In the past five years the tax world has seen more turbulence and change than in the 50 years before. The quote attributed to John Maynard Keynes that "the avoidance of taxes is the only intellectual pursuit that still carries any reward" has certainly lost its luster, if it ever had it. There is continuing public outrage (and activism by non-governmental organizations and politicians), about tax avoidance by multinationals, there is BEPS, EU anti-tax avoidance directives, fiscal state aid investigations, and stepped-up activity by governments, all aimed at curbing tax avoidance. In this turmoil, where some big household names seem to be the culprit, the difference between tax avoidance and tax evasion and the relative magnitude of the tax gap caused by these phenomena, seems to have dissolved. While the focus is on large multinationals, governments find themselves in an uncomfortable position as well. They vie for business, compete with their tax systems – and one country's tax incentive often is another country's base erosion – but they declare war on tax avoidance and evasion. Sometimes the seemingly opposing forces dovetail nicely, as is the case with the diverted profits tax and reduced tax rates in the United Kingdom. And transparency is paramount, but administrative practices remain largely uncovered.
How to navigate these waters? Tax planning and advice are no longer just technical in nature. Planning and advice should take into account the broader context and be sustainable.
Each of the above-mentioned developments have their own dynamics and appropriate responses, but there is also a significant common element. While tax competition is there to stay, the anti-tax avoidance measures have significantly narrowed and will continue to narrow the margins for tax planning that relies on systems arbitrage and/or that is devoid of substance (and with substance I do not mean 'window dressing' for the sake of it, but real business operations). The tax planning focus will move to countries that have a solid and stable investment climate coupled with attractive corporate income tax rates and an otherwise benign fiscal climate for business. Prime candidates are the United Kingdom, Switzerland and Ireland, although the first two have to overcome the anxiety caused by Brexit and the recent referendum on tax reform, respectively.
As I write this piece, the changes are unfolding. The BEPS minimum standards are being implemented, in part, e.g. country by country reporting, through domestic legislation, and in part, e.g. anti- treaty shopping measures, through adoption of the multilateral instrument, which – after a 'speed dating' session at the OECD in Paris earlier this year – is expected to have an impressive number of signatories at the signing ceremony in June. But also other BEPS measures, that are not minimum standards, will gradually find their way in domestic tax law and tax treaties. Moreover, BEPS seems to have incentivized a number of countries to apply the spirit of BEPS even in the absence of implementation of BEPS measures. Moreover, some countries find BEPS a good stepping stone to question traditional allocation of taxing rights – and explore other nexus principles to justify larger bites out of the tax apple.
Then there is the European Union. The EU has shown interesting dynamics. For decades the adoption of tax measures in the EU was a slow and protracted process. Harmonization through directives has been limited and harmonization through judgments of the European Court of Justice has upset the EU Member States more than it pleased them. The Code of Conduct Group, set up in 1998 with a view combat harmful tax competition, has been less than successful. But the dynamics changed significantly in the post financial crisis world, with the unfolding of BEPS, Luxleaks, the hearings by the Public Accounts Committee in the United Kingdom, by the Senate Investigations Committee in the United States, hearings in Australia, and those organized at the European Parliament by the TAXE Committee and subsequently by the Panama Inquiry Committee. These events encouraged the European Commission to be bold in its approach, both through developing anti-avoidance directives and by using the EU state aid rules as a political and tax policy weapon. EU leaders found themselves in awkward positions. President of the European Commission Jean-Claude Juncker, under whose two decades watch as Luxembourg's Finance Minister that country's ruling practice thrived, declared in his State of the Union 2016 "that every company, no matter how big or small has to pay its taxes where it makes its profits" and underscored that "the Commission watches over [tax] fairness [as] the social side of competition law." Dutch Finance Minister Jeroen Dijsselbloem, during the Dutch presidency of the EU, pushed for the adoption of the first anti-tax avoidance directive, no matter how watered down it became, or inconsistent with the end goal of the EU Single Market. He had to declare victory. Another awkward moment was when certain EU countries decided to appeal against final state aid decisions by the European Commission in some of the recent fiscal state aid cases involving advance tax rulings. On the one hand these countries had to stand up for advance tax rulings granted by their tax administrations, but on the other hand they did not wish to be seen by the public as defending tax structuring that in the eyes of the European Commission and the public at large was abusive. A delicate balance to maintain. Unmistakably there is a significant political component to all of this. In the push to curb tax avoidance, the distinction between tax avoidance and tax evasion is deliberately blurred. And although the information disclosed through Panama Papers seems to relate mostly to individuals hiding their money, certain institutions used the occasion to again point the finger at multinational enterprises.
Let me return to the question how these waters should be navigated. To me, for multinational enterprises (and their advisers) it all starts with the articulation of a solid tax strategy, one that includes the principles upon which tax planning is based and that secures the governance of tax right from the boardroom. And companies should be transparent and unapologetic about their tax strategy. In many cases there is a very good story to tell, because the tax planning is sustainable and global effective tax rates are often well within a bandwidth around the average of statutory rates in OECD countries. The public outrage is largely fed by outliers, or focus on a single country, rather than on the global position. Once there is a solid tax strategy and transparent reporting about the execution of that strategy, in many cases it would become much easier for a company to take a more assertive position in the public debate. In my view that is a necessity. The current debate suffers from a lack of balance. This lack of balance translates into poor legislation, pressure on tax authorities to take a tough stance in audits, more potential for unresolved international tax disputes, etc. Articulating a sustainable tax strategy will also increasingly become part of the corporate and social responsibility/sustainability agenda – and moreover institutional investors will increasingly demand the articulation of a sustainable tax strategy.
And then there is US tax reform. It is clear that the current US tax system has reached the end of the rope. A system that taxes worldwide income, that has an uncompetetively high rate and on top of that endless deferral possibilities, is a standing invitation for the type of tax planning that keeps tax advisers busy, but is otherwise disliked by many. The recent prospect of US tax reform has the potential to undo the tension. Interestingly, if the House Republican Blueprint with the destination-based cash flow system would materialize, with the rate reduction and the mandatory deemed repatriation of foreign earnings, most of the current tax planning incentives disappear. There is also a big paradox in that blueprint, in that it has elements of a VAT system and a likelihood that the tax will end up with the consumer, rather than with the company itself and ultimately with its broader group of stakeholders (shareholders, employees, consumers). That seems to be at odds with the public outrage that calls for a larger tax contribution by companies.
It is clear that the tax world is confusing – and confused – and that tax is no longer the domain of the technicians, but rather the domain of institutions and individuals that understand the system and the broader dynamics that I addressed above. To me it certainly has become a more interesting world.