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Global Tax Reset: The changing world of tax
International taxation today is essentially a complex web of individual country tax laws and bi- and multilateral trade agreements between nations, and a modernization is needed to better reflect the realities of today’s global business economy. The global landscape of Base Erosion & Profit Shifting, unilateral action by countries, and increased international tax audits is resulting in a Global Tax Reset. As such, it needs to be managed strategically.
A new paradigm
In 2013 the G20, which is comprised of the most powerful world economies, engaged the the Organization for Economic Co-operation and Deverlopment (OECD) to address perceived inequities and inconsistencies in the global tax landscape. This became the Base Erosion and Profit Shifting (BEPS) Actions. Since then, the G20 has endorsed the OECD’s 15-point action plan to modernize the principles underlying today’s international tax landscape and to develop a consistent framework for countries to base their tax legislation upon.
At the core of the G20/OECD’s project is:
- Eliminating tax mismatches such that all income is taxed
- Aligning profits with value creation
- Increasing consistent levels of transparency with tax authorities
- Implementing change in a coordinated fashion
The confluence of the G20/OECD’s efforts, combined with the changing perspective of taxation, increased sharing of information between tax authorities in different countries, and the pressure on governments to collect additional tax revenues, are culminating in sweeping changes to tax laws and treaties. This is triggering a complete Global Tax Reset for businesses with worldwide operations. While some of the proposals will be seen as increasing tax risk and bringing greater complexity, ultimately having a consistent tax platform is important to global businesses. The alternative is individual country measures, such as the UK Diverted Profits Tax, which creates inconsistency and potentially uncertainty.
Key areas the Global Tax Reset will impact
The G20/OECD’s recommendations are contingent upon countries enacting legislative changes to their tax laws and revising their treaties with other jurisdictions; however, there are two key areas—compliance and business model—that are likely to be significantly impacted and businesses should start evaluating now to mitigate risk.
A central component of the G20/OECD’s proposal is Country-by-Country (CbC) reporting and a CbC template containing standard items to be disclosed by country to all tax authorities where the multinational has operations. A core expectation is that this is a standard to be adopted consistently and will take effect in 2017.
The G20/OECD has also recommended that businesses provide a “master file” detailing transfer pricing policies for all categories of intercountry transactions related to a business and a “local file” that discloses and analyzes the activities that are taking place in each country. For the master file and local file, while jurisdictions may choose to implement these recommendations as prescribed it seems likely that some, like China, will opt to incorporate elements alongside their existing transfer pricing requirements.
Historically, tax collaboration at the governmental level most often occurred bilaterally between two countries through treaty and disclosure requirement negotiation. In contrast, in the Global Tax Reset environment, local country legislation will to a far greater extent stem from a collective conversation among nations around minimum standards and best practices. In this regard, the Convention on Mutual Administrative Assistance in Tax Matters which has more than 80 country signatories and continues to grow is a useful precedent, and one of the potential options for government to government exchange of CbC information. Other options are using the bilateral tax treaty network, and the transparency-driven Tax Information Exchange Agreement network.
Businesses need to think about how they will gather the information required to comply with CbC requirements and start running simulations on 2013 and 2014 data now to identify gaps and issues. Organizations that operate decentralized models or those who have grown by mergers and acquisitions may find this process difficult and time consuming if their technology systems have not been fully integrated as transactions occurred.
In principle, CbC reporting should provide tax authorities with a higher level of understanding of businesses’ global supply chains. For businesses, this means a possible increase in tax controversy, the potential for breeches of confidential commercial information, and a road map for future tax legislation that could trigger higher overall tax liabilities.
"...in the Global Tax Reset environment, local country legislation will to a far greater extent stem from a collective conversation among nations around minimum standards and best practices."
Companies will need to look at both their business model and the financing of operations as a result of the BEPS proposals. The changes around financing, transfer pricing, and the definition of taxable presence may require adjustments to the business model in order to comply with the new requirements or thresholds. Resulting systems changes may require a long lead time.
Most multinationals’ financing strategies are intertwined with their cross border activities. They frequently have complex financing strategies, often driven by legacy merger and acquisition activity. This will be challenged on two key fronts. The first will look at the structure of intra-group financing and try to eliminate the use of entities or instruments that are viewed differently in the lending and borrowing territories – the ‘hybrid’ mismatch. The second action will be to look to restrict interest deductions to more closely align with external finance costs of the group. Historically intragroup finance costs and external charges are often quite different for a variety of reasons.
Traditionally, transfer pricing has been evaluated at the transactional level. In a Global Tax Reset world, the entire global supply chain for a business will be more likely to come under scrutiny. Going forward, tax authorities will seek to tax the profits where the value is added within the supply chain which may yield different results compared to the historical transactional standard.