that to fund lower tax rates. But then you’ve got the UK at the edges of Europe saying, “We’re going to use this as an attractive tool to bring business.” I think this will be really interesting to watch play out, because you have got two very different trends.
The UK almost being the only outlier there, and whether more come to its side or whether they follow the recommendations of the European parliament and the CCCTB model, I think is something that’s going to be really important for companies around Europe.
Stephan Kuhn: Jeffrey, back to you, we see also a trend that there are more anti-avoidance rules being proposes and enacted, particularly in the area of General Anti-Abuse Rules (GAAR). What are you seeing?
Jeffrey Owens: You know, I can’t resist it when someone says GAAR to me, it sounds aggressive already! A few points though; one, GAARs have been around for a long time. What’s interesting is that there is a different group of countries coming on the scene now and saying, “Maybe we should do this.” You look at the diversity.
You know, on the one side you have India and then on the other, the UK. Two very, very different countries. But my expectation is that we will see more and more countries actually going down this path, in part because they see this is the way to counter abusive schemes, in part because, I think, they are just afraid. They are afraid of whether they can they keep up with tax planning or not.
The second thing that’s important to recognize is that there is not one single, unique model for GAAR. You have other GAARs that are primarily directed at dealing with both tax evasion and tax avoidance. On the question of indirect transfers of assets, again we are all tending to focus on India, but let’s get real — there are other countries. China has a very similar provision in Circular 698 and they are beginning to use it.
What’s been interesting is that a number of OECD countries are looking at India and saying, “Maybe they have a point. What would I have done if I were the Indian tax authority?” It’s actually surprising that they went it alone and didn’t go to the OECD and said, “Let’s have a general rule.” That way, you multi-lateralize it and I think that’s where it is going to end up, as it happens.
So this debate is not going to be limited to one country. I think there’s going to be a debate in how do we deal with these types of offshore transfers.
Debbie Nolan: I think just the discussion and the debate that we have about whether GAAR is anti-avoidance or anti-abuse lends itself to a considerable amount of uncertainty. So you might have legislation or even a policy that introduces a GAAR, but how it’s administered by the tax authority is in question and leaves a lot to be desired as far as guidance and controls.
Indirect taxes, transfer pricing
Stephan Kuhn: So, a lot of change is happening in a lot of different areas. I think to end up the discussion around what legislation changes will we see, I’ll return to you, Jeffrey, and ask, How much of a further shift to indirect tax will we see? And of course, we’d be missing a hot topic if we didn’t cover how the transfer pricing environment might change in the coming years.
Jeffrey Owens: In indirect taxes we have definitely gone through a revolution. In two generations, we’ve moved from six countries having a VAT to more than 160. It can’t be that bad.
It’s not fool-proof but, for government, it’s a money-making machine. So not only have you seen more and more countries actually putting in a VAT but, in terms of the way countries are responding to the crisis, the primary tax response has been to increase VAT.
I think it’s unfortunate that they have chosen to increase the rates, rather than look at the base, because I don’t think it’s viable to have VAT rates at 25% that puts enormous pressure on the system.
One of the things I would like to see, and you as the business community can help us, just as the non-EU countries learnt from the experience of the EU in the design of VAT, why can’t we reverse the process? Why can’t we look at South Korea? Why can’t we look out at Chile? Why can’t we look at New Zealand or Singapore and say, “What can we learn from them in the design of VAT?” Because if we did, we certainly wouldn’t design the VAT as we have it today.
The other thing that’s important is to recognize, and this comes back, Chris, to a point you raised earlier, is public perception. Because when you talk about VAT, you commonly hear the argument that “it’s regressive.” But actually, it’s not that that regressive, and you can design it in a way to reduce the regressivity.
And secondly, that’s probably the wrong point to make — or at least make first. If you are concerned about the way inequalities are growing, then the key question to ask is not whether a particular tax reduces inequality, not even whether the tax system reduces inequality, but does the tax benefit system do that? We need to shift the political debate because otherwise, we’re going to be blocked in further progress on VAT.
Chris Sanger: Many people looking at VAT actually seem to assume this is a tax on the individual paying for the goods. Actually, it’s just a tax on the production of the goods, much like corporation tax. I think the focus we’re seeing on the global shift to indirect taxes is actually aggravating some of the tax activism we’re seeing.
Stephan Kuhn: Let’s turn to transfer pricing. Being fresh from the OECD, can you give us an overview of where things are heading and what the focus points are in this area, Jeffrey?
Jeffrey Owens: I think we’ve spent more than 25 years refining the guidelines. When we did the ’79 guidelines, it was a publication of a relatively tiny size compared to where it is today. It was actually written in very nice English. Today I think very few people actually read the guidelines, because it just got too complex. I think what the OECD has decided is that the way to go isn’t to simply keep on refining but, rather, to simplify.
The discussion drafts that were put out ten days ago are taking us in that direction. It’s saying, can we make it simpler? It’s never going to be simple, but can we make it somewhat simpler? Can we put on an emphasis on how we administer these rules?
Can we strip out routine transactions? That would enable us to then focus on the really difficult things. Can we actually review the position and the guidelines on safe harbors?
So from that perspective, I think there’s some good news coming out of here. It should make your lives, as tax directors, a little bit easier, because the emphasis is shifting, not from refining the guidelines, but rather to making them easier to apply in practice.
On the second point you raise, and I think this is particularly relevant for economies in transition and developing countries, the OECD has done a great job in selling the idea of the arms’ length principle. But you can’t go into a country, and spend one day with them, trying to help them understand the rules and then walk away and then they say, “Ok, now we’ve got transfer pricing rules and we’ll apply them.” Particularly when those countries don’t have mechanisms in place to resolve disputes.
So in a sense, I think you can hold the OECD responsible for the spread of the arms’ length principle, but now we need to be follow that up by helping these countries to actually be able to apply it. And when I say “we” I’m not slipping back into my former role at the OECD, but I mean we as the tax profession and you as taxpaying businesses. Business has to get engaged in the process of educating and helping tax administrations in developing countries to apply the arms length principle.
Debbie Nolan: We’ve seen that, too, in Latin America, exactly what you’ve described, where a country has now suddenly gained energy around transfer pricing. There’s recognition around the world that that’s a revenue raiser for many countries but, if they don’t have dispute resolution processes, or they don’t have tax treaties, then companies get caught in the middle.
I think its incumbent on those tax authorities also to engage with external stakeholders to ensure that it’s administered fairly. There are some countries that are willing to do that and other countries who are not.
But, you know, when you think about transfer pricing, you think about the OECD as being the key influencer over that, but there are many other organizations coming on the scene to influence transfer pricing. The U.N., IMF, World Bank, CIOT, CIAT ….
Chris Sanger: But there does seem to be a growing perspective that the system isn’t delivering for everybody, and possibly, for anyone. It’s not really delivering for governments. It’s not really delivering for corporates, because corporates are spending a lot of time focusing on doing transfer pricing reports for areas that are ultimately low risk. Governments are then looking at this then and thinking we need to go and investigate, I think that’s going to be really a quite a seismic change over the next few years as we see this develop.
Debbie Nolan: One positive thing is that there are a lot of countries that are implementing advanced pricing agreement programs — perhaps even before they have created really robust transfer pricing administration, because they recognize that having rulings with large companies and agreements up front can be in the best interest of the government as well as the company.
Even in the United States there’s a reengineering of the advanced pricing agreement program, combining that with requests for competent authority assistance to make it more efficient. So there’s a lot happening that’s positive in this area.
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