Tax transparency. Building confidence

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1 Tax transparency Building confidence

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3 Contents Foreword 1 Executive summary 3 What is on the agenda? 5 The transparency context 9 Transparency in practice: the options 15 Transparency and tax authorities 30 Overall conclusions 37 Further information 39

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5 Foreword Our report Tax transparency Seizing the initiative, published on 7 May 2013, excited quite some debate. Our view that in the UK a tipping point had been reached and increased voluntary reporting should be considered as a way to mitigate or shape mandatory changes, was met with a mixture of agreement and resistance. The public debate continues to evolve and in this report we get to the heart of what we consider to be the key drivers of concern and the purpose of increased transparency in light of them. There has been growing pressure from some quarters for mandatory country by country reporting and we examine whether this can really answer ongoing concerns. We see considerable complexity and cost with this route and remain to be convinced that country by country reporting is capable of providing the anticipated solution in all circumstances. We believe it is necessary to rebuild confidence that international tax laws are appropriate to modern businesses and supply chains (or can be adjusted to be so), and that tax authorities have sufficient skill and information to robustly scrutinise multinational organisations. That said, we recognise that there remains an appetite for more information about the way individual organisations make decisions around tax and how they engage with tax authorities. Accordingly, in this report we consider the different disclosure options discussed in our original report in more detail. We hope this will aid multi-national groups in their deliberations on the course of action which best suits them, their business and their stakeholders, and that the ultimate outcome will be increased confidence. At a time when the 2013 Lloyd s Risk Index highlights taxation as the number one threat to global business, the debate on the direction of international law and enforcement has continued with the base erosion and profit shifting (BEPS) Action Plan published by the OECD on 19 July As you will read, we support the development of disclosures to tax authorities that meet the key design principles we set out in this report. We also set out the case for collaborative and constructive dialogue between taxpayers and tax authorities on how the law applies to particular facts and circumstances. We explain how a collaborative approach is key to reaching appropriate out of court settlements of disputed tax and how public confidence can be built that HMRC reaches settlements that are in the public interest. These may have received a bad press in some quarters but, in a world where there cannot always be one precise answer, working collaboratively to agree a mutually understood position can sometimes be the only sensible alternative to litigation that may be in nobody s interests. This report is intended to move the debate forward on a practical basis. We hope that you will find it insightful and thought provoking. As with our first report, we hope that many will respond to inform the debate. John Dixon Managing Partner, Tax, UK & Ireland Tax transparency Building confidence 1

6 We believe that MNCs still need to consider seizing the initiative by increasing UK disclosure that builds confidence in their approach to tax and the way in which they engage with tax authorities. 2 Tax transparency Building confidence

7 Executive summary Confidence in the tax system is at the heart of an effective tax regime and the recent furore over the taxation of multinational companies (MNCs) has challenged and, for some, overturned such confidence. We believe there is a need to rebuild confidence that: International and domestic tax rules are appropriate for modern business practices (taking account of the work being done as part of the OECD BEPS initiative). Tax authorities have the information as well as the appropriate skills and resources to administer and enforce the rules. MNCs have an acceptable strategy and approach to tax and are paying an appropriate amount of tax in each of the territories in which they operate. Disclosure is a part of building that confidence. What should be disclosed and to whom depends upon a variety of factors and we believe there is no one size fits all. Instead the approach will be different for different organisations. Indeed the various approaches we are seeing being taken by MNCs show the range of views held on this as well as reflecting the differing circumstances. Any increased UK disclosure from MNCs should focus on providing information and explanation that answers stakeholders concerns. This includes building confidence that an appropriate amount of tax is being paid. However, we also believe that most accept it as being quite legitimate for companies to factor tax into their commercial decisions; after all many tax incentives are designed by governments with this in mind. The current UK Government aspires to have the most competitive tax regime for this reason. We are not convinced country by country reporting meets this need. It is unlikely to be practical for such reporting to adequately distinguish between legitimate investment decisions and inappropriate profit shifting. In particular, transfer pricing is complex and the required analysis of value drivers gets to the heart of an MNC s competitive advantage, such that public disclosure might additionally risk harming competition. In our view, it is not practical to provide the level of detail that would be informative. However, we believe MNCs still need to consider seizing the initiative by increasing UK disclosure that builds confidence in their approach to tax and the way in which they engage with tax authorities. Failure to build confidence could well increase the likelihood of further compulsory disclosures. In most cases, we think a clear explanation of the way in which tax decisions are made, what drives effective tax rates and the manner of engagement with authorities are the key disclosures an approach starting to be adopted by some organisations, including a few in the FTSE 100. However, the answer is likely be different for some MNCs and each will need to consider their own position. In fact we are seeing some MNCs disclose far more than this. Tax transparency Building confidence Where more disclosure is considered appropriate, it is key that data is accompanied by explanation. From the variety of approaches taken by different FTSE 100 companies in relation to a range of additional tax disclosures, it is clear that the decision as to the route to take is a complex one. Indeed, we surveyed Tax Directors for their views around the tax transparency debate and 70% of our 68 respondents where from organisations with turnover in excess of 1bn. Respondents expressed concern around the risk of information being taken out of context and around the difficulty of providing the information in a form that would be easily understood. Commercial transactions are complex and organisations often need to exercise judgement in relation to corporation tax liabilities. We believe that collaborative working relationships including appropriate disclosure to tax authorities are key to designing and applying legislation that supports commercial transactions and limits any concerns in relation to the ability to inappropriately circumvent liability. We welcome the work of the OECD in connection with the BEPS Action Plan to focus on transfer pricing documentation with a view to enhancing transparency for tax administration while taking into consideration compliance costs for business. We believe MNCs and the public alike support well-resourced tax authorities who robustly and appropriately scrutinise the tax position of MNCs. However, there is a difference between robustness and aggression it is quite natural for tax authorities and MNCs to be motivated to take different positions on complex and imprecise matters. Excessive aggression, on either the taxpayer or authority side, risks litigation that is not in either s interest. Confidence in tax authorities is not just about broader public confidence; an effective tax regime requires confidence amongst taxpayers themselves, including MNCs, that a transparent description of their affairs will be met with a reasonable application of the law. Although most MNCs do not recognise the cosy relationship with HMRC that has sometimes been portrayed, we recognise the need for public confidence that out of court settlements are made in the public interest. Government has responded by emphasising it aims to resolve disputes through collaborative working wherever possible, and reach agreement without litigation, as that is the quickest and most efficient approach, while also overhauling HMRC s governance and the way out of court settlements are scrutinised. It will no doubt wish to monitor progress to ensure the desired confidence is built. 3

8 We believe that a key challenge from the perspective of the public is to ensure MNCs profits are allocated for tax purposes appropriately amongst the territories in which they operate. 4 Tax transparency Building confidence

9 What is on the agenda? The unprecedented media attention, particularly in the UK, has clearly shaped and shifted the debate on MNCs approach to tax paid here. Coverage has focused on the changes required to restore trust, hold MNCs accountable and counter artificial shifting of profits. The volume of coverage has not decreased since we published our first Transparency report, and the debate appears to have shifted from the identification of issues to contemplation of possible solutions. The debate has shifted from the identification of issues to contemplation of possible solutions. Public view We believe that a key challenge from the perspective of the public is to ensure MNCs profits are allocated for tax purposes appropriately amongst the territories in which they operate. However, there are still points of division when it comes to articulating what it is that has caused this problem, and what should be done to fix it. Is the international tax system broken (as some have said) or are some simple updates required? Is it just the enforcement of the system that requires improvement? Will the provision of greater publicly available information enlighten the public on the activities of companies and allow them to judge appropriateness, or could it inadvertently confuse in equal measure? Significant resource would be required to compile and enforce rigour in the provision of such information. Is the cost worth it or is there a better way to achieve the objectives? Finally, is further disclosure necessary so the public can directly scrutinise the conduct of MNCs or is this a better, and more appropriate, task for tax authorities? What is proposed? The publicity has fuelled an array of different policy proposals from interested parties. The Tax Justice Network and Michel Barnier, EU Commissioner for Internal Market and Services, are amongst those who propose country by country reporting, albeit in slightly differing forms. While others have proposed a Fair Tax Mark, there are inherent challenges where any such approach is not carried out by tax authorities who have all the relevant information. The CBI has promoted seven tax principles and the G8 communiqué spoke of restoring confidence in the international tax system. Labour party policy documents advocate intelligent transparency, promoting publication of information of practical benefit to the revenue authorities in developing countries where they operate. While the Government has not committed to additional tax reporting requirements, it has agreed to potential country by country reporting of non-financial and diversity information. Where to from here? It follows that clear choices need to be made how these will take shape in the midst of the current mixture of reactions is extremely difficult to predict. By seizing the initiative in terms of the information provided publicly and to tax authorities and by providing a constructive narrative, we believe MNCs increase the chance that these choices will work for them. In this second Transparency report, we therefore consider the key options for public disclosure in a tax transparency context, what additional disclosures might be made to tax authorities and how building confidence in the job done by authorities interacts with what stakeholders expect to be disclosed publicly. Tax transparency Building confidence 5

10 Timeline This timeline shows how the debate on transparency has evolved and illustrates how it looks set to continue Extractive Industries Transparency Initiative formed. The European Parliament requests that the European Commission consider the area of Transparency and Accounting. The Council of the European Union initiate discussions on the proposals for EU Directives on Transparency and Accounting. As part of a campaign led by Christian Aid, Stephen McPartland MP wrote to the members of the Hundred Group asking both for support for country by country reporting as well as insights into attitudes to tax. September June November July December September November January President Obama signs Dodd-Frank Wall Street Reform and Consumer Protection Act. EFRAG releases the discussion paper Improving the Financial Reporting of Income Tax. European parliament votes on proposals to amend EU Directives on Transparency and Accounting and issues proposed rule, which is to be debated by the tripartite group of EU Parliament, Commission and Council of 27 Member States. UK Public Accounts Committee invite large US multinationals, Big 4 Heads of Tax/Tax Policy to discuss their tax positions and practices. 6 Tax transparency Building confidence

11 The UK Government announces proposals to require potential suppliers under Government contracts to confirm they have not been involved in certain tax avoidance arrangements. EC Conclusions and Commissioner Barnier announcement proposing to extend country by country reporting to all large groups. UK Labour Party policy documents on corporate tax transparency and reform. BEPS update meeting. EY publishes first Tax Transparency Report. CBI proposes seven tax principles for UK businesses. OECD issues its report Base Erosion and Profit Shifting, which highlights the complex and urgent policy debate ahead and the intent to consult with business. EFRAG releases its feedback statement on Improving the Financial Reporting of Income Tax discussion paper. The UK Government issues its response to the Public Accounts Committee report and recommendations on HMRC s performance, in particular in respect of the UK taxation borne by multinationals. Australian tax bill includes requirements for the ATO to publicly report the Australian income, taxable income and tax payable for companies and other corporate entities with income of A$100mn and over, with additional reporting where Minerals Resources Rent Tax or Petroleum Resources Rent Tax is payable. UK launched its implementation of the Extractive Industry Transparency Initiative. BEPS report released detailing 15 actions including one to re-examine transfer pricing documentation to enhance transparency for tax administration while taking into consideration the compliance costs for business. February March May July 2013 February April June Australian Government instructs the Treasury to analyse whether greater reporting of taxes paid by multinationals in every country is desirable. The EU announces proposals that would require financial services firms to report profit before tax and payments to and from governments to be reported annually to the European Commission as part of a range of proposals that form part of the EU s Capital Requirements Directive IV. Australian Assistant Treasury releases a Treasury discussion paper proposing disclosure by the Australian Taxation Office of the total income, taxable income and income tax payable of large corporate entities with total income of A$100mn or more with a proposed start date of 2013/14. EU finalises drafting of Accounting Directive to require reporting of payments to governments by EU extractive and logging entities. The European Parliament agrees proposals that will require banking entities to report profit before tax and payments to and from governments to be reported annually to the European Commission as part of a range of proposals that form part of the EU s Capital Requirements Directive IV. France Finance Ministry plans for country by country reporting. Fair Tax Mark report released by the Fair Tax Campaign. EU Accounting Directive signed, including country by country reporting requirements for those in the extractive industry or involved in the logging of primary forests. G8 Summit with tax transparency high on the agenda. Tax transparency Building confidence 7

12 Organisations must be clear as to the overarching aims of disclosing additional information in order to ensure what is published meets this need. 8 Tax transparency Building confidence

13 The transparency context A natural response to the unprecedented media attention around payment of corporation tax is a demand by stakeholders for increased transparency. We believe this is matched by an equivalent desire from many MNCs to make sure that any explanations are understood. Many feel they have nothing to hide in the tax debate and that, if armed with the same information and understanding, the public would come to the same conclusion. A natural response to the unprecedented media attention around payment of corporation tax is a demand by stakeholders for increased transparency. Some organisations see a direct correlation between greater transparency and being regarded more favourably. The temptation, therefore, exists to view transparency as an endeavour where more is better. However, as explored below, we believe that greater public transparency can also deliver unintended costs. Indeed, in our recent survey on transparency, almost a third of respondents expressed concern around the risk of the information being taken out of context and interpreted negatively. Others also cited the risk of making commercially sensitive information available to competitors and the associated cost and/or required resource. Organisations must, therefore, be clear as to the overarching aims of being more transparent in order to ensure what is disclosed meets this need: The overall approach taken in managing their tax affairs ensures that the tax paid in relevant territories is appropriate, bearing in mind the activities undertaken there. The organisation engages with relevant tax authorities in an open manner to allow robust scrutiny of its affairs and ensures that appropriate judgements on tax liabilities are being taken. A reasonable approach is taken to managing corporate tax risk, and There are processes within the organisation to ensure adherence to the policies that have been put in place. The key question is how this desired outcome translates into practical disclosures. Below we start by exploring what stakeholders (other than tax authorities) might reasonably wish to know. In the next Section we assess some of the practical issues and how specific disclosure options meet the aims of MNCs and their stakeholders. What do stakeholders want? Against this background, it is important to question the sort of transparency stakeholders want. In our view, this has evolved considerably over the lifetime of MNCs tax affairs receiving widespread media attention. Initial reporting was a product of the need for reporters and the public alike to inform themselves on the issues that appeared to be generated by some of the early headlines. How could it be right that MNCs with sizeable turnover from UK consumers apparently paid no tax here? There was a search for an explanation against a backdrop that such an apparent anomaly must be a signal of wrong doing. Questions centred on the conduct of the organisations concerned and whether it was legally or morally wrong. In the absence of understanding, it was inevitable that media and the public alike initially called for greater public disclosure from MNCs. Tax transparency Building confidence 9

14 Now it is much more widely acknowledged that MNCs are likely to have supply chains which involve various activities being undertaken in different territories, and that there is a consequent need for the overall profits of the organisation to be allocated amongst those activities so that each country may tax its fair share. Building confidence in the rules and their enforcement has evolved to become a key concern of many stakeholders. Many realise that this is achieved by imposing a transfer price that attempts to emulate the price that might have been paid by the relevant subsidiary companies had they been independent of each other. Some recognise that this is inevitably an inexact science, especially since many such subsidiaries might trade with each other in a different way than they might be prepared to if they were independent parties. For example, a German and a UK subsidiary might undertake a joint research project where they cooperated on different aspects to build overall knowledge in a manner that might not have been so commercially acceptable if they were independent. Finally, there is increased understanding around what causes a company to have a taxable presence in other countries, and some subsequent questioning of whether the rules that govern this are still appropriate in the modern economy. The fact remains, however, that while there is perhaps more recognition of the complexities, the issue of whether abuse is taking place is still a difficult concept. Nonetheless, perhaps as a result of this changing understanding, the debate has shifted towards the following questions: (i) to what extent do international tax rules require amendment? (ii) what steps are required to improve enforcement? We believe that building confidence in the rules and their enforcement has evolved to become a key concern of many stakeholders. One might suggest that media scrutiny is more adept at highlighting deficiencies and the need for change than it is at designing, implementing, monitoring and enforcing the changes. Many stakeholders will not wish to take over this role. 10 Tax transparency Building confidence

15 The role of politicians The role of policy makers cannot be overlooked in terms of the issues at the root of the ongoing debate around transparency, particularly as their policies reflect some of the key areas of discussion. Politicians have reflected the concern that MNCs might, as the G8 Lough Erne communiqué put it, reduce overall taxes paid by artificially shifting profits to low-tax jurisdictions. But this raises the question as to what makes such a shift artificial and what is in line with Government intentions? Indeed, the UK and Canada have at some point publicly stated their ambition to have the most competitive tax system in the G20, currently with the explicit aim of attracting investment and enterprise in their respective territories. Many European territories have some incentive for R&D or innovation activities for the same reason. It follows that policy makers accept that it is expected that organisations will take into account the tax environment when making decisions on where to locate an investment or activity, a view which we believe is broadly reflected in other stakeholders opinions. What form of transparency meets the needs of MNCs and stakeholders? At its heart, we believe transparency is a key driver in building confidence. MNCs wish to use public disclosure as a means of building stakeholder confidence that they pay the appropriate tax and are open with tax authorities. This latter point is crucial given the view stated above that, for many stakeholders, building confidence has as much to do with confidence in the law and its enforcement as it does with the conduct of MNCs. There appears to be a growing opinion in some quarters that confidence can be built by requiring MNCs to disclose details on the profits and taxes they pay in each country (so called country by country reporting ). The next section focuses on this option and asks whether it really is the answer before going on to assess the merits of other options. Tax transparency Building confidence 11

16 Why is corporation tax sometimes complex? Here we set out why it can sometimes be difficult to determine precisely the amount of corporation tax a MNC owes in each territory in which it operates. Because corporation tax is a matter of national sovereignty even across countries as closely aligned as the EU each country will set its own tax rules and rate, based on its own choices as to how much revenue it wishes to raise from companies subject to its tax. Many MNCs have research, production, distribution, marketing, sales and support facilities in many different territories and in each territory they must determine how much profit made by the combined organisation is properly attributable to the value generated by assets and people in that territory. Very often personnel in different territories work together in a way that would be commercially unfeasible if they weren t part of the same overall organisation. This might take the form of technical collaboration, joint brand building, sharing of best practice and pooling of corporate functions such as treasury and finance. This can mean that the combination of activities undertaken in one territory has no open market value and instead it is necessary to determine how much of the overall group profits are represented by that effort (the so called profit split methodology). Additionally, any collaboration across territories requires an estimate of how valuable the individual contributions in each territory were relative to each other. In general, there is a detailed mapping of functions and then a detailed mapping of the contribution to those functions by different territories. A weighting of the relative value of functions is arrived at through a number of detailed interviews and, where available, evidence from independent sources ( comparables showing how third parties have agreed to share the overall profits from a joint collaboration in broadly similar circumstances). The resulting allocation of profits is calculated on the basis of this information. If the process is undertaken well, the results may not be that sensitive to variations in an individual assumption. But the combination of judgements, however diligently arrived at, means that a range of results may be justifiable. 12 Tax transparency Building confidence

17 In very high level terms, international tax rules treat income differently depending on whether it is earned by actively carrying on a business or trade (such as manufacturing, selling, providing services, and so on) or whether it is passive income, which is earned by allowing others to use an asset without any ongoing activity by the owner of the asset (for example, royalty income from licensing trademarks or patents might be passive income if the owner is not actively involved in managing the licence). Broadly speaking, the rules are designed so that income which derives from activity is taxed where that activity is located whereas income that arises from passive ownership is much more likely to suffer tax in the location of the person paying for the use of the asset (the source ) as well as being subject to tax in the territory of ownership (generally with a credit for anything taxed at source). There is inevitable difficulty at the boundary; how much activity is required before there is an active business? Finally there is the question of when an activity extends beyond its normal base to form a taxable presence in another country (known as a permanent establishment ). An organisation may sell to UK customers from an entirely overseas base but what if local support is provided in terms of delivery, after-sales care or a visit by an overseas representative to the UK during the sales process? Determining whether enough has been undertaken in a country to constitute a permanent establishment can require the weighing up of a number of indicators, some of which may point towards one existing and some against. And if a permanent establishment does exist, how much of the overall profit should be allocated to it? This requires similar analysis to that already described above. In other words, there may be a range of answers that it would be reasonable to arrive at within the tax rules applicable in each country, let alone in light of the differing tax systems in different countries. Taxpayers and tax authorities alike will all be motivated to interpret the information towards a reasonable answer within the range that gives them the best result. For tax authorities, the question of how their tax system defines the appropriate tax liability for corporations may be based on what will give the tax authority the greatest share of profits possible. However, it may alternatively be based on encouraging investment into the country in ways which do not directly give rise to significant corporation tax receipts. A willingness by all parties to work together to determine what is the appropriate tax due under the law of each country concerned is the only way to avoid needless litigation or double taxation. Tax transparency Building confidence 13

18 Disclosure is complex and is filled with difficult choices on how information is presented so as to best communicate the actual position. 14 Tax transparency Building confidence

19 Transparency in practice: the options In this Section we explore the various disclosure options and assess how they answer the needs of MNCs and stakeholders. We begin by setting out some of the practical issues that should be borne in mind for any disclosure. Then we discuss whether country by country reporting could provide the answer in terms of greater transparency to the public before outlining a range of other disclosure options that an organisation could consider. The practical issues which organisations should consider before making a disclosure include: It is critical to ensure that what is said is robust and correct, regardless of whether or not it is compulsory. Any inaccuracies inevitably give the impression that at best there is a poor attitude to tax matters and, at worst, there is something to hide; perhaps even fraud. Stakeholders become used to receiving information; it is much easier to introduce new reporting than to cease to provide information that has historically been delivered. Accordingly, reporting changes should be viewed as a long-term commitment (and where appropriate, meet the new requirement under revisions to the UK Corporate Governance Code of presenting a fair, balanced and understandable assessment of a company s position). Disclosure is complex and is filled with difficult choices on how information is presented so as to best communicate the actual position. With these choices comes the risk that others misinterpret and illustrate a different position than intended by presenting the same underlying information in a different manner. It is critical to ensure that what is said is robust and correct, regardless of whether or not it is compulsory. The risk of unintended consequence is, therefore, a particular concern when developing responses to this debate. Any meaningful disclosure of an MNC s tax affairs is by its very nature likely to be complex. In our tax transparency survey, almost a third of MNCs considered that it would be difficult to provide information in a form that would be easily understood. Even with careful design, it follows that the risk of misinterpretation is high. Moreover, there is a risk that some readers might seek to interpret any information provided in a manner that paints the organisation s activities as unacceptable, even if that portrayal relates to planning that stakeholders, armed with a more detailed knowledge, might regard as perfectly acceptable. There are numerous routes for public disclosure and the principal options are considered in more detail below. A common theme unites them all the risk of unintended consequence is best mitigated by accompanying information with explanation. However, no amount of explanation can fully eliminate the risk that greater transparency may, in some circumstances, have an unintended impact. Is country by country reporting the answer? Some argue that country by country reporting is necessary to achieve sufficient transparency to the public. We will, therefore, go on to examine the different proposals before assessing how far they go to answering the public need as we see it. Tax transparency Building confidence 15

20 Proposals already under consideration Extractive Industries Transparency Initiative (EITI) One of the first formal country by country reporting initiatives was the 2003 EITI, revised in May The EITI is an international initiative that aims to secure the participation of leading resource nations as well as the MNCs who operate in those countries. Those adopting the EITI standard are required to report payments made to national and local governments, including profit taxes. There are also requirements for governments adopting the EITI standard to disclose payments they receive from companies. The G8 communiqué published 19 June 2013 stated the following, demonstrating the countries support for the EITI initiative: The US, UK and France will seek candidacy status for the new EITI standard by Canada will launch consultations with stakeholders across Canada with a view to developing an equivalent mandatory reporting regime for extractive companies within the next two years. Italy will seek candidacy status for the new EITI standard as soon as possible. Germany is planning to test EITI implementation in a pilot region in view of a future candidacy as implementation country. Russia and Japan support the goal of EITI and will encourage national companies to become supporters. The UK launched their implementation of the EITI standard in July Dodd-Frank Act The Dodd-Frank Act requires all companies subject to SEC rules engaged in the commercial development of oil, gas or minerals to annually disclose, for fiscal years ending after 30 September 2013, information on payments made to federal and foreign governments, including taxes based on corporate income, production and profits. EU Accounting Directive The new EU Accounting Directive (Directive 2013/34/EU) includes requirements for large and public-interest entities which are active in the extractive industry or logging of primary forests to disclose material payments made to governments in the countries in which they operate, in a separate report, on an annual basis. The information is to be broken down country by country and project by project, and includes: taxes on income, production and profits; production entitlements; royalties; dividends; signature, discovery and production bonuses; licence fees, rental fees, entry fees; and payments for infrastructure improvements. EU Member States are required to bring into force the laws, regulations and administrative provisions necessary to comply with the Directive by 20 July 2015, and may provide that these provisions are first to apply to financial statements for financial years beginning on 1 January 2016, or during the calendar year The Directive includes requirements for a review by the Commission to consider the effectiveness of the regime and the potential extension of the reporting requirements to additional industry sectors, and also whether the report should be audited. EU Capital Requirements Directive IV (CRD IV) CRD IV includes country by country reporting requirements, which will apply to banks and potentially large asset managers. By 1 July 2014, in-scope institutions will be making their first public disclosures for the countries in which they operate in respect of 2013 financials. EU headquartered institutions will need to make disclosures in respect of their global operations and non-eu headquartered institutions will need to make disclosures in respect of operations established in the EU. It remains to be seen whether the disclosures will be reconcilable to other sources of publicly available information given some of the complexities around interpretation. The full disclosures which will include profit, tax and public subsidies data are not required to be made public until Tax transparency Building confidence

21 Although the data required is obtainable, one of the immediate challenges for the industry is preparing the disclosures and being prepared for an audit in a relatively short space of time. No guidance or interpretations have been provided by the European Commission. Member States are starting to transpose the rules into domestic legislation including France, Germany and the Czech Republic. The UK published a consultation paper on 20 September 2013 regarding proposed law and guidance. So the rules are starting to become a reality for many large financial institutions given the deadline for making the first disclosures is less than nine months away. Potential extension of EU requirements to other industries A potential extension of these EU proposals was signalled by the European Council Conclusions of 22 May 2013, which included a commitment to examining the proposed amendments to directives on disclosure of non-financial and diversity information by large companies and groups with a view to ensuring country by country reporting by such large companies and groups. Although the conclusions refer to non-financial information, Michel Barnier, EU Commissioner for Internal Market and Services, suggested that rules to require large companies to report their profits, taxes and subsidiaries on a country by country basis should be drawn up as soon as possible. The disclosure requirements for banks, introduced by CRD IV, were cited as a possible template. Country by country reporting was not included in the measures put forward by the European Commission to reduce aggressive tax planning in December 2012 and the proposal was not taken forward in the subsequent G8 meeting of 18 June However, many are campaigning to ensure that EU proposals include a provision for country by country reporting. Notwithstanding the obvious interest from a number of Member States, there is likely to be significant resistance to these proposals, which could prevent adoption. Our most fundamental concern with country by country reporting is whether it can effectively build the confidence that stakeholders want. Complexities and challenges This leads to the question of whether country by country reporting is the answer to the public concern. We first consider some examples of the potential complexities and the challenges that those considering a form of country by country reporting would need to resolve before the output could be truly meaningful. The simplest form of country by country reporting may be to focus purely on the taxes paid by a company in a particular year. However, it is unlikely that this would provide sensibly comparable data in all cases. Tax payments are often made in instalments that do not align exactly with an accounting period. For example, in the UK, payments by larger companies are made on a quarterly instalment basis. The first two payments are made during the accounting period to which the relevant taxable profits relate, but the final payments are made during the following period. Comparing cash tax to accounting profits in a particular accounting period does not, therefore, appropriately align the tax with the relevant profits. Taxes paid in a particular year may also be reduced (or increased) by a number of factors inherent in a particular territory s tax regime. For example, many territories have regimes where capital transactions, such as the disposal of shares, can be tax free provided certain conditions are met. This is the result of explicit policy decision of those governments, but the non-taxation of such profits could heavily skew the effective cash tax rate in a country. Tax transparency Building confidence 17

22 In addition, many countries provide special incentives where a company undertakes significant capital investment, for example in infrastructure or plant and machinery. The tax paid in a year of significant investment may, therefore, be significantly reduced as a result of these incentives. However, the company is simply availing itself of the tax benefits designed by governments to encourage investment for the mutual benefit of the company and the local economy. In some cases, the effect of the incentives may only be one of timing for example, tax depreciation may be provided by local legislation at a different rate to accounting depreciation, thereby impacting the timing of cash tax payments. One answer to this timing difference issue may, therefore, be to introduce deferred tax (i.e., tax that will automatically arise in a later period as a result of actions in this period) into any form of country by country reporting and to consider total tax, that is current and deferred tax combined. However, the introduction of deferred tax itself gives rise to a number of complexities. For example, where losses are not recognised for deferred tax purposes, due to the uncertainty of future profits to use those losses, this has the effect of increasing the overall effective tax rate in a year. In subsequent periods, if those losses are in fact utilised, the effective tax rate would be lower for that particular year. There are many other examples that could be given. This highlights the many complexities that would require considerable thought in order for any country by country reporting to be meaningful to readers. However, our most fundamental concern with country by country reporting is whether it can effectively build the confidence that stakeholders want. After all, it does not help to ascertain whether an organisation should be taxed in another territory or whether profits are appropriately allocated between territories. In our view, stakeholders wish organisations to be transparent on how they make decisions in relation to tax and their approach to engaging with tax authorities in a manner that allows appropriate scrutiny of their affairs. One argument put forward in favour of country by country reporting is that the overall profit mix can be compared with geographic turnover information and disclosures on the number of employees, so that a picture can emerge over the extent of the risk that profits are being artificially shifted to low tax jurisdictions. We have significant reservations as to whether it is practical to disclose sufficient information publicly for this question ever to be answered robustly, without serious cost and risk to MNCs in terms of divulging information that inhibits their ability to compete with and maintain advantage on rivals. In the sidebar on page 12, we set out why corporate tax can sometimes be complex. But, in short, transfer pricing is a matter of judgement and studies typically analyse in depth the value drivers in any given supply chain. Governments in some countries, such as the current UK Government, are quite open in aiming to have a competitive, low tax regime that is designed to attract investment and activity. Most see it as quite legitimate for MNCs to consider a country s tax regime amongst the many other factors that will shape decisions on where to locate activities and investments. A concentration of activity and profit in more favourable tax jurisdictions is precisely the intent of policy makers, albeit as a result of the concentration of economic activity. 18 Tax transparency Building confidence

23 Readers of an MNC s country by country disclosure would, therefore, need to have sufficient information on the key drivers of value in the MNC s supply chain and specialist economic knowledge, in order to distinguish between: Groups legitimately responding to the different country tax incentives in making their investment decisions. Apparently unusual shifts of profits that might be regarded as artificial. This is why we support the OECD s focus on enhanced transparency to tax authorities, who will not only have access to relevant confidential and proprietary information about the company, but also the staff with the expertise to interpret the figures. Rather than wide public country by country reporting, effort should be focused on providing the relevant information to tax authorities in a manner that does not impose an incommensurate burden on organisations. Governments should ensure that tax authorities have the skills, the manpower, the time and the resources to effectively police the tax system. The public can then gain confidence that the system is being suitably enforced. At this stage we remain to be convinced that mandatory country by country reporting is an effective means of meeting stakeholder needs. Instead, this concern is best resolved by taking steps to restore confidence in the rules, as the BEPS project seeks to, and ensuring that tax authorities have the required information. This includes sufficient visibility of an MNC s overall supply chain, to allow the public to have confidence in the enforcement process carried out by tax authorities. Other disclosure options Even if country by country reporting is not the answer, we see a clear need for at least large listed public groups to address issues in relation to tax in a manner that answers the current concerns being expressed. In our view, certain stakeholders wish organisations to be transparent on how they make decisions in relation to tax and their approach to engaging with tax authorities in a manner that allows appropriate scrutiny of their affairs. In this Section we examine some of the options in more detail. We categorise the main disclosure options below. These are not necessarily alternatives; instead they describe the various potential building blocks to the overall disclosure an organisation makes. We have included excerpts below to demonstrate the concepts discussed. However, it should be noted that these are only extracts and to get a full picture of an organisation s tax position, all of the disclosures made need to be considered together. What is right for one organisation might not be right for another. More detailed tax reconciliation/explanation of tax drivers There may be a case for reconsidering the categories set out in the tax reconciliation with a view to providing more clarity. In many cases, this may be sufficient to answer any questions that could be raised about a company s tax affairs. Because of its very simplicity, companies should consider whether this additional detail could, in fact, raise further questions in respect of complex arrangements, where one line is not sufficient to provide the full detail. In such cases, companies could consider additional narrative disclosure beneath the numerical tax reconciliation to prevent any public misunderstanding. Tax transparency Building confidence 19

24 An example of a more detailed reconciliation is the one published by Rio Tinto in its Annual Report This is set out below and is complemented by its Taxes paid report 2012: Excerpt from Rio Tinto 2012 annual report 9 Taxation 2012 US$m 2011 US$m 2010 US$m Taxation charge Current 3,876 6,131 5,026 Deferred (3,447) ,439 5,296 Prima facie tax reconciliation (Loss)/profit before taxation Deduct: share of profit after tax of equity accounted units Add: impairment after tax of investments in equity accounted units (a) 2012 US$m (2,568) (1,034) 2, US$m 13,214 (704) US$m 20,491 (1,101) Parent companies and subsidiaries (loss)/profit before tax (1,145) 13,102 19,390 Prima facie tax payable at UK rate of 24% (2011: 26%; 2010: 28%) (275) 3,407 5,429 Higher rate of taxation on Australian earnings at 30% Items excluded in arriving at Underlying earnings: Impairment charges 1,321 1,909 (23) Gains on disposal of businesses and on newly consolidated (185) (30) (77) operations Foreign exchange on excluded finance items (50) 15 (32) Impact of tax law changes on recognition of deferred tax assets (b) (1,205) 342 Other exclusions 157 (91) 13 Impact of changes in tax rates and laws (5) 20 (96) Other tax rates applicable outside the UK and Australia (71) Resource depletion and other depreciation allowances (121) (182) (163) Research, development and other investment allowances (57) (78) (74) Recognition of previously unrecognised deferred tax assets (84) (13) Unrecognised current year operating losses Foreign exchange differences (3) (63) Withholding taxes Other items (49) (40) (140) Total taxation charge (c) 429 6,439 5,296 (a) Impairment of investments in equity accounted units is net of tax credits of US$784mn (2011: US$349mn). (b) Minerals Resource Rent Tax (MRRT) is an additional tax on profits from the mining of iron ore and coal in Australia, which came into effect on 1 July In computing MRRT liabilities, a deduction is given in respect of the market value of the mining assets as at 1 May A deferred tax asset has been recognised in 2012 on the temporary difference between the amount that is deductible for tax purposes and the carrying value of the assets in the accounts, to the extent that its recovery is probable. This temporary difference will reverse over the life of the mines. (c) This tax reconciliation relates to the Group s parent companies, subsidiaries and proportionally consolidated units. 20 Tax transparency Building confidence

25 Disclosure of all subsidiaries One of the accusations occasionally levelled at MNCs is that they operate in secretive jurisdictions which do not require public disclosure, so that stakeholders, including potential investors, may not appreciate that the group in which they are investing has operations in certain territories. In addition, it is considered by some that this secrecy around where a group operates is indicative of tax avoidance or even evasion. The definition of tax havens has taken many different forms throughout the tax transparency debate, and a number of territories are considered by some to be havens, even where many people, with full information, would not consider this to be the case. Groups could consider publicly disclosing the names and locations of all their subsidiaries, so as to provide full transparency over the territories in which they operate. Indeed, there are requirements under UK company law for groups to disclose details of their subsidiary undertakings. While just listing the number of group companies in tax havens may, for some, suggest some degree of tax avoidance, it is not a good indication as there are many non-tax reasons for such companies. Since this is an area of confusion and debate, organisations should consider whether all of these companies are actually still required or whether they have remained in place simply because of the perceived effort required to remove them. Where they are required, consideration should be given to explaining why they are located in those specific jurisdictions. In addition to any disclosures made by companies in accordance with UK company law, we note that SSE explains in its 2012 annual report and accounts that it does not use so-called havens to reduce its tax liability. Resolution Ltd includes in its 2012 annual report and accounts an explanation of the commercial decision to establish the company as a Guernsey-based company, explaining that this does not reduce the tax paid by its operating businesses: Excerpt from Resolution Ltd annual report 2012 Taxation The Company recognises that the taxation of Company profits and its activities in each of the countries in which it operates helps to fund the infrastructure and welfare support systems of those communities. Taxation thus represents an important contribution by the Group to those communities. The decision to establish the Company as a Guernsey based company, with its head office in St Peter Port, was based primarily on the grounds that the solvency laws of Guernsey offer the Company greater flexibility both to buy and to sell operations in a manner consistent with its strategy at the time than would be possible in many other jurisdictions, including the UK. The Company has now confirmed its intention to move from an externally advised, project-based structure to a more conventional, simplified corporate structure, more appropriate for a company no longer seeking acquisitions or a specific exit event. As a result, and subject to shareholder approval, the directors expect to conduct the affairs of the Company in such a way that it will become UK tax resident in due course. Despite the generally low tax rate currently applicable to Guernsey companies, the Company being resident in Guernsey does not reduce the tax paid by its operating businesses, which are based predominantly in the UK and elsewhere in the EU. FLG, which produces 99% of total Group profits, continues to pay tax on profits in full in the UK and elsewhere in the EU. According to the Company s analysis, being based in the UK rather than in Guernsey would not have materially affected the amount of tax being paid in the UK in respect of Tax transparency Building confidence 21

26 Explanation of the principles upon which decisions relating to tax are made Further confidence and understanding of a group s behaviour and attitudes to tax can be provided through a public statement of the group s tax policy, including its approach to tax management and tax planning. In our view, companies should not be afraid to explain that they consider tax both as an appropriate legal obligation, but also as a cost of business. We believe that the public would consider this to be appropriate behaviour, provided this management is undertaken in the context of the commercial operations of the business, and is not driven by artificial structures that are against the express intentions of governments. Approximately one quarter of FTSE 100 companies describe their tax strategy in the annual report and accounts. A further 12 describe their tax strategy outside the annual report and accounts on their websites, sometimes in separate corporate social responsibility documents. Elements of the tax strategy that are commonly discussed include: Engaging in transactions that are aligned with the commercial intentions of the business, and not using artificial tax structures Taking advantage of relevant reliefs to protect value for shareholders Meeting all of a company s legal obligations to pay tax, but not paying more than the law requires Considering the spirit of the law as well as the letter of the legislation. Legal and General included a Tax Matters section in its 2012 annual report and accounts, an extract of which is below: Excerpt from Legal and General 2012 annual report and accounts: Tax strategy We are committed to meeting all legal requirements and making all appropriate tax payments in the territories in which we operate. When evaluating tax planning, we will also always consider the Group s reputation, brand and corporate and social responsibilities. We will: Not pursue arrangements which are not in line with our Group Code of ethics Avoid tax pitfalls by considering tax as part of every major business decision and ensuring appropriate controls are in place to manage our tax risks Not undertake transactions whose sole purpose is to create an abusive tax result Discuss in real-time our interpretation of the law with HMRC where we pursue tax planning Include Board-level oversight as part of our tax risk governance processes Be transparent in respect of our tax affairs and provide disclosure in our Annual Report and Accounts about our tax approach, tax rate and cash tax payments Contribute to the development of UK tax policy and legislation where appropriate Country by country analysis of total tax contribution UK USA LGN LGF 1% 4% 11% 17% 14% Profits taxes borne 2% 24% Other taxes borne (property taxes, VAT, 63% social security) 42% 81% 82% PAYE collected from annuitants Other taxes collected (Payroll, Premium, VAT) 23% 36% 561m 23m 29m 47m 22 Tax transparency Building confidence

27 Unilever includes a Tax Principles section on its website, an extract of which is below which sets out its approach to tax and tax management: Excerpt from Unilever tax principles: Our approach to tax Multinational tax policies have been the subject of much debate in recent years, and there is interest in how we make decisions about tax as well as how much we pay and where. Our tax principles As part of our continuing journey towards sustainable growth and recognising the key role that tax plays in the area of advancing economic development, Unilever has adopted the following set of global tax principles. We believe these principles illustrate good corporate practice in the area of tax management and tax transparency, balancing the interests of our various stakeholders, including consumers, investors and the governments and communities in the countries in which we operate. 1. Compliance We act at all times in accordance with all applicable laws and are guided by relevant international standards (for example OECD Guidelines). We aim to comply with the spirit as well as the letter of the law. 2. Transparency We are transparent about our approach to tax. We regularly put forward understandable, timely and transparent communication about our tax policy and total tax payments. 3. Transfer pricing We aim to pay an appropriate amount of tax according to where value is created within the normal course of commercial activity. Any transfer pricing is always calculated using the arm s-length principle. 4. Structure We do not use contrived or abnormal tax structures that are intended for tax avoidance, have no commercial substance and do not meet the spirit of local or international law. 5. Tax havens Secrecy jurisdictions or so-called tax havens are not used for tax avoidance. 6. Relationships with governments We respect the right of governments to determine their own tax structures, rates of tax and collection mechanisms. 7. Relationships with tax authorities We seek to develop strong, mutually respectful relationships with national tax authorities based on transparency and trust. Where countries have weak or poorly constructed fiscal regulation and/or institutions we support work to help develop the capability of tax authorities and systems. 8. Accountability and governance We ensure that as a business we have the mechanisms in place to adhere to the above principles and provide both relevant training and opportunities for employees to raise any issues of concern confidentially, consistent with the Unilever Code of Business Principles. We report annually to the Board on adherence to the Unilever Tax Principles. How much tax does Unilever pay? Unilever s commercial activity generates considerable tax income for the governments in the countries in which we operate. In 2012, we paid a total of 1.7bn in corporation taxes. In addition, we pay and collect numerous other taxes, such as employee taxes, sales taxes, customs duties and local taxes. Transfer pricing National governments are concerned about how multinational companies account for the value of sales between their operating subsidiaries, as internal prices could be set at artificially low levels to reduce profits in high-tax countries. Both governments and NGOs are increasingly scrutinising companies tax practices, as they are keen to ensure that taxes are not lost to countries, thereby depriving them of income and development. Our own worldwide policy on transfer pricing is in line with current best practice guidance issued by the OECD. It is based on the so-called arm s-length principle to determine payments. We continue to engage with the OECD on this issue and will review our policy in line with any newguidance. Tax transparency Building confidence 23

28 Disclosures on governance/risk management In many cases, the tax policy of a group is reviewed by the Board, and this fact could be publicly disclosed to further enhance confidence that commercial decisions are driving the group s tax position, and not the other way around. One area of concern, noted by stakeholders in the tax transparency debate, is the focus of tax risk in certain territories, particularly developing economies that may be perceived to have insufficient resources to defend their position against an MNC. Clear disclosure of a group s governance and risk management would help to clarify how these risks are managed to ensure that the appropriate amount of tax is being paid around the world. Groups should also consider setting out how they manage their relationship with tax authorities. As we discuss throughout this report, we believe the public wants confidence that the tax authorities are provided with relevant information on a timely basis to enable them to robustly monitor the affairs of MNCs. Narrative around open and effective communication should help build this confidence. Key themes in disclosures on governance and risk management include: Maintaining a public tax/tax risk policy Review of the tax policy by the Board Looking to achieve clarity in respect of tax matters Maintaining an open and honest relationship with tax authorities. In its 2012 annual report Rolls Royce includes a section on taxable finances, which sets out the group s tax principles, governance, and relationships with authorities. Excerpt from Rolls Royce annual report 2012 Taxation The Group believes that it has a duty to shareholders to seek to minimise its tax burden but to do so in a manner which is consistent with its commercial objectives and meets its legal obligations and ethical standards. Every effort is made to maximise the tax efficiency of business transactions and this includes taking advantage of available tax incentives and exemptions. However, the Group has regard for the intention of the legislation concerned rather than just the wording itself. The Group is committed to building open relationships with tax authorities and to following a policy of full disclosure in order to effect the timely settlement of its tax affairs and to remove uncertainty in its business transactions. Where appropriate, the Group enters into consultation with tax authorities to help shape proposed legislation and future tax policy. Transactions between Rolls-Royce subsidiaries and associates in different jurisdictions are conducted on an arms-length basis and priced as if the transactions were between unrelated entities, in compliance with the OECD Model Tax Convention and the laws of the relevant jurisdictions. 24 Tax transparency Building confidence

29 Explanation of the tax profile of the organisation in narrative form As we set out in the next Section, some MNCs prepare and maintain a global transfer pricing framework to aid tax authorities understanding of their affairs. Such frameworks often get to the heart of the key value drivers in an MNC s business and the source of their competitive advantage. As such, many MNCs might consider it unthinkable to share this publicly, but disclosure of its existence might be a useful means of building confidence in the way the MNC concerned deals with tax authorities. Some groups may wish to focus on a particular element of their tax profile that is a major driver of their effective tax rate or tax profile, particularly in cases where there has been media coverage of this area. Using clear wording to explain a particular incentive (e.g., capital allowances), in a way that non-tax specialists can easily understand, could be an effective way of avoiding anger around perceived tax avoidance. On 28 June 2013, RWE npower released its Tax Commentary 2012, which sets out the group s tax policy, relationships with tax authorities, and a brief explanation of relevant tax rules such as capital allowances, transfer pricing and efficient funding. The report uses both numbers and narrative explanations to provide a picture of the main drivers of the company s tax rate. The capital allowances section of that is set out below. Excerpt from RWE npower Tax Commentary 2012 Capital allowances The cost of a capital asset, when it s being used in a business over a period of time, can be spread over the expected period of its use before it wears out. This is known as depreciation. Capital allowances give businesses a type of tax relief that s broadly equivalent to depreciation, because depreciation itself is not an allowable UK tax deduction. Capital allowances are available on some but not all of a business s assets. The assets that do or don t qualify have changed over time, but recently we ve seen moves towards removing tax relief for assets and/or reducing the rates of relief altogether. Nevertheless, for some capital intensive businesses (those that need to invest heavily to operate effectively), capital allowances can provide a temporary benefit when the tax relief on an investment starts out being larger than the accounting depreciation. The result is that taxable profits can initially be lower than expected. Npower saw this happen in This example shows how timing can impact on the differences between taxable profits and accounting profits (the figures are simplified). Example An existing energy company builds a new power station costing 1bn. It is depreciated in the company s accounts over a 20 year period ( 50m each year, for 20 years, equals 1bn). We ll assume that the capital allowance rate is 15%, which is the simple average of two rates that were available (10% and 20%) up to March This percentage is applied to what s known as the unrelieved balance of expenditure each year. As an example, in year 6, capital allowances are (15% x Year 5 closing tax value of 444m) 67m. This shows how taxable profits are initially lower than reported accounting profits, with the result that less tax is payable than expected. But something that isn t usually as widely reported perhaps, is that in Year 8 onwards (as shown in this example) the difference then reverses so that more tax is payable than expected. Over the life of the asset then, the total capital allowances will equal the total depreciation. Claiming capital allowances doesn t avoid tax it just delays it. Year Accounts value of power station (start of year) Expenditure in year Depreciation in year Accounts value (end of year) Capital allowances Tax value (end of year) Tax profit (lower)/ higher than accounts profit by: Tax transparency Building confidence 25

30 Disclosure on total taxes paid and/or collected Corporation tax is not, of course, the only contribution companies make to the economy. It is individual shareholders, employees and customers who ultimately bear the cost of corporation tax. The provision of jobs and the payment and collection of related employment taxes and of indirect taxes and capital/infrastructure investment are just some of the other ways in which companies provide direct social and economic value to the countries in which they operate. We agree there can be some value in setting this out in a public format, and for some groups this may be an appropriate way of responding to the debate. However, we remain to be convinced that this disclosure, which can be costly and time consuming to prepare, is sufficient to address the concerns raised in the UK, in particular around whether the appropriate amount of corporation tax is paid in the relevant territories. There is an awareness of the other contributions companies make to society, but many are also clear that this does not alter a company s obligations with respect to corporate tax. Even those who recognise that tax is ultimately borne by individuals might regard apparently aggressive tax planning as an unacceptable means avoiding a burden that has been intended by Parliament. The approach here will, however, depend on the circumstances of the individual group. SAB Miller s Tax and development report 2013 sets out the taxes paid by the company, by region and an extract is shown below: Excerpt from SAB Miller s Tax and development report 2013 How much we pay and where In the year to 31 March 2013 our total tax contribution, including both our own taxes and those we collect on behalf of governments was US$10 billion. These figures are the cash taxes directly generated by our economic activity in each country and are thus a fair reflection of our tax footprint and what we contribute to government tax revenues. They include not only the corporate income tax on our profits, but also excise, VAT collected from customers, employee taxes and other taxes that we bear. Our tax contribution is considerable and meaningful. In Mozambique, for example, taxes paid as a result of our business activities represent 6% of government revenues. Further, in both Mozambique and Tanzania, our businesses have recently been recognised by their respective Revenue Authorities for outstanding compliance and tax contributions. Only a third of our volumes were from North America and Europe with the rest in Africa, Latin America and Asia Pacific. We earn 72% of our EBITA in emerging and developing countries and the chart on the right confirms that 73% of our taxes were paid in those markets. Taxes on production Excise is a tax which most governments levy on the production of a range of goods, including alcoholic drinks. It is a tax which is levied by reference to production rather than on the company s income. It is often assumed that it s the consumer who pays the excise tax on alcoholic drinks, and that the producer simply collects the money on the government s behalf. However, because excise is levied on production, it is for producers, wholesalers and retailers to decide how much is passed on to the consumer in prices and therefore how much the industry must absorb itself. This may often mean that there is no direct correlation between an increase in taxation and the price to the consumer. Equally, excise increases can materially impact a company s margin and profitability. 26 Tax transparency Building confidence

31 SAB Miller/Tax (Continued) B C D E F A A Excise 64% B VAT collected 19% C Employment 7% D Profit 5% E Indirect 3% F Withholding 2% G Property 0% F E D C G B A Emerging and developing countries 1 A Americas 34% B Africa 26% C Europe 9% D Asia Pacific 4% Developed countries 1 E Asia Pacific 10% F Europe 9% G Americas 8% 1 Since there is no single definition of the term developed country that is recognised internationally, we have adopted the allocation given in the International Monetary Fund s World Economic Outlook Report. As noted by the United Nations Statistics Division the designations developed and developing are intended for statistical convenience and do not necessarily express a judgement about the stage reached by a particular country or area in the development process. 2 Total tax contribution is based on the cash payments in the financial year as opposed to the tax charge in the financial year. In February 2013, The Berkeley Group released an Economic Impact Assessment report, detailing the company s contribution to the UK economy over the financial years 2008 to The report includes details both of direct contributions to the economy such as tax paid, but also the company s wider socio-economic contributions such as job creation and affordable housing. Excerpt from The Berkeley Group s Economic Impact Assessment report Executive summary In November 2012 The Berkeley Group Holdings plc (Berkeley) commissioned Ernst & Young LLP to perform an Economic Impact Assessment of Berkeley s contribution to the UK economy over the financial years This report presents the results of the Economic Impact Assessment undertaken by Ernst & Young. The analysis is based on Berkeley s own data, both published and internal, and on publicly available statistics. Berkeley s contributions to UK plc 2012 Contribution to the UK economy Total contribution to Economic Activity in bn Total contribution to GDP in bn Employment Jobs directly or indirectly supported in ,000 Total number of jobs created per home built Tax generation Total UK tax contribution between 2008 and bn International investment Amount of international investment attracted to the UK between 2008 and bn Homes built Number of new homes built in the last five years 13,000 Affordable homes provided (commitments ) 7,000 Change in number of homes built % (UK -35%) Development benefits Contribution to infrastructure, education, healthcare and communities through S m (commitments ) Tax transparency Building confidence 27

32 Careful consideration The exact combination of the above disclosures will be a matter for individual deliberation by MNCs. As we said in our first report, we think it is better for MNCs to consider seizing the initiative and voluntarily disclose information which builds stakeholder confidence. However, more is not always better and groups should carefully consider whether increased disclosure answers their stakeholders concerns in the most concise and down to earth way. Consideration also needs to be given on where to make any additional disclosures. In our first transparency report, we explained that the annual report may not be the appropriate place to communicate all the additional information on tax transparency. As mentioned already, revisions by the Financial Reporting Council to the UK Corporate Governance Code require directors to ensure that the annual report and accounts present a fair, balanced and understandable assessment of a company s position and prospects and this needs to be considered when determining where to make the disclosures. Confidence is not just built through what is publicly disclosed, but also through the way that MNCs engage with tax authorities in a manner which allows for robust scrutiny. We believe that stakeholders want confidence in a tax system which does not require them to play a long-term part in the enforcement process. Confidence is not just built through what is publicly disclosed, but also through confidence that MNCs engage with tax authorities in a manner which allows for robust scrutiny. 28 Tax transparency Building confidence

33 A consensus seems to have emerged that there are a few key issues to address in relation to the tax system and the way in which it is enforced by the tax authorities. Tax transparency Building confidence 29

34 Transparency and tax authorities As discussed above, a consensus seems to have emerged that there are a few key issues to address in relation to the tax system and the way in which it is enforced by the tax authorities: Are national and international rules fit for purpose? Is the information provided by MNCs sufficient to equip tax authorities to robustly enforce those rules? What other steps are required to restore confidence in the job that tax authorities do? We deal with these questions below. The key test of legislation is not its simplicity but the quality of its design and its ability to meet the commercial complexities associated with the activity being taxed. Are tax rules fit for purpose? No-one doubts the complexity of tax, but some have questioned whether complex rules themselves provide the platform for sophisticated groups to structure their affairs so that less or no tax is due. Some have argued that more investment in simplification is required as a means of limiting the opportunity for unacceptable behaviour. We agree that needless complexity must be avoided, but question whether that means simplicity more generally is an achievable means of limiting unacceptable behaviour. Our sidebar on page 12 explains why tax is sometimes complex. Taxation is one of the many cash flows that arise from any economic activity and the maximisation of returns will be a concern for decision makers. They will no doubt take other factors into consideration. Indeed, the Companies Act 2006 requires directors of a company to act in the way most likely to promote the success of the company for the benefit of its members as a whole and, in doing so, give consideration to (amongst other matters) customers, employees, suppliers, the community and the environment. Most would recognise that a rising tax rate might dissuade investment in an activity or a territory, just as a falling one might attract it. In that sense, companies are no different from individuals, whose behaviour might be shaped by an increase in ISA allowances, a reduction in tax relief for pensions or a proposed tax on second homes. It is quite natural and legitimate for tax to be factored into all these decisions. Complexity is often required or desired because business transactions are in themselves complex so a simple system may not reflect economic reality. However, complexity may also arise because tax inherently distorts behaviour. For example, a company may wish to upgrade an important asset or move to larger premises in order to grow and meet demand for its product. But selling an important asset at a gain in order to invest in another one might make no economic sense if that gain was taxed upon sale. Many readers will know that the UK rules contain various provisions for re-investment relief designed to reduce this distorting effect. Many other complexities are necessary for the same reason. Other complexities result from governments over the decades introducing special rules and reliefs precisely because they affect behaviour. Experience shows, however, that this is not always and solely in the manner intended. In our view, the key test of legislation is not its simplicity but the quality of its design and its ability to meet the commercial complexities associated with the activity being taxed. As the commercial world changes, consideration must be given as to whether laws need to be adapted we should not be surprised that it has often been MNCs with newer business models (such as in the digital economy) that have attracted a lot of scrutiny. 30 Tax transparency Building confidence

35 Tax authorities generally receive a vast amount of information that accompanies the calculation of profits and tax due. We believe transparency has an important role to play in supporting this endeavour. If the role of the legislator is to respond to changes in the way business is done, then it is almost inevitable that there is an element of catch up. Well designed rules are the best means of ensuring that the intended tax effect cannot be circumvented either deliberately or as a bi-product of the way commercial practices are developing in any case. What information do tax authorities need? Some have painted tax authorities as lacking in information about the profile and activities of MNCs. In fact, tax authorities generally receive a vast amount of information that accompanies the calculation of profits and tax due, or is submitted upon enquiry. The BEPS proposals will serve to enhance this. Accordingly, we regard the key issue as being the steps required to ensure that the information provided to tax authorities is constructive and that tax authorities are equipped to make sense of it. BEPS Action Plan enhanced transparency for tax administration The BEPS Action Plan includes a focus on enhanced transparency for tax administration, including a re-examination of transfer pricing documentation and a requirement for new reporting on the global allocation of income, economic activity and taxes amongst countries. Much work will be required to design rules on disclosure that effectively balance increased information with the costs of compliance. In our view, the key design principles of any such rules should be as follows. Key design principle Clarity Simplicity Objectivity Confidentiality Enforceability Why? The disclosures should help tax authorities by providing information that may not be currently available, in a clear format. The reporting requirements should be simple to understand and simple to complete, not requiring disproportionate effort. The reporting requirement should aim to collect data that is objectively verifiable, rather than requiring subjective judgments to complete. Taxpayers have the right to expect that any new disclosures will be made in confidence to tax authorities and will only be shared with other tax authorities. The reporting requirement should require an enterprise to provide only data that is within its power to provide. Given that individual entities have the power to provide information only on themselves and their subsidiaries, success for this project requires a well designed reporting requirement alongside a collective multilateral commitment by tax authorities to rapid information sharing. Tax transparency Building confidence 31

36 Of these principles, the last is particularly difficult. It cannot be right that an entity is compelled to disclose information that is not in its power to obtain, but that difficulty goes to the heart of concerns that complex ownership structures allow MNCs to cloud the picture to their advantage. We believe the solution to this lies partly in mechanisms for information sharing after all, the information sought can be expected to be in someone s power to provide, even if they are resident in a different territory. Some MNCs already present a comprehensive framework of their value chain to relevant authorities in a transfer pricing framework report, and this form of report may already provide the qualitative information about the overall value chain that the OECD is asking for. However, the BEPS report suggests that taxpayers should provide additional information on the global allocation of income, economic activities and taxes paid. The exact form of any reporting requirement that will come out of the BEPS action plan is, of course, not yet known. However, the messaging from recent meetings of the G8 and G20, and the OECD action plan itself, all indicate a strong desire for a summary disclosure allowing fiscal authorities to assess rapidly the extent to which the income earned and taxes paid are aligned with economic activity, on a country by country basis. We believe that in designing a disclosure template, the OECD and tax authorities should consider very carefully the type of information required, and the level of detail. This is important for two reasons. The first is that highly detailed information might be very difficult for some taxpayers to provide if the company s accounting system is not set up to extract this information. The second is that if the information does not provide a rounded picture of economic activity, it is liable to misinform rather than aid tax authorities in understanding the country by country allocation of profits and tax. The economic activity in a country cannot be measured simply by counting workers: it also requires an understanding of the economic value-add of the assets and business risks that are managed by those workers. In our view, MNCs should take the opportunity now to consult with policy makers in governments and at the OECD, through whatever channels are available, to help them understand what level of reporting detail the majority of companies can realistically provide without major accounting systems changes, and to discuss what information measures might best be requested that would provide a rounded picture of economic activity. The BEPS Action Plan is moving fast and without adequate consultation now, there is a chance that the compliance burden placed on taxpayers by any additional reporting requirements may be higher than necessary. 32 Tax transparency Building confidence

37 Complex questions of tax interpretation also require open and constructive dialogue between taxpayers and tax authorities exploring alternative interpretations of the law in relation to the transaction in question. What other steps are required to build confidence in tax authorities? We stated earlier, and in our sidebar on page 12, that transfer pricing, like many areas of tax, is inherently complex with prices or profit splits within a range being empirically justifiable. Additionally, transfer pricing has a system of competent authority dispute resolution procedures as tax authorities in different jurisdictions will argue for the price or profit split that they consider most appropriate and there may be tension between the tax authorities as to the appropriate price or profit split. Absent this mechanism, an adjustment in one territory might lead to the same profits being taxed twice, which few would regard as appropriate. We support steps to ensure authorities are properly resourced to collect the taxes appropriately due. Further, it is quite right that authorities should robustly scrutinise the affairs of all taxpayers including MNCs. However, we draw a distinction between robust scrutiny and tax authorities seeking to maximise tax revenues by taking extreme positions in the way they interpret the law themselves. In complex positions where there is more than one possible interpretation of the law, it is preferable that taxpayers and advisers work collaboratively and constructively with the tax authority to determine how the tax law applies to the particular facts and circumstances. The OECD s recent report Co-operative Compliance: A Framework, drawing on the experiences of 24 countries, highlights the benefits to both tax administrations and business of this kind of co-operative compliance model. The report points out that: It is only possible to have an effective discussion about the interpretation of the law if all facts are clear and accepted by both parties. Within a co-operative relationship the parties try to obtain a common understanding of all the relevant facts and circumstances in order to speed up the process and resolve disputes quicker. A cooperative compliance approach allows a tax authority to focus its compliance resources cost effectively on areas of greatest tax risk. Since dialogue with the tax authority is conducted on a confidential basis, it is possible for judgement-based legislation to be applied appropriately on the basis of the tax authority fully appreciating the context and detail of the transactions in question, however commercially sensitive. A cooperative approach also recognises that complex questions of tax interpretation also require open and constructive dialogue between taxpayers and tax authorities exploring alternative interpretations of the law in relation to the transaction in question. For such a dialogue to work effectively, it must be conducted in confidence. In general, tax authorities encourage taxpayers and their advisers to work collaboratively in resolving complex disputes precisely because this offers the most effective way of collecting the tax appropriately due. In our experience, few of our MNC clients would recognise the description of a cosy relationship with HMRC. An overly assertive position on either the taxpayer or authority side inevitably risks complex matters being resolved by litigation, with its associated expense and time lag, delaying the collection of revenues and working against the current Government s stated policy of a competitive tax regime. Confidence in tax authorities is not just about broader public confidence; an effective tax regime requires confidence amongst taxpayers themselves, including MNCs, that a transparent description of their affairs will be met with a reasonable application of the law. However, we also recognise public unease if out of court settlements are not backed up by proper governance and scrutiny of HMRC s conduct. The UK Government has taken steps to improve the way in which HMRC dispute resolution is governed and monitored and it will be essential to pay active attention to how this beds in to ensure it builds the confidence required. Tax transparency Building confidence 33

38 The UK Government has taken steps to improve the way in which HMRC dispute resolution is governed and monitored and it will be essential to pay active attention to how this beds in to ensure it builds the confidence required. A complex challenge We conclude that complexity in the domestic and international tax system is inevitable and that changing commercial practices gives legislators a complex challenge. Transparency to tax authorities has a role in more quickly shaping better rules that reflect commercial practice and in building confidence that tax cannot be inappropriately circumvented by the well advised. We believe that tax authorities need to be well resourced and have a good understanding of current commercial practices. We support international efforts to ensure consistent information is provided to authorities, as long as key design principles are followed such as those set out above. We advocate authorities acting robustly. Many international tax issues are inherently complex and overly uncompromising authority behaviour reduces the chance of settling issues by negotiation and of building the confidence amongst taxpayers that a transparent description of their affairs will be met with a reasonable application of the law. The House of Lords Economic Affairs Committee, to which we gave evidence, recommended the creation of a cross-party group of MPs and peers that could take evidence in private to more readily scrutinise HMRC s approach to delivering on its mandate to police the tax system, with a view to reinforcing the confidence that taxpayers should have in the operations of the tax authority. If this is taken forward, we believe that it is important that the review should not lead to a change in the tax agreement determined in a particular circumstance as it is important that taxpayers can rely on any conclusion reached with HMRC. Instead, the view should focus on HMRC s approach so that lessons can be learned for the future if necessary. 34 Tax transparency Building confidence

39 Tax transparency Building confidence 35

40 In the end, transparency comes down to enabling the public to understand the realities of corporation tax and tax authorities to understand the true nature of an MNC s business. 36 Tax transparency Building confidence

41 Overall conclusions Confidence in the tax system has been challenged and we believe there is a need to rebuild confidence that: The international and domestic tax rules are appropriate for modern business practices. The tax authorities have the information, as well as the appropriate skills and resources, to administer and enforce them. MNCs have an acceptable strategy and approach to tax and are paying an appropriate amount of tax in each of the territories in which they operate. Disclosure is a part of building that confidence but it is not an easy task and it is not clear which is the best way to achieve it. It is for that reason that we are seeing organisations take different approaches. We believe that there is no one size fits all approach and that what and how information is disclosed will depend upon the circumstances of a particular organisation. However, in our view, MNCs should consider seizing the initiative or risk compulsory rules that may be less effective at building the confidence that is desired. We believe the most important public disclosure is a clear description of an MNC s approach to tax, what drives its effective tax rate and how it engages with tax authorities. Information must always be accompanied by explanation if it is to have its intended effect. MNCs tax affairs may now be high profile but we believe most understand that it is appropriate for MNCs to factor tax into their commercial decision making process. There is a difference between this and artificial reduction that bears no relation to commercial reality. We believe the public wants to be confident that tax authorities are robustly scrutinising MNCs who in turn are transparent in their affairs. The BEPS Action Plan is the latest in a journey to ensure that domestic and international tax laws are appropriate to the ever-changing commercial world. Transparency to authorities is key precisely because it allows the law to appropriately adapt. MNCs should not be ashamed to present corporation tax for what it is as complex as the economic activity it seeks to tax; something which inevitably affects commercial decision making. It is incumbent on both MNCs and HMRC to act and negotiate reasonably for the tax system to operate efficiently. In the end, transparency comes down to enabling the public to understand the realities of corporation tax and tax authorities to understand the true nature of an MNC s business. That way, the public can be expected to regain confidence in the tax system under which we all operate. Tax transparency Building confidence 37

42 In our view, MNCs should consider seizing the initiative or risk compulsory rules that may be less effective at building the confidence that is desired. 38 Tax transparency Building confidence

43 Further information If you would like to discuss any of the policy issues raised here, please contact one of the following: John Dixon Head of Tax, UK and Ireland Tina Gill Head of Global Compliance and Reporting, UK and Ireland Claire Hooper Tax Partner, UK and Ireland Jason Lester Tax Partner, UK and Ireland Chris Sanger Head of Tax Policy, UK and Ireland Tax transparency Building confidence 39

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