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2016 will go down in the history books for many reasons. And there has been no shortage of interesting developments in international tax in the past year, as we recount in this special feature.
BEPS – Fueling Uncertainty?
On the global stage, the OECD's base erosion and profit shifting project is now well advanced. By the end of November 2016, the total number of countries and jurisdictions participating had reached 90, and this number is soon expected to exceed to 100 mark.
However, while those of us who track international tax developments are now very familiar with BEPS and the project's aims, familiarity certainly isn't helping taxpayers to plan their tax affairs, as numerous surveys show.
A survey conducted by financial advisory firm in 2016 Grant Thornton revealed that 78 percent of businesses have not changed their business's approach to taxation, despite the numerous recent changes that have taken place at jurisdictional level in response to the OECD's final BEPS recommendations. And it seems that uncertainty is fueling this unresponsiveness on the part of many multinationals.
As Francesca Lagerberg, Global Leader of Tax Services at Grant Thornton International, explained: "It is fascinating that after the initial excitement around BEPS, and its potentially game-changing elements, so few in the survey have taken active steps to change what they are doing. The reasons for this are likely to be many. A number of companies will be reluctant to be the first mover in this area and may be looking to see what others are doing in their industry or region. Governments have not yet explained how or even if they will implement BEPS in some countries, so that leads to business caution."
The area of greatest concern seems to be transfer pricing. According to a survey of over 250 senior tax executives conducted by tax and audit firm Ernst and Young, 49 percent of all respondents are currently seeing tax authorities raise audit issues that reflect the BEPS focus areas, a jump of 16 percent year-on-year. 60 percent selected transfer pricing as the top focus area being raised as an audit issue, with 54 percent saying it is also the top BEPS area affecting them in terms of changes in law and reporting requirements.
Yet, is also appears to be the case that companies have yet to fully get to grips with new transfer pricing reporting requirements, as demonstrated by second instalment of EY's 2016 Transfer Pricing Survey, announced in December. This showed that just 21 percent of businesses are fully compliant with transfer pricing documentation requirements in all jurisdictions.
EY commented that its survey indicates that many businesses are in a position of heightened risk, in a climate of unprecedented transparency. And these unfavorable operating conditions are likely to linger for some considerable time until BEPs changes are fully bedded in to the international tax system.
Peter Griffin, EY Global Transfer Pricing Leader, observed: "The survey shows that transfer pricing professionals are scrambling to meet new standards and bracing for more conflict. It may take several years or more before the full impact of BEPS becomes clear, but too many companies are not as far along as they need to be. For global businesses, the time to evaluate, address, align and adjust is now."
The European Union – Upsetting The Tax Apple Cart
In the European Union, BEPS isn't the only thing that taxpayers have to deal with. There, the European Commission has upset the international tax apple cart with its ongoing investigations into private tax rulings agreed between member states' tax authorities and multinational companies.
The most controversial tax development in the EU in 2016 was the Commission's announcement in August that Ireland granted undue tax benefits of up to EUR13bn (USD13.6bn) to US technology firm Apple.
The Apple affair has had ramification well beyond Europe's shores. Indeed, in an ironic turn of events, the United States Government has accused the EU eroding the US tax base with its attempts to counter tax base erosion in the EU.
Responding to the publication of the Commission's final decision on the Apple case on December 19, a US Treasury spokesperson stated: "Treasury has reviewed the European Commission's decision against Apple. We continue to believe the Commission is retroactively applying a sweeping new state aid theory that is contrary to well-established legal principles, calls into question the tax rules of individual countries, and threatens to undermine the overall business climate in Europe. Moreover, it threatens to erode America's corporate tax base."
With the issue of tax avoidance still high on the political agenda in many countries, there is unlikely to be any let up in the Commission's campaign against tax rulings in 2017. Indeed, the European Network on Debt and Development claimed in a report published in December that "sweetheart tax deals" in the EU have "soared" despite the ongoing investigations, a revelation that may well embolden the Commission to take tougher action. However, considering that many companies rely on tax rulings to make sense of an already unclear tax environment, this could merely lead to yet more uncertainty.
Despite governments' robust responses to incidences of tax avoidance by multinational companies and wealthy individuals, it was ironic that one of the most significant tax developments of the year was a tax avoidance scandal, namely, the Panama Papers affair. And it was an event which inevitably led to increased calls for greater international transparency around individuals' and companies' tax affairs, and the beneficial ownership of companies.
In fact, considerable progress was made towards the former during 2016. On August 25, the OECD announced that a further five jurisdictions had signed the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, bringing the total number of signatories to over 100. This is significant because the Convention is the foundation upon which the OECD's recently agreed tax transparency standard, known as the Common Reporting Standard (CRS) rests, and will allow jurisdictions to exchange financial account information with each other in a similar manner to the United States Foreign Account Tax Compliance Act (FATCA).
Countries that have signed up to the CRS will exchange information "automatically" with one another. This represents something of a step change in international tax enforcement. Traditionally, information about an individual or business has been sent from one tax authority to another on request, based on evidence that tax fraud or some other crime has taken place.
The financial information to be reported with respect to reportable accounts includes interest, dividends, account balance, income from certain insurance products, sales proceeds from financial assets and other income generated with respect to assets held in the account or payments made with respect to the account.
Reportable accounts include accounts held by individuals and entities (which includes trusts and foundations), and the standard includes a requirement that financial institutions "look through" passive entities to report on the relevant controlling persons.
The financial institutions covered by the standard include custodial institutions, depository institutions, investment entities and specified insurance companies, unless they present a low risk of being used for evading tax and are excluded from reporting.
Naturally, given the depressing regularity with which corporate and government databases are being hacked, there are concerns about the security of the data exchanges, as well as how governments will choose to use the information on their citizens given that there are some unsavoury regimes out there.
The OECD assures us that the standard contains specific rules on the confidentiality of the information exchanged and that the underlying international legal exchange instruments already contain safeguards in this regard. Where these standards are not met (whether in law or in practice), countries will not exchange information automatically, it says.
With the first exchanges set to take place in 2017, we will soon see if the CRS is as effective as its adherents claim it will be.
Trumponomics – Stage Set For US Tax Reform?
In the United States, the year began on a relatively quiet note as far as federal tax developments were concerned – as the nation prepared to move into full election campaign mode, it was always unlikely that major tax legislation would approved. And the ongoing impasse on the matter between Democrats and Republicans would probably have ruled out the chances of a tax reform bill passing anyway.
However, this stalemate didn't prevent the Government making major changes to taxation through its power to regulate, and measures first announced in January 2016 designed crack down on corporate inversions and attendant corporate tax avoidance strategies, particularly earnings stripping, were described as some of the most sweeping changes to corporate taxation in the United States for 20 years.
The new regulations, which were released in their finalized form on October 13, 2016, are intended to limit earnings stripping following inversions, a practice whereby US subsidiaries borrow from their new foreign parent company (or another foreign affiliate), increase their interest payments, and reduce their US taxable income by using the interest expense deduction. The Internal Revenue Service (IRS) would be allowed to re-characterize certain debt instruments as equity under Section 385 of the Internal Revenue Code.
In a statement, Treasury Secretary Jack Lew said: "In the absence of Congressional action, it is Treasury's responsibility to use our authority to protect the tax base from continued erosion.
However, there remains widespread concern that the measures overreach their intended target of inversions and earnings stripping, and Treasury had been urged, particularly by Republican lawmakers, to delay issuing final Section 385 rules until the economic impact of the regulations could be fully assessed. Senate Finance Committee Chairman Orrin Hatch (R – Utah) repeatedly raised the alarm, stating on the day of the release of the final regulations that: "While the final regulations will need to be scrutinized closely, it is immensely concerning that, despite stark bipartisan concern, the Administration moved forward with completing rules that could jeopardize American businesses and the economy here at home."
Given President-elect Donald Trump's pledge to reverse legislative and regulatory measures introduced under the presidency of Barack Obama, it may be the case that the Section 385 measures are short-lived. In any case, if Trump and the Republican leadership in the House of Representatives succeed in their aim of implementing pro-business, pro-growth tax reform, the new regulations may well become irrelevant anyway.
Which brings us on to another major event of 2016 – the result of the November 8 presidential election, which significantly increases the chances of the first major overhaul to the US tax code since the mid-1980s. Why? Because for the first time since 2010, from early 2017 the US president will have Congress largely on his side, allowing him to push through much of his agenda. And Trump has identified tax reform as a priority issue to be approved and enacted during his first 100 days in office.
Although Trump's tax plan, which tended to evolve as the election campaign wore on, lacks detail, he is mostly on the same page as House Speaker Paul Ryan (R – Wisconsin), who released a more comprehensive tax reform blueprint in June 2016. So, we can expect Republicans to push for a deep cut in the 35 percent corporate tax rate, international tax reform which attempts to encourage US multinationals to repatriate and invest the estimated USD2.5 trillion in foreign profits held abroad to avoid America's high corporate tax rate, and simplification of the corporate and individual tax codes, with reductions in tax for most US taxpayers.
Trump and Ryan seem to agree that the carrot must be dangled in front of corporations to encourage more domestic investment and production. However, both also believe in the stick, and this is where both men's visions diverge, with Trump proposing import taxes of up to 40 percent on products shipped back to the US by companies which have relocated facilities in foreign countries. Ryan on the other hand, favors a subtler – but no less controversial – border adjustment tax, which would in effect adopt a system similar to that under a value-added tax in respect of international trade, to eliminate a current disadvantage for US companies.
Any US tax reform bill will of course have to be approved by the Senate, and this is where the process could bog down given the Republican's slender majority in the chamber from 2017. However, as things stand, the stage looks set for some significant changes to US taxation next year.
Corporate Tax Rates – A Race To The Bottom?
It is somewhat ironic, in an era when tax competition is increasingly being frowned upon by the framers of the BEPS recommendations, that BEPS appears to be driving more competition between jurisdictions on tax rates rather than less. And this is because countries have fewer levers with which to compete as they phase out special tax regimes and introduce new anti-avoidance measures to align with the BEPS proposals. Could tax reform in the US add fuel to this process?
In Europe in particular, we continue to see downward pressure applied to corporate tax rates. Italy has just approved a budget that will reduce corporate tax in 2017; France also has plans in place to gradually reduce its high rate of corporate tax. And in the Netherlands, the Government has repeatedly stressed that corporate tax cuts should be considered more seriously as the country begins to repeal special tax schemes which have attracted large numbers of multinational corporations to the country.
While the United Kingdom Government has rejected the idea of reducing corporate tax to as low as 15 percent, it will nevertheless continue with phased tax reductions which have already been legislated for, and which will reduce corporation tax to 17 percent by 2020. The Australian Government is nevertheless very keen to cut the 30 percent corporate tax – now comfortably above the global average of around 23 percent – despite political opposition and plans to reduce the budget deficit. And Japan is also in the process of lowering corporate tax, having lowered the effective rate below 30 percent in 2016, with a further reduction set to take place in 2017.
However, as far as corporate tax rate developments are concerned, Hungary stole the limelight in November 2016 when it announced plans to introduce a nine percent corporate tax in 2017 – to be Europe's lowest corporate tax and one of the world's most competitive.
Hungary's shock move signals its intent to compete aggressively with other low-tax Central and Eastern European countries, many of which have attracted significant amounts of investment from Western Europe since this bloc acceded to the EU. It will therefore be interesting to see if Hungary's neighbors respond in kind with tax cuts of their own in 2017. Either way, it seems likely that corporate tax cuts will outnumber rate increases in the coming year.
2016 could also be seen as a watershed year for environmental taxation after governments agreed at the Paris Climate Conference in December 2015 to put a price on carbon emissions. Indeed, in January 2016, an International Monetary Fund report concluded that carbon pricing systems are potentially the most effective carbon emission mitigation instruments, are straightforward to administer, raise revenues, and encourage technological changes towards low-emission investments.
In April, the Carbon Pricing Panel agreed on a global target for putting a price on carbon pollution, including through carbon taxes. The Panel, which includes six heads of state and government, two city and state leaders, and the heads of the World Bank Group, the IMF, and the OECD, challenged world leaders to expand carbon pricing to cover 25 percent of global emissions by 2020 – double the current level – and to achieve 50 percent coverage within the next decade.
Prospects for meeting these ambitious targets have been given a considerable boost by China, which emits about one-third of the world's carbon, and which seems to have made a serious commitment to reduce pollution through the application of taxes. While the Government said in March 2016 that it would not introduce a separate carbon tax, it is currently operating a pilot carbon emissions trading scheme (ETS) through seven regional trading venues, with plans to have a national ETS in operation from 2017.
Then, in August, China unveiled a draft environmental tax law which will replace the current system of pollution fees to offer tax incentives to businesses which clean up their operations. The law includes four categories of environmentally-harmful activities, including the pollution of air, water, the production of solid waste and noise emissions.
Over 80 percent of respondents to the International Emissions Trading Association's annual survey, conducted by PwC, said they expect an expansion of carbon markets, driven by the Paris Agreement. According to the survey, by 2025, new emissions trading systems (ETSs) are expected to be started up in Canada, Australia, Brazil, Chile, Japan, Mexico, South Africa, and Turkey. This is in addition to the national ETS in China that is expected to begin next year.
However, the US's chances of joining them anytime soon appear to have been dealt a blow with the election of Donald Trump to the presidency, and the rejection by voters in Washington state of America's first carbon tax. And it remains to be seen how this affects global efforts to combat carbon emissions.
VAT And GST Developments – From India to Europe
An almost historic moment arrived in India in August 2016, when parliament finally passed a constitutional amendment bill paving the way for the introduction of a goods and services tax system, possibly by April 2017. This marked a major milestone on a journey which began around 10 years ago.
GST is considered an important economic reform because, as the Indian Government says, it is "one indirect tax for the whole nation," and will transform India into "one unified common market." This will put an end to a situation whereby interstate commerce is hindered by a hodgepodge of cascading indirect taxes. At central level, these include Central Excise Duty, Additional Excise Duty, Service Tax, Additional Customs Duty, and Special Additional Customs Duty. There are even more indirect levies at state level, including value-added taxes, Entertainment Tax, Central Sales Tax, Octroi (effectively a local customs duty) and Entry Tax, Purchase Tax, Luxury Tax, and gambling taxes.
Unfortunately, India's GST won't be quite as simple as hoped. In November, GST Council, formed of representatives from both the central Government and the states, has agreed that GST should be introduced with four rates. The two main rates – 12 percent and 18 percent – would be levied on most goods and services. A 5 percent rate would apply to common, non-essential items, and a 28 percent rate would apply to "luxury goods" and tobacco products. A zero rate would be levied on consumer essentials.
Nevertheless, the India Government has received praise from observers and analysts the world over for a reform that is expected to boost economic growth and stabilize the tax base. Ratings agency Standard and Poor's commented: "This is arguably the most important structural reform to date by the Modi Government, and will improve efficiency, cross state trade, and tax buoyancy."
In the European Union, however, it could be argued that a single VAT system – at least notionally – is hindering cross-border intra EU trade, rather than promoting it. This is especially the case in the e-commerce sector, where the dauntingly complex VAT compliance rules have deterred many small digitally-based company from selling their goods and services to customers located in other member states.
This is where the EU's Digital Market Strategy and Action Plan on VAT come in, and these initiatives have culminated in proposals for a major overhaul of the EU VAT rules, which were announced by the European Commission on December 1.
By introducing an EU wide portal for online VAT payments (the "One Stop Shop"), the Commission is hoping to reduce VAT compliance expenses for businesses by about EUR2.3bn (USD2.9bn) a year. Currently, online traders have to register for VAT in all the member states to which they sell goods. Often cited as one of the biggest barriers to cross-border e-commerce, these VAT obligations cost businesses around EUR8,000 for every EU country into which they sell. The Commission is now proposing that businesses make one simple quarterly return for the VAT due across the whole of the EU, using the online VAT One Stop Shop.
In addition, a new yearly threshold of EUR10,000 in online sales will be introduced under which businesses selling cross-border can continue to apply the VAT rules they are used to in their home country. This will, the Commission said, make complying with VAT rules easier for 430,000 companies across the EU, representing 97 percent of all micro-business trading cross-border. Furthermore, a second new yearly threshold of EUR100,000 will make life easier for SMEs when it comes to VAT, with simplified rules for identifying where their customers are based.
The proposals have been welcomed by bodies representing the interests of online traders in the EU. However, companies face a wait before the new simplified rules are introduced. It is envisaged that the new thresholds could be applied by 2018 on e-services, and by 2021 for online goods.
It is impossible to predict with any great certainty what's in store for taxpayers around the world in 2017. If we all knew that, then the armies of forecasters, economists, political commentators and analysts would very quickly have to find new careers!
It's probably fairly safe to assume, however, that the international tax landscape in 2017 will be just as fluid and uncertain as it was in 2016. Governments will continue to respond to the OECD's BEPS recommendations throughout the year, but, as in 2016, we can probably expect these responses to lack consistency and uniformity, as countries interpret their commitments to reduce tax avoidance in their own particular ways. And this will continue to make tax compliance something of a minefield for multinational businesses and individuals with financial affairs in more than one jurisdiction.
What's more, despite the fact that the US FATCA law is well established, and that its global equivalent, the CRS will be rolled out over the next couple of years, calls for greater tax transparency are unlikely to abate.
Tags: tax | Tax | business | Europe | BEPS | India | tax reform | law | interest | Hungary | regulation | trade | tax avoidance | transfer pricing | individuals | services | FATCA | environment | investment | United States | compliance
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