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Tax Regulation And Enforcement « Back
Matt Atkins, July 2012
Tax authorities around the world have become much more aggressive in their enforcement of taxation rules and regulations, and are willing to pursue all avenues of investigation. This fact highlights the need for companies to stay on top of their compliance strategies. But while managing tax strategies and creating tax efficiency are crucial to maximising profits, in the current climate of increased audits, companies must be prepared for scrutiny and disputes, especially given the complexities and depth of tax investigations and related litigation.

Driving forces

Governments globally are enacting an ever-increasing number of changes to their tax laws, regulations and tax administration processes. The UK General Anti-Abuse Rule (GAAR) and the US Foreign Account Tax Compliance Act (FATCA) are just two examples of state action on tax avoidance and evasion. In an economic environment ravaged by the financial crisis of 2008 and its subsequent fallout, governments worldwide have prioritised the reduction of deficits and the balancing of national budgets. In order to raise revenue in an effective and efficient manner, authorities are focusing their meagre resources on high-risk issues and taxpayers, and attempting to improve compliance by enforcing information reporting and withholding requirements, as well as increasing disclosure and transparency requirements.

But while an increased focus on the generation of tax revenue is a major contributor to this vigorous enforcement, a convergence of trends is behind this behaviour, asserts Debbie Nolan, a partner at Ernst & Young. “The rapid pace of globalisation means that the dynamics of taxation are changing. While tax enforcement was once approached as more of a ‘national’ exercise, cross-border capital flows have grown exponentially and issues related to the migration of intangibles, royalties, service fees and intra-group financing now challenge taxpayers and tax administrator alike. Even a globally mobile workforce creates challenges for taxpayers and tax authorities alike, both from a compliance standpoint and an enforcement standpoint.” Indeed, a revolution in how business is conducted has been seen in the past two decades as advances in communications technology has opened up the globe as a marketplace and driven new business models. Hi-tech firms such as Google and Apple, much of whose revenue comes via intellectual property, along with online retail outlets such as Amazon, present difficult questions about which jurisdiction they should pay tax in.

A further trend of the past 20 years has been the emergence of developing economies and their impact on the world of business. While these nations can offer great commercial opportunities they can also present risks. As tax administration processes in many emerging nations are still evolving, they can be unpredictable and frustrating for companies trying to plan and manage their risk related to tax policy. For this reason, as well as strengthening their enforcement efforts, countries are also showing a greater desire to take a more collaborative approach to taxation.

Avoidance and evasion

In recent years, governments have also become wise to the legal methods that some corporations employ in order to minimise tax exposures and the issue of tax planning has received widespread media attention. Global companies – many of which have been able to save billions on tax by basing their operations in low-tax jurisdictions – have come under the microscope, spurring the authorities into action.

The New York Times recently published a report on the tax arrangements of US tech-giant Apple, finding that in 2011 the company avoided paying $2.4bn of federal income tax. While the fact that 64 percent of Apple products are sold outside of the US, and the vast bulk of manufacturing takes place in China, it is unsurprising that the company’s US tax liabilities came in below the expected norm; however, the tech giant’s use of subsidiaries in low-tax jurisdictions including the Netherlands, Ireland and the British Virgin Islands dramatically reduces even these tax exposures. Furthermore, Apple even manages to shield from the authorities profits that do make it into the US. While headquartered in Cupertino, California, Apple’s profits are collected 200 miles away in Reno, Nevada, which benefits from a 0 percent corporation tax, as opposed to California’s 8.84 percent.

Similarly, late last year, The Guardian revealed that Amazon was able to pay no corporation tax in the UK in 2011, although it generated £3.3bn of sales. The online retailer based itself in Luxembourg in 2006 and runs the UK operation as an ‘order fulfilment’ business only. All profits, therefore, leave the UK and cannot be taxed. While it is unclear whether HMRC is investigating the case, Amazon’s tax affairs are under investigation in the US, China, German, France, Japan and Luxembourg.

A challenge by a tax authority could be damaging in an age when reputation is a prized asset.  However, the issue should rest at the door of the courts, and not with the authorities or media when the companies are working within the law, says Peter Connors, a partner at Orrick. “Legislators and others will continue to make accusations regarding the use of offshore tax jurisdictions. However, many of the structures are legitimate and merely have been developed in the context of the country’s tax system. The tax systems, regulations and often treaties need to be changed.” That said, governments are now making moves to act on what they see as artificial and abusive tax avoidance schemes, for instance, where some companies have taken advantage of strategies that enable them to change corporate residence and reduce their worldwide effective tax rate, though depending on how this has been accomplished it can be an entirely legitimate manoeuvre.
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