Aggregation v Consolidation: The risk hidden within the CCCTB Richard Murphy FCA FAIA (Hon) Professor of Practice in International Political Economy, City, University of London and Director, Tax Research LLP September 2017 Rm D503, Department of International Politics School of Social Sciences City, University of London Northampton Square, London EC1V OHB Phone: 0777 552 1797 Email: richard.murphy@city.ac.uk Richard Murphy s work on tax compliance, the tax gap and country-by-country reporting is undertaken as part of:
1. Summary Although it is called the Common Consolidated Corporate Tax Base (CCCTB) the European Union's (EU) latest proposal for corporate tax base reform i is not in fact based on what an accountant would call consolidation: it is instead based on what might properly be called aggregation after tax adjustments have been made. Aggregation adds up existing sets of accounts but does not require that they be prepared on a consistent basis. Since almost all EU member states have their own inconsistent generally accepted accounting principle this might result in in the creation of two significant risks. The first is that the adjustments made to eliminate intra-group transactions from these accounts as required by the CCCTB may not be in equal and opposite amounts, leading to an inconsistent and illogical tax base being used for apportionment purposes within the CCCTB. Second, this permitted use of inconsistencies in the EU tax base might well be exploited by those seeking to secure advantage from regulatory arbitrage. This was previously done between tax laws: now it might be done between accounting bases. Basing the CCCTB on the consolidated financial statements prepared on the basis of International Financial Reporting Standards (IFRS) that most EU based groups that will be subject to the CCCTB must prepare for public reporting purposes provides a superficially attractive alternative to aggregation. However, the attraction is only superficial. Firstly, that is because IFRS accounts are quite specifically stated by the IFRS Foundation, which promotes IFRS, to be unsuited as a basis for tax payment calculation and the most cursory review suggests that this is the case. For example, the CCCTB only seeks to tax realised profits (i.e. those with a cash consequence) but IFRS based financial statements mix realised and unrealised profits in their reporting without differentiating the two. Secondly, because IFRS does not prescribe what is called a capital maintenance concept to those entities using it, meaning that they have discretion on the basis they adopt for asset and liability valuation, IFRS accounts cannot necessarily be compared one with another and this is not an appropriate foundation for a corporate tax base where this quality of comparability is essential. Thirdly, IFRS consolidations will often extend beyond the EU member states and as such to use the published consolidated accounts will require extensive provision to be made for what might best be called de-consolidation of activity outside the EU. This will be complex. Fourthly, to use IFRS is cumbersome. It would require an initial adjustment of local accounts to an IFRS basis, then consolidation, then the de-consolidation of non-eu activity, and then adjustment to a CCTB (common corporate tax base) acceptable tax base. Finally, in all this there is also an acceptance that a series of third parties, from the private sector dominated IFRS Foundation that sets IFRS, to the corporate taxpayer itself, and their auditors, can each determine critical stages and processes in the establishment of the tax base. This may, however, be exploited, firstly in the standard setting process but more especially by corporate tax payers who may seek to keep significant parts of that process (i.e. those elements relating to operations outside of the EU) out of EU tax administration sight, meaning that EU tax authorities would be left with remarkably little ability to audit this extended process. This is not the outcome the CCCTB was meant to achieve. 1
As a consequence this paper proposes another approach. It suggests, as the CCCTB does, that locally prepared accounts of the subsidiaries of EU multinational groups be the starting point for the CCCTB and then offers, firstly a clearer definition of the tax based as expressed in accounting terms to replace that in Article 7 of the CCTB before going on to suggest that the consolidation process be amended. This amended process would be only slightly more complicated than the existing proposed aggregation process. That aggregation firstly requires the elimination of all intra-group transactions (two exceptions apart) before, secondly, aggregation takes place. The suggested amendment to require consolidation made here proposes that a consistent tax base be adopted first of all; that secondly intra-group transactions be eliminated with the same two exceptions that the CCCTB currently has; followed, thirdly, by consolidation, which would at this point be no more complicated than aggregation because of the adoption of a consistent accounting base. The proposed accounting base that permits this process suggests the use of what might best be called an accruals adjusted cash flow approach. What this means is that the cash consequence of transactions arising in the period (having allowed for barter) are subject to tax and the adjustments made in IFRS and other generally accepted accounting principles to reflect the substance and not the form of transactions are ignored. An historic cost basis of asset valuation is used and discounting of liabilities and marking to market is not permitted. Prudent provisioning is allowed, but only with an evidence base being available. Deeming transactions to take a form contrary to their cash flows is not permitted. Because the base assumes all revenues are taxable unless exempted and no deduction is allowed for tax unless specifically permitted the need for a general anti-avoidance principle is avoided: it is implicit in the definition of the tax base. This base closely approximates (excepting on deferred relief for capital expenditure) to that many economists prefer. The necessary amendments to achieve these goals are suggested. 2. Aggregation v consolidation The essential difference between the approaches is that aggregation assumes that the accounts of each individual subsidiary company are consistent with each other. It then applies the tax adjustments specified in the Common Corporate Tax Base (CCTB) proposals ii to them, including the elimination of intra-group transactions, translates the resulting adjusted figures into a common currency and then aggregates them i.e. adds them up. The resulting total us then used for apportionment between member states. That the process involves addition is confirmed by CCCTB Article 3, subsection 23, which says iii : 'consolidated tax base' means the result of adding up the tax bases of all group members, as calculated in accordance with Directive 2016/xx/EU; (Emphasis added) Consolidation on the other hand requires that all the accounts of the subsidiaries of a group are firstly restated so that they are prepared in accordance with one consistent set of accounting rules, irrespective of the local accounting requirements of the state where they were initially prepared. Then they are consolidated to form one consistent set of accounts. This process involves the elimination of all intra-group transactions, which is assisted by the fact that they are all at this point 2
all accounted for consistently which is not true in the aggregated approach where these adjustments might have very different impacts in differing sets of accounts in different countries, and then makes the required CCTB adjustments before apportionment to states for tax assessment can take place. The reasons why consolidation is to be preferred to aggregation are: Aggregation does not eliminate accounting inconsistencies between member states and their differing locally acceptable accounting standards. It is not possible to suggest a comprehensive summary of all these differences here but they include differing treatments on: Sales or turnover, especially on long term projects; Stock or inventory valuation; Asset valuation; Recognition of liabilities, and especially long term liabilities; Pension accounting; The split between loan and equity capital and so on interest charges; The timing of loss recognition and debt provisioning. The result of there being different local generally accepted accounting principles across Europe is that if tax advantage could be generated under the CCCTB by exploiting such differences to defer or cancel tax liabilities. The process of financial arbitrage, which has largely existed between tax systems to date, would move to accounting standards (which are usually lightly regulated and are often heavily influenced by the accounting profession) instead if the CCCTB as currently proposed using an aggregation basis. Arbitrage means that accounts prepared on different bases are aggregated as if they are consistent when this is not true. This problem will become apparent when the intra-group adjustment in different companies on different sides of the same transaction will differ. The CCCTB offers no guidance on how to deal with this inevitability at present. Consolidation overcomes this problem by requiring one set of accounts be prepared in the first instance. As a result a consistent and single set of accounting standards is applied to all transactions before any CCTB adjustments for tax take place. Consequently the opportunity for accounting arbitrage to exploit the CCCTB is eliminated by requiring consolidation and not aggregation. 3. Why a separate tax consolidation is needed to provide an appropriate tax base for the CCCTB The BEPS Monitoring Group (of which I am a member) has argued that aggregation is inappropriate but that the CCCTB adjustments can be made to IFRS based group accounts, which it is almost certain that a group subject to the CCCTB will have. I stress that I think that this option will be better than aggregation, by far, but also suggest that making this adjustment will not be easy and that it might be better to suggest that an explicit tax consolidation take its place. 3
The essential problems with IFRS based accounts are threefold for tax purposes: They do not appropriately distinguish between realised and unrealised profit; They do not require a consistent capital maintenance concept (or asset valuation basis) meaning that it is possible for differing results to be reported by similar companies; The process of 'discounting' that is inherent to the IFRS process of both liability estimation and interest recognition is inherently uncertain and an unsuitable base for tax calculation. This last point is important: the IFRS Foundation have consistently said over many years that the accounts that are prepared using their standards are not intended to be suitable as a basis for taxation and that adjustment will always be needed. The question is then, in my opinion, as to whether that adjustment is needed before the CCTB adjustment process or as part of it. I stress the point is simultaneously technical, administrative and procedural, but it is also something more than any of things as it also drives to the heart of the intention of the tax base that is to be created. In my opinion corporate taxes must be charged upon a tax base that does three things: It must be certain i.e. everybody must know where they stand with regard to it; It must be equitable: the same rules must apply to everyone; It must not prejudice the continuing ability of the business to trade. These three principles require that: The tax base must relate to cash flows, even if some cash flows (such as spending on capital items, R&D and spending without business benefit) are differentiated for the assessment of taxable cash flows; The way in which this adjusted cash flow is determined is consistently applied; The rules for doing so must be determined by tax authorities and not third parties, which would be the case if IFRS was used as a basis for taxation. This point is considered fundamental for the restoration of confidence in corporate taxation when there is such limited public trust in multinational corporations at present. These principles in turn require that any consolidated tax base must be based on ability to pay. This is the primary economic motive in determining the base. This is quite emphatically not based on a 'true and fair view' of the results for a period, which is the IFRS goal i.e. the motivations of the systems are quite different. This is reflected in tax practice; my research iv has shown that not one of 154 tax jurisdictions reviewed in 2014 based their corporate tax charge on unadjusted profit. Ability to pay inherently relates to cash flow in a corporate environment. The bias in tax accounting must, then, be to reveal this quality and not economic profit. The principles noted also require that a tax system must be as simple and equitable as possible. This suggest that as many transactions as possible must be valued for tax purposes at their value in 4
exchange. This is either the cash sum settled at the time of the transaction or subsequently as a result of it, or it is the value implicit in a barter or exchange transaction. What in that case is clear is that it is not the job of effective tax systems to impute transactions where they do not exist. So, for example: Leases should be accounted for as hire contracts and the parties should be taxed as such; Interest should only be recognised as paid when the parties agree that is the case and not when accounting standards deem such a charge to have arisen; Receipts of equity and loans are not taxable but all sums payable as a result of them in excess of sums received should be treated as dividends or interest; Related entities under common control should be treated as single entities for tax purposes and those transactions that take place between them should be treated as profit redistributions based on the location of added value arising and not as taxable transactions in their own right (so ending transfer pricing arrangements) 1. In addition, any tax system should be prudent. This means that: A sum received not otherwise explained is taxable income; A payment is, unless explained, not a tax allowable business expense; Assets shall be valued at the lower of cost and net realisable value but losses shall not be anticipated unless evidence to support the provision is available; No sum shall be discounted because implicit interest rates are always assumptions akin to provisions; Gains or losses arising on revaluation, marking value to market and for similar reason shall be ignored for taxation purposes. The resulting tax base arising from these suggestions might be summarised as follows: The net taxable revenue of members of a group shall be based their financial statements that shall be adjusted so that taxable revenues shall be all cash, exchange or barter receipts arising during or due for the period less those accounted for in previous periods, those of a capital nature and those explicitly exempted from charge; less those cash, barter or exchange payments made or due for the period that were incurred for the purposes of the trade of the corporation less those accounted for in previous periods, those that represent loan or equity capital repayment and those that are explicitly exempted from deduction; less those allowances and reliefs specifically permitted and those excesses of deductions over revenues brought forward from previous periods. This could either be used as practical interpretation of the proposed Article 7 of the CCTB or might replace it by amendment is that was considered desirable. The term excess of deductions over 1 For the sake of elimination of doubt: this paragraph rejects arm s length pricing between related parties within the EU and states that apportionment based on the location of best available indicators of value added is to be preferred. By default transfer pricing will remain necessary at the ERU s water s edge. 5
revenues replaces the term loss since the tax base as defined is neither a profit nor loss but a sum potentially chargeable to tax. The result is a tax base that: Assumes all revenue is taxable unless specifically exempted; Assumes all expenses are disallowable unless permitted (so avoiding the need for a general anti-avoidance principle); Relates to what might best be called accruals adjusted cash flow, which is close to the ideal economic basis for this tax; Is computable whatever accounting system may be in operation in each EU member jurisdiction since all transactions are always initially recorded in the general ledgers of taxable enterprises at their cash value; Permits for easy consolidation and minimal dispute between accounting treatments in different jurisdictions. In other words, the base is economically and administratively logical, is cost effective, is designed to eliminate tax abuse from the outset and delivers the best consolidation technically available. In contract, if IFRS were to be be used the alternative adjustments required would be to: Establish revenue on an appropriate basis that reflects cash flow generation in the period; Restate asset values on the basis noted; Eliminate all provisions that are unsupported; Remove from the consolidated account all those entries that do not reflect the form of transactions undertaken; Restate interest and equity returns to sums actually paid; Use the arm's length basis for intra-group transactions outside the CCTB area Make adjustment for all exempt revenues; Make disallowance for all non-allowed expenses; Make adjustment for allowances and reliefs. It is suggested that this is considerably more cumbersome than the tax consolidation process noted above. Which in turn is considerably more efficient than the aggregation process. 4. Consequent suggested amendments to the CCCTB I suggest that the following amendments are appropriate. If the IFRS approach was used these would be different: a. Article 3 subsection 23: Delete: 'consolidated tax base' means the result of adding up the tax bases of all group members, as calculated in accordance with Directive 2016/xx/EU; 6
Replace with: 'consolidated tax base' means the consolidated net taxable revenue of the group members, as calculated on a consistent accounting basis applicable to all group members in accordance with Directive 2016/xx/EU; b. Article 7: Delete 1. The tax bases of all members of a group shall be added together into a consolidated tax base. Replace with: 1. The net taxable revenue of members of a group shall be based their financial statements that shall be adjusted so that taxable revenues shall be all cash, exchange or barter receipts arising during or due for the period less those accounted for in previous periods, those of a capital nature and those explicitly exempted from charge; less those cash, barter or exchange payments made or due for the period that were incurred for the purposes of the trade of the corporation less those accounted for in previous periods, those that represent loan or equity capital repayment and those that are explicitly exempted from deduction; less those allowances and reliefs specifically permitted and those excesses of deductions over revenues brought forward from previous periods. c. Article 9 Delete: 1. With the exception of the cases referred to in subparagraph 2 of Article 42 and Article 43, profits and losses arising from intra-group transactions shall be ignored when calculating the consolidated tax base. 2. Groups shall apply a consistent and adequately documented method for recording intragroup transactions. Groups may change the method only for valid commercial reasons and only at the beginning of a tax year. 3. The method for recording intra-group transactions shall enable all intra-group transfers and sales to be identified at the lowest cost for assets not subject to depreciation or the value for tax purposes for depreciable assets. 4. Intra-group transfers shall not change the status of self-generated intangible assets. Replace with: 7
1. With the exception of the cases referred to in subparagraph 2 of Article 42 and Article 43, profits and losses arising from intra-group transactions shall be ignored when calculating the consolidated tax base. 2. Groups shall apply a consistent and adequately documented method for recording intragroup transactions. All such transactions shall be eliminated from the tax base as a result of the consolidation required by Article 7 (1). i https://ec.europa.eu/taxation_customs/business/company-tax/commonconsolidated-corporate-tax-base-ccctb_en ii https://ec.europa.eu/taxation_customs/sites/taxation/files/com_2016_685_en.pdf iii https://ec.europa.eu/taxation_customs/sites/taxation/files/com_2016_683_en.pdf iv https://www.gov.uk/dfid-research-outputs/unitary-taxation-tax-base-and-the-roleof-accounting-ictd-working-paper-34 8