Responding to the recent political demands that companies pay the ‘right’ amount of tax in the countries in which they operate, the OECD’s Base Erosion and Profit Shifting (BEPS) initiative aims to create a framework to reduce the ability of companies to shift income to reduce their tax burden. Their proposals could impact substantially on financial services firms. Time is short, and the industry needs to respond now.
One of the significant consequences of the financial crisis has been the development of acute concern over whether corporations are paying the 'right' amount of tax. These concerns have been fed by a number of key factors. First has been the need of governments in the developed world to sustain and maximize their tax take in the face of continued commitment to government expenditure at a time of economic retrenchment. Second, there has been increasing political and public outrage – stimulated in part by the mass media – at some multinational corporations that have been revealed to pay relatively low levels of tax.
At the same time, globalization has steadily increased the opportunity for corporations to arrange their affairs so that taxable profits are reported in low-tax rather than high-tax jurisdictions. Globalization has made it much easier for businesses to locate productive activities in different geographic locations.
The resultant erosion of domestic tax bases ('base erosion') and the associated transfer of reported profits to low-tax jurisdictions ('profit shifting') has generated an increasing focus on 'unfair' tax avoidance. It is argued that this damages the tax revenues of individual states; distorts economic performance; and brings taxation systems generally into greater disrepute. In some cases financial institutions (mostly, but not exclusively banks) have been criticized for facilitating such strategies as well as undertaking them on their own account.
Prompted by policy developments at the G20, the OECD has taken an increasing interest in this issue of BEPS. The OECD has argued, that BEPS has a number of critical consequences:1
According to the OECD: 'it is an issue of fairness: when taxpayers (including ordinary individuals) see multinational corporations legally avoiding income tax, it undermines voluntary compliance by all taxpayers… Business cannot be faulted for using the rules that governments have put in place. It is therefore governments' responsibility to revise the rules or introduce new rules.'2 The OECD is therefore developing as a matter of urgency a program to tackle BEPS through new regulatory frameworks as part of its overall program of modernizing tax regimes.3
So in July 2013, the OECD published its Action Plan to tackle BEPS.4 The Action Plan sets out 15 actions, many directly focused on corporate structure and performance, to address BEPS issues in a coordinated and comprehensive manner (see Table). Work to refine and implement the deliverables on BEPS is now being undertaken at a rapid pace. Much has been written in the specialist press and elsewhere about the potential implications. But the key point is that companies in the financial services sector need to consider – as a matter of urgency – how to respond.
The current political focus on fairness in corporate tax matters raises two fundamental challenges for financial services firms. First is the risk of changes to the law that will result in greater tax burdens and greater compliance burdens. Already some countries, including Mexico, France, Germany, Australia and Austria, have begun to introduce domestic measures targeted at BEPS. Norbert Walter-Borjans, Finance Minister of North Rhine-Westphalia, has argued forcefully that Germany should act unilaterally to tackle BEPS if the OECD project has not made sufficient progress by the autumn of 2014.5 Conversely in the UK, despite the government claiming it expects companies to "pay the tax they owe", the Chancellor of the Exchequer has announced his intention to "create the most competitive tax environment in the G20."6
Second, the question of fairness raises issues of politics, morality and corporate reputation, beyond technical matters of finance, tax and compliance.7 It presents major challenges to senior executives, who are now having to balance their primary responsibility of maximizing returns to shareholders – and hence of minimizing avoidable costs – with that of being seen to behave in a responsible way in a broader context.
Defining fairness presents particularly acute problems, and translating it into a reliable basis for tax policy is even more difficult. The challenge has been faced on previous occasions. In Europe, the long-standing Code of Conduct for business taxation was first set out in the conclusions of the Council of Economics and Finance Ministers (ECOFIN) of 1 December 1997, which gave guidance on how to identify potentially harmful tax practices. Key criteria included:
Increasingly, these criteria are being subsumed into a more overtly political framework. The G20 assert simply that "Profits should be taxed where economic activities [driving] the profits are performed and where value is created".8
There is a danger that the superficially attractive concepts of fairness and justice are used to mask national protectionism, and to attempt to insulate high-tax, high-spend economies from international competition from more economically efficient, low-tax jurisdictions. Algirdas Šemeta, European Commissioner for Taxation and Customs Union, made this link explicit earlier in 2014, when he said: "Why is fair tax competition so important? To put it simply, our social and economic model relies on it."9 In a subsequent speech, he stated the Commission's intent to impose its interpretation of "fair" tax competition more widely: "Switzerland has agreed to remove a number of harmful tax regimes that were of concern to Member States… Our efforts to secure fair tax competition are bearing fruit, even beyond EU borders. Our sights are set on tackling unfair tax practices worldwide. If we continue to work as a union, with ambition and determination, I have great hopes that this can be achieved."10
This substantial overlay of politics and international competition onto what is already a set of challenging technical issues means that the timescale for BEPS implementation – with all actions complete by the end of 2015 – is extremely ambitious. There is an obvious risk of slippage. And against this background, there is the danger of unilateral action by countries determined to press ahead.
These challenges raise the spectre of the coordinated approach to tackling BEPS failing, with a growing likelihood of unilateral action leading to double taxation, double non-taxation and much increased uncertainty. In the global economic context, this could have significant detrimental impacts on investment and growth.
It is often tempting to delay formulating a response to new regulatory initiatives until the detail of new requirements is finalized. The temptation is understandably greater when financial services firms are already addressing a massive range of challenges, not only in the form of new regulation but also in the face of fundamental threats to core strategy, business models and operations. Prioritizing action can enable sensible planning, avoid wasted effort and reduce an overload of demands to manageability. In this case, however, targeted engagement with the process now is highly desirable.
The timetables are short. As the table of actions shows, the majority will impact directly on individual companies' organization and operating models. Many of them are due to be translated into formal recommendations within a few short months, in September 2014. While this target may slip a little, it is clear that by the end of this year companies will need to be formulating detailed plans for reaction. At a minimum, therefore, the actions targeted for early implementation need to be reviewed and analyzed for potential impact.
An additional reason for early action is that many of the actions will be able to be implemented immediately, without the need to wait for domestic legislative initiatives. The actions on transfer pricing, for example, may be automatically incorporated into the laws of some countries. Other issues, for example on permanent establishment (PE) status, will require specific rule changes, and have a later target date. But even here, the timescale is comparatively tight.
Prioritizing action can enable sensible planning, avoid wasted effort and reduce an overload of demands to manageability. In this case, however, targeted engagement with the process now is highly desirable.
These considerations point to a further conclusion: it is urgent that the financial services industry makes its views known on specific proposals, both collectively and individually. The recent history of political and regulatory response to the financial crisis has shown that regulators are willing to engage constructively with representations which support the general thrust of policy but which seek to reduce unhelpful or harmful consequences. When an initiative is as broadly framed and widely targeted as is BEPS, there is an inevitable danger that individual sector concerns are overlooked. The financial services sector is already heavily regulated; but its interests are not currently held in high regard. It is therefore all the more important that the industry's voice and views are made known.
Finally, many of the changes which may flow from BEPS could require important reconfiguration of organization and structure. Where these involve realigning the location of profit reporting with the location where economic value is created, significant transfers or relocation of people and teams may be required. These actions are expensive and time consuming. Planning needs to start now.
For further information, please contact:
KPMG in the UK
Tel: +44 20 7311 5811
KPMG in Ireland
Tel: +353 1 4101278
KPMG in the UK
Tel: +44 20 7311 2252
KPMG in the US
Tel: +212 872 6489