In recent years, tax practitioners have had little interest in the question whether or not a relationship exists between structural changes in a country's economy and the level of taxation. About 20 years ago, this question did attract some attention especially in connection with the tax system of developing countries. A small group of fiscal economists, including Professor Richard Musgrave, tried to determine inter se relationship between economic policy and its influence on the level and the structure of tax system. Tax experts used this experience to advise policy makers on changes that they could bring to the tax systems.
However, forecasting about the future of tax policies is dependent on the relationship between economic structures and taxation. One may pose a question how structural changes will influence the international tax system? This article proposes answers to the posed question and explains the likely scenario as a consequence of changes in economic policies and the emerging trends in tax processes.
Many countries believe that mega businesses are illegally shifting their profits to countries where there are low rate of taxes to address basic erosion and profit shifting (BEPS). Recently OECD did make a call for co-ordinated action; however, individual countries failed to pay any heed to this call and initiated individual actions. These actions included audits, new legislation and re-drafting of policies and procedures. As a consequence the arm's length principle (an important concept of international taxation) is under greater focus and there are divergent views amongst the global community whether or not to rely on it. These directions are also posing questions in respect of the power of tax authorities to re-characterise the bona fide arrangements including disregarding the binding contracts and of the legal entities emerging from legally-enacted regulations1.
The complex regulatory regime has given rise to the problem of double taxation, since nations are taking diverse positions in an aggressive manner. The tax litigation is thus on the rise and emerging challenges are re-structuring the International Tax environment.
The current rules on international taxation were developed and implemented when cross-border transactions were not so prominent. But now the role of multi-national corporations is under scrutiny in many developing countries and their administrations are being advised to plug the gaps that allow such institutions to gain benefit through tax planning and thereby reducing the taxation by shifting of profits to locations where there exists more favourable tax regime.
To address the problem of base erosion and profit shifting (BEPS), OECD has issued procedural guidelines. These steps are the cause of existing turbulent environment and the same has led to adoption of coercive methods by the tax authorities in the shape of intensified enforcement actions. However, the truth is that in order to fill the revenue gaps and to address austerity drives such actions are not going to help. Efficient tax authorities are implementing coercive policies to please their bosses and making the political governments more unpopular2.
These coercive policies include demand for onerous documents and information requests, conducting raids, targeting specific industries, issuing unwanted summons, use of outside experts and to initiate the criminal enforcement actions. These actions, at times, result in agitating of demands due to significant increased assessments and criminal liabilities3. Tax policy as such is developing in a void where no one knows the right direction hence this newly emerging environment is fraught with unknown dangers.
In this regard, OECD released a co-ordinated action plan to address the issue of base erosion and profit shifting. The action plan did caution the administrations to review their policies, since the emerging trends in taxation may cause harmful effects resulting in chaos and double taxation.
At Global level, many countries, for example, India, are enacting general anti - avoidance rules. India has recently introduced rules for transfer pricing and methodology is being worked out to implement the purpose of rules. Similar efforts are also being made by Australia and Canada.
The aforesaid measures are being taken to combat the tax evasion based on tax planning. But for international businesses these actions are causing difficulties and hurdles. These unilateral measures of individual states will to deter the set-up of international businesses in many developing countries4.
There are growing differences among the nations in respect of International tax standards. The issues of residence and source based income are already causing a difference of opinion on basic taxing rights and fundamental tax principles, and this conflict may lead to more cross-border disputes.
A well established principle of International taxation namely, arm's length is now at the verge of being abandoned. The new OECD plan in this regard calls for country by country reporting, that means, the global businesses would be under an obligation to provide information on their global allocation of income, economic activity and taxes paid. Though it may be useful for risk assessment, but practically it will amount to denial of arm's length principle5, and purposes for increased audit activity. Be that as it my, it is obvious that OECD's support for arm's length principle is diminishing.
Ability of re-characterisation of valid transactions by a tax authority is another area of concern for the businesses. The new OECD guideline directs that re-characterisation should only be made where authorities detect unusual circumstances6.
On the name of poverty elevation, many countries are proposing that local businesses should be given a preferential tax treatment at the cost of well established rule of arm's length dealings. That is why many practitioners are proposing that OECD should avoid destabilising the established principles into vague concepts. Existing conflicting opinions on the understanding of well established standards and government's directions to interpret taxpayer's business Judgements in their own way is another controversy, which may add to difficulties and complexities.
Tax harmonisation is another area, which is being jeopardised by states in the name of incentives to local businesses thereby causing a conflict in the uniform application of tax laws. Even at times, such preferences may lead to double taxation.
Another leading problem is that of triangular cases, that is, where more than one jurisdiction lays claim to the same item of income. In such cases tax assessments made by one country do affect or can affect the tax assessment of the other countries7. These are the issues which are leading the MNC's to opt for alternative dispute resolution (ADR) option8.
The businesses in these circumstances may prefer bilateral or multilateral advance pricing agreements and opt for the issuance of advance rulings on complex issues. The fact is that these agreements and rulings are not being accepted and admitted by the tax authorities particularly when the tax authorities are confronted with the difficult choice of applying the agreements or rulings to jeopardise their revenue9.
In many countries taxpayers are resorting to opt for the judicial process of appeals against the disputed tax assessments and the option is gaining popularity10. Where the complexity of procedures is not simplified, one should not forget that the rate of litigation will increase by adding unnecessary costs. For example, transfer pricing is the accepted norm of international taxation law and in many countries issues emerging from transfer price are for final settlement it is hoped that states will not take hasty decision of our abandoning the transfer pricing concept of international taxation before the superior judiciary for final settlement.
(The writer is an advocate and is currently working as an associate with Azim-ud-Din Law Associates Karachi)
1 These changes are thus redefining the arena of dispute settlement, hence arbitration is gaining popularity.
2 The recent turbulent voices in Italy, Greece and Spain emerged from consequences emanating from market failure due to bad fiscal policies.
3 Many developed and developing countries are resorting to risk assessment approaches to enforce such rules to protect the tax base and so called perceived national interest.
4 These unilateral steps will also contribute to the risk of double taxation.
5 The action plan provides that it may be appropriate to go beyond the arm's length principle and employ special measures making arm's length principle meaningless.
6Concern is growing that there may be modification to the international tax rules and the OECD's impending work on the allocation of profits for intangibles will likely add fuel to this debate. Until an international consensus is reached on the ability of tax administrations to recharacterise transactions, tax authorities will assert the power to ignore risk allocations, to recharacterise bona fide arrangements, disregard of legal entities, and to invalidate binding legal agreements. This approach will lead to uncertainty.
7 In these cases, bilateral income tax treaties do not operate effectively to resolve the tax controversies because those treaties generally do not facilitate the direct involvement of other affected countries.
8 These pre-litigation approaches to dispute resolution require more transparency and robust disclosures by taxpayers, but they also provide an opportunity to create a co-operative environment between the parties and the resolution of matters in a more effective and efficient manner.
9 These include treatment to pricing, domicile and source.10 For many, this dispute resolution options looks appealing.
Comments
Comments are closed.