Taxing times in a post-crisis world

June 30, 2010

Large fiscal deficits in many countries are prompting governments to rethink their tax policies. While business will undoubtedly feel the impact, a clear approach to tax strategy can help to mitigate the uncertainty.

Tax has rarely been higher on the political or corporate agenda. Although the critical phase of the global financial and economic crisis may now be over, governments around the world remain deeply indebted. Their desire to restore public finances to a stronger footing, and mitigate the impact of future crises, is prompting a thorough reassessment of tax policy. And in an environment where public attitudes have hardened against banks and business in general, it has become politically expedient to direct the most draconian reforms at the corporate world.

The deterioration in public finances and a desire to make up the shortfall in revenues have provided fresh impetus to the co-ordination of tax policy across borders. Following the G20 meeting in April 2009, world leaders committed to clamping down on tax havens and promoting the exchange of tax information between jurisdictions. Since then, under the auspices of the OECD, more than 190 tax information exchange agreements have been signed and 110 tax treaties renegotiated.

Tax has even been singled out as a contributing factor to the crisis. In a June 2009 paper, the International Monetary Fund argued that problems in the economy had been exacerbated by tax policies that helped to fuel the credit boom. “Corporate-level tax biases favoring debt finance including in the financial sector are pervasive, often large and hard to justify,” noted the authors.

The renewed zeal for tax reform among politicians and international institutions has created considerable uncertainty among business about where these changes will ultimately lead. “People have always complained about uncertainty in the tax system but it does seem to be particularly severe at the moment,” says Professor Michael Devereux, director of the Oxford University Centre for Business Taxation.

For companies trying to deal with the aftermath of the crisis, this uncertainty adds another layer of complexity to the strategic decision-making process. Profound change in the global economy is encouraging a broad re-think of business models, corporate structures, growth strategies and financing. But in many cases, uncertainty about a rapidly evolving tax environment is hampering the decision-making process.

Consider mergers and acquisitions, which many companies may be seeking to apply in their efforts to achieve growth. The debate over the extent to which the tax treatment of debt contributed to the financial crisis has sparked concern that policy-makers could seek to change the rules over the deductibility of interest. “If you were looking to finance a major transaction in the UK at the moment, you might be quite nervous,” says Chris Wales, a former economic advisor to the former British prime minister, Gordon Brown, and an advisory board member at the Oxford University Centre for Business Taxation. “If you are taking on a lot of debt and your calculations are based on interest being deductable for tax purposes, you will need confidence that this will remain the case. But recent political discussions have made that a very difficult issue to be certain about.”

The uncertain tax treatment of strategic transactions highlights the importance of bringing the tax function into the planning process at an early stage. Not only will this direct discussion towards initiatives that are attractive from a tax perspective, it will also prevent resources being wasted on plans that are not viable. “Companies need to think more strategically about tax,” says Alex Postma, EMEIA International Tax Services leader at Ernst & Young. “You can significantly reduce the impact of tax on every part of the business cycle by making it a key component of strategy development.”

A changing tax environment means that companies can find themselves straying into controversial waters with pre-existing structures and transactions. “There’s a big problem whereby structures that were acceptable two years ago and might have been even relatively industry standard are suddenly no longer acceptable,” says Roger Bindschedler of Davenport Lyons, a law firm. “Companies have to be very careful that they’re not just redoing a structure they did two years ago without checking that it is still acceptable.”

This increasing focus on tax as part of strategic thinking, along with growing concern about the potential for risk and controversy, is placing tax issues squarely on the boardroom agenda. Tax authorities are encouraging this transition, either with explicit legislation or best practice guidelines. “Tax is becoming a more important part of corporate governance discussions within businesses,” says Postma.

In addition to performing a more central role in strategy and corporate governance, the tax function continues to play a vital role in improving cost efficiency. As organizations seek to improve the bottom line, avoiding unintended tax costs and building in tax efficiencies will be critical factors to convert into successful enterprise-wide strategies. “There are a lot of tax planning opportunities available but you have to be very careful that you don’t overstep the mark and you have to be very reputable about what you’re doing,” says Bindschedler.

This highlights the importance of a responsible approach to tax planning. Legitimate tax planning techniques play an important role in reducing a major cost for the business and maximizing shareholder returns in a competitive environment. But at the same time, companies have a responsibility to observe regulations, provide appropriate documentation and develop good working relationships with tax authorities.

The tax function may play a vital role in cost cutting, but it has itself been a victim of the zeal for efficiency. The downturn has forced companies worldwide to make cost savings across every business function, and tax has been no exception. As a result, many tax functions are struggling with a lack of resources at a time when they face an increasing compliance burden and more vocal demands from both internal and external stakeholders. “I’m not sure whether board members actually realize how much more is being thrown on the plate of the tax director,” says Postma.

The growing demands on the tax function mean that the role of the tax director is broadening far beyond its technical heartland. “Tax directors are expected to engage on a wider range of issues than ever,” says Wales. “There is a greater burden in terms of risk management, they must understand the dynamics of the business, engage with government to spot policy developments and lobby on the company’s behalf.”

There are a growing number of signs to suggest that the global economy is returning to health. But, as has recently been shown with the sovereign debt problems facing Greece, the crisis is far from over. Fiscal deficits will persist for many years across the industrialized world, which means that public spending cuts and tax increases are inevitable. For companies seeking to grow while maintaining a focus on costs, this is a worrying prospect. The tax function may not have all the answers to this conundrum, but it is an increasingly important part of the solution.