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The emergence of tax-related risk

Tax risk is certainly not new, but it has begun to loom much larger over the last few years. The onset of BEPS, which the various countries are gradually transposing into their national legal systems will, paradoxically, only complicate tax management, rather than making it simpler. Simplification, however, was one of its original goals. This is undoubtedly a tax revolution rather than a tax evolution, and will bring pluses and minuses with it. But one thing is certain, the greater complexity of tax management will crystallise this risk while at the same time increasing it. Treasurers will also be involved and severely impacted.

Greater complexity

The art of managing tax risk has become more complex than ever before. Keeping

control over the risks that come with taxes of all types, both direct and indirect, is

indisputably a greater challenge than anyone imagined when the OECD and Mr

Saint-Amant published the famous fifteen BEPS (Base Erosion Profit Shifting)

Actions. An incredible paradox! They were trying to simplify tax rules that were

thought to be too complex and to have too many loopholes, and they end up with

the risk of a situation that is even more complex than it was before. The old

saying "don't over-egg the pudding" would seem to apply to tax, too. The BEPS

recommendations have fundamentally changed the approach to tax, which now

becomes all-embracing and global, and which advocates total transparency and

full and comprehensive reporting. Non-compliance and its consequences,

including the possible impact on reputation, make the blood of tax managers and

C-level Officers in every multinational corporation (MNC) run cold. This

development in taxes became necessary as a result of the worldwide financial

crisis, bottomless government deficits and the excesses of overly aggressive and

creative tax advisers. The digital revolution was the icing on the cake, making it

essential to review the historical models to enable taxes to be collected when

confronted with the new intangible assets being created.

Seeing tax slip through their fingers

Governments were confronted with the risk of seeing taxes slip through their

fingers. The approach to tax now needs to pass through the prism of absolute

transparency. If everything is transparent, as if by magic, there will no longer be

any artificial structures (or at least fewer of them) set up to evade taxes or

mitigate them. This tax risk is still a no-go area, and seeing it come out into the

light of day now reminds us of how crucial and complex tax strategy is becoming.

The public relations message about it has to be handled with kid gloves, with the

overarching aim being not to be held up as an example of malpractice.

Reputations are affected, even if no tax fraud is established. And the various cases

that the European Commission has singled out reminds us that, when it comes to

taxes, for a quiet life you need to keep your head below the parapet, or even

better stay completely below the radar. BEPS was intended to simplify taxes

(amongst other things) by heaping opprobrium on double non-taxation structures

and other hybrid instruments. With transparency, many more companies risk

being seen as CFCs (Controlled Foreign Corporations) and of being faced with tax

demands from various tax authorities. Each one wants to go right back to the

ultimate source, to ensure that tax has indeed been received by the others. In a

world of BEPS, corporate tax also becomes a key criterion in choosing the location

of treasury management centres, and there is a danger of a "tax war" breaking

out between countries, within the European Union itself. Taxes are becoming a

maze, an inextricable labyrinth of twists and turns, because everyone wants their

fair share and proper slice of the cake.

Nothing will still be as it was before

Transparency, consistency and substance are the watchwords under BEPS. Brexit

and the reaction that may be expected from the UK, which will wish to reduce its

corporate tax in response, and Trump's tax reforms in the US, will add an

additional degree of complexity to the situation, without any doubt. Some

companies will be tempted to relocate in an attempt to give more substance to

whatever place they claim to operate in. On the other hand, the pseudo-holding

companies and "non-permanent establishments" will disappear, as will structures

artificially contrived to mitigate taxes. No, it is a certainty that nothing will be the

same as it was before. In a digital world, in the throes of change,

dematerialisation needs to be addressed to avoid losing control over the taxation

of revenues generated in a country (e.g. 2017 VAT changes to intangible rights).

BEPS is therefore much more than just a tax issue. It goes far beyond that.

Ensuring that people don't start talking about you

Companies have found, in this world of wolves ravening for taxes to plug their

deficits, that naming and shaming can do a great deal of harm. The cases that the

media have latched onto, such as Google, FIAT, Starbuck, Apple, etc., still leave

their mark, even if the companies are not found guilty. Being named in the press

for breaking tax rules is very much frowned upon. Stakeholders are putting more

pressure than ever on companies to force them to be tax compliant. These days,

people take a dim view of those who stray from the straight and narrow. Seeking

ways of mitigating taxes has now become dangerous. The tax authorities in every

country have become scrupulous, meticulous and meaner. You have to be

squeaky clean and explain everything, or at least be able to do so. Transfer

pricing, making decisions on the permanent establishment concept, restricting

the deductibility of interest, restricting the use of losses carried forward and the

prescribed comprehensive documentation, amongst other things, make tax risk a

major risk.

There is also a feeling that jurisdictional risk is shifting back to the developed

countries. This is due to the adoption by these countries (particularly the G20

countries) of the OECD rules on taxes, and by the requirement for greater

budgetary responsibility, which involves additional types of tax and better

collection of existing taxes. However, Trump's tax reforms could also have serious

consequences given the influence of the USA on the world economy. At this stage,

this proposed gargantuan reform gives rise to a barrel-full of uncertainties as to

what turmoil it may eventually produce. Treasurers need to keep a very close

watch on this matter. The debate on what a fair share of tax might be is

continuing to attract a lot of attention and some stakeholders are encouraging

MNCs to publish as much information and tax data as possible, country by

country and business by business, to be as clear, as transparent and as honest as

possible. With a subject that is as off-limits as tax, it really hurts to bring

everything out into the light of day, and culturally it is no easy thing for

management to deal with this subject in its annual report.

Over-egging the pudding is self-defeating

As always, trying to achieve too much is self-defeating and the backlash could be

dangerous. Moving from a certain degree of opaqueness to absolute transparency

is a tricky exercise. The way the public relations message is presented becomes

very important. With BEPS, interest will no longer be fully deductible because it

will be capped. To achieve the best tax situation for the group, it will be necessary

to schedule cash flows and to capitalise subsidiaries appropriately. The number of

tax disputes will certainly increase. To avoid or avert them, APAs (Advance Pricing

Agreements) will have to be negotiated to keep down future transfer pricing risks.

Unfortunately, it takes time to negotiate them and renew them as time goes by.

With BEPS, it is also important to build up a greater amount of mutual trust

between companies and the tax authorities. The best behaved pupils will be

identified quickly and looked after. Virtue in tax and total transparency will

benefit those the companies that practice them. But it is reasonable to suppose

that we will be paying more tax overall in the future. The mass of documents and

sets of forms to be produced will increase disproportionately – for example, the

famous country-by-country reporting (i.e. CbCR), or comparative transfer pricing

documentation for intercompany loans. Information systems will have to be

adapted in response to this so as to produce, easily, the required reports and

substantiating documentation supporting and justifying your transfer pricing

strategy and intra-group operating margin.

BEPS contains positive points and other less beneficial features

Gradual approach

If I had to give advice about a gradual approach, I would suggest starting with: (1)

clearly defining the strategy and approach to managing taxes. How are we to

prepare ourselves for "more aggressive" and more numerous demands from the

tax authorities? What is the reputational risk appetite as regards taxation? This is

usually defined as being zero. How are we to oversee and monitor it, and also to

produce the data required by the tax authorities? How are we to handle the

potential tax disputes that will inevitably arise, and anticipate and mitigate the

risks deriving from tax audits and investigations? (2) The tax authorities are

themselves also becoming more sophisticated everywhere, and equipping

themselves with tools to collect taxes better. We have to adapt and take on staff,

particularly treasury staff, and give them adequate training to meet the growing

needs. It is vital to keep the C-level properly informed, together with the Board

of Directors, to give it the reassurance it looks for (3). The public relations

message will be crucial (4) both in content and in form. Politicians and the general

public have started to pay very close attention to taxes, showing zero tolerance.

There is no longer room for DIY and amateurism. I take the view that we need to

adopt a global and coordinated policy on how to handle tax controversies. In a

globalised world in which all information is accessible to everyone, even the tax

authorities, and spreads like wildfire, it is a good idea to be very cautious and opt

for a coordinated approach by a specialist team to prevent any risk. There will be

regular tax audits, particularly into financing and treasury management, to

identify areas of possible danger. Preventative tax measures will take over from

the former approach of simply reacting after an investigation. We can no longer

wait and see what happens, we have to be proactive and maintain a continuous

watch. After that, the computerised tax authorities and the greater sophistication

of tax inspectors will increase the need for appropriate IT tools. These IT

applications will be able to compile information, process it, and analyse its

potential impact. It will be useful to be able to trace transactions and manage

databases of historical data. Then come (5) the Alternative Dispute Resolutions

to estimate and evaluate the risks connected with agreements such as APA’s,

rulings, etc., and how potentially to reduce the risks for the business in the future.

It is important to have a strategy on anticipating tax risks and on how to address

them during tax investigations. Similarly, it is a good idea to build up mutual trust

based on a track record of good relations with the tax authorities. Using

mediation might be advisable, for example with MAP’s (Mutual Agreement

Procedures). Preparing the required reports properly should reduce future risks.

And finally (6), it involves deploying people, resources (internal and external),

processes and technology. BEPS requires greater staffing to meet the demands.

You would be well advised to design regular reports and performance indicators

for management and the Audit Committee to keep them informed of the status of

tax matters.

BEPS, more than just a tax issue…

It is therefore clear that BEPS is much more than just a simple tax issue. As

regards the financing aspect and in-house bank transactions, it is the

responsibility of the CFO, of Tax department and Treasury department to ensure

they are able to produce the material required to substantiate their tax strategy

and their transfer prices. Surely BEPS is just a catalyst, the spark that puts the

spotlight back on tax risk. This risk is intensified and returns to centre stage for

the CRO (Chief Risk Officer). Over to you to be meticulously prepared. No, in tax

matters, it is absolutely certain that nothing will ever again be the same as it used

to be. The word "taxes" will cause tax managers and treasurers to lose sleep for a

long time to come.

François Masquelier, Chairman of ATEL

July 2017

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