GAAR rising

March 27, 2013

With GAAR now being introduced in several countries around the globe, what does this mean for business?

Complexity in the world’s tax systems has grown in tandem with the challenges of doing business in an increasingly connected global economy. Today, the application of many of those laws lags business innovation.

As a result, some laws do not operate as originally intended, or create uncertainties that were not foreseen. At their extreme they can impede desirable business activity.

In other instances, taxpayers may be seen as taking advantage of some laws in ways that tax administrators find undesirable. These resulting uncertainties can limit economic growth and impede tax administration.

Many countries have taken steps to modernize their corporate tax systems to align better with rapidly shifting business models. Several countries have reduced their corporate tax rates and have moved to a more territorial approach to taxing business income.

The United States, home to a large number of the world’s largest multinational corporations, continues to debate whether a switch to a territorial tax system will be a central part of the tax reform that leaders in both political parties say they want, while countries such as Japan and the United Kingdom have moved closer to territorial taxation.

A widening anti-abuse net

The globalization of business and the mobility of capital, however, continue to challenge tax administrators who worry about the potential exploitation of what are perceived to be unintended tax benefits. Emerging markets such as Chile, China and India are making headlines by widening their tax net and, in some cases, disregarding holding company entities.

And some countries that are enacting reforms aimed at increasing their competitiveness are at the same time considering antiavoidance measures that may actually increase uncertainty.

A global effort

The recent focus on tackling “tax abuse” can also be attributed to the rising deficits and falling tax revenues that have resulted from the global financial crisis. Governments have been spurred to act by multilateral organizations, including the G20, the Organisation for Economic Co-operation and Development (OECD) and the European Commission.

Tax activist groups have turned a spotlight on tax havens, high-net-worth individuals and, now, the seemingly low effective tax rates reported by some multinational companies. A series of steps, including increased information exchange, expanded disclosure requirements, and joint and simultaneous tax audits have been put in place to address what countries view as unacceptably aggressive tax planning.

A wave of national change

Many countries are now taking a different and more dramatic approach. Countries such as the United Kingdom, India and China have either proposed or adopted broader anti-avoidance statutes that empower authorities to challenge what they perceive to be “aggressive” tax planning or “treaty abuse.” Countries including Ireland and South Africa are flexing GAARs long on their books, becoming bolder about threatening to apply them or actually applying them.

And countries that have been testing the judicial limits of their anti-avoidance statutes for decades, such as Australia, are becoming even more assertive in the wake of economic adversity and are looking to further tighten their rules.

Other countries, including emerging economies, are watching these developments and contemplating their own policies, either to replicate what they see as leading practices or as a defensive measure in response to other countries’ use of such legislation.

Feeding uncertainty

Businesses increasingly fear that countries that once used GAAR only reluctantly, and in the most extreme circumstances, are beginning to use it more extensively than it was originally designed to be used. They have good reason to be worried.

While judges in several GAAR cases have defended businesses against overly broad application of the rule, some countries that lose in court have responded by proposing new laws to make their GAAR tougher and, in the case of India, retroactive. In countries without a GAAR, tax authorities are increasingly challenging business arrangements on the grounds that they lack substance, even if such arrangements comply with the applicable law.

GAAR’s rise as a favored enforcement tool, however, has the potential to increase the uncertainty businesses already feel operating in the challenging global economy; a poorly designed or administered GAAR is in neither the taxpayer nor the government’s interest.

The proliferation of anti-avoidance rules amplifies the uncertainty global businesses already feel as they operate in this intensely interconnected and interdependent economy. Such rules can breed distrust where cooperation would more likely generate mutually satisfactory resolution to controversy, as evidenced in the headline of an October 2012 Reuters news agency story about the new GAAR proposal in the United Kingdom:

“Businesses spooked by UK tax avoidance clampdown.” Adding to the complexity of this new environment is the fact that GAAR approaches vary from country to country, along with the penalties they may carry and the administrative procedures for appeal and relief.

Jean-Baptiste Colbert, Controller-General of Finances under France’s King Louis XIV, once described taxation as the art of “plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.” With so many challenges from so many directions now facing multinational corporations, the hissing is getting louder.

The rise of GAAR — and the growing interest by multilateral organizations and other interest groups in targeting what they perceive as overly aggressive tax planning — represents part of the next chapter in this evolving tax enforcement story.

In this report, we look at the growing number of countries developing such measures, the characteristics of these measures, how and when the measures may be invoked, and what companies can do to mitigate risk in each phase of their tax risk management.

Read more: GAAR rising: mapping tax enforcement’s evolution (pdf, 2.12 MB)

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