Tax in a borderless world
Globalisation brings costs and benefits, even for the tax professional. The move towards a borderless world has opened up new opportunities for taxpayers to minimise their overall tax liabilities. Much of this tax planning is legitimate. Good tax planning is driven by the reality of businesses having to operate with increasingly complex laws, particularly affecting international activities, while at the same time wanting to legally minimise their costs, including tax costs.
Nevertheless, this same complexity has opened the way to rule bending with “creative” accounting. Worse, a significant number of these tax schemes examined by tax administrations have been found to be in breach of the law. These practices include deliberately concealing earnings, misreporting transactions between different parts of the same firm, and so on. In addition, increasing numbers of individuals and businesses have taken advantage of the greater freedom of movement across international boundaries presented by globalisation, political integration and advances in technology to reduce illegally their tax liabilities. This form of non-compliance has been assisted by the policies and practices of certain offshore financial centres that facilitate the concealment of undeclared income and assets.
Few people are enthusiastic about paying taxes. However, most people understand that taxes provide the funds required for the delivery of essential community services and the infrastructure that households and firms rely on, in research, healthcare, education, security and more. Non-compliance with tax laws reduces the funds available to government for such services. Also, it is blatantly unfair to the majority of law-abiding taxpayers who must, as a result, bear more than their fair share of the tax bill. National revenue bodies, meanwhile, have found themselves stranded at the border, as the rise in international tax non-compliance has made it more difficult for them to apply the law in an efficient and fair manner.
While it is difficult to quantify the overall revenue losses from non-compliance across borders, it is generally regarded in many countries as a serious revenue leakage. Ireland recently collected almost 900 million euros from residents who had been using Channel Island banks to evade Irish taxes. The UK expects to recover £1.9 billion from its recent clampdown on offshore evasion. And a recent report by the US Senate estimated that the Internal Revenue Service could be losing some $40-70 billion to tax havens. Left unchecked, it is inevitable that national tax bases will be further eroded, with negative consequences for compliant citizens and businesses, as well as government and the overall integrity of the tax system.
Non-compliance cuts across all taxpayer segments and takes many different forms. Individuals can conceal taxable assets or income through the use of offshore accounts, trusts or by creating so-called shell companies and locating them in tax havens or other countries that do not provide information for tax purposes. Also, small or closely-held businesses may use these shell companies to shift profits abroad, often using fictitious invoices or over (or under) charging for intra-firm transactions. Another all-too-common practice is for some large corporations to manipulate transfer prices between subsidiaries to artificially shift income into low tax jurisdictions and expenses into high tax jurisdictions.
Clearly, governments owe it to their citizens to stop such practices. That is why they are honing their risk assessment strategies to identify the areas, sectors or activities most at risk. New ways are being explored to exchange information between tax authorities, including the sharing of experiences in dealing with tax shelters. Governments also recognise in today’s more open environment the need for better access to domestic sources of information, including information held by other government departments and anti-money laundering units. Tax administrations have had to become more open in communicating their compliance strategies to taxpayers and their positions on particular types of tax schemes.
This is important in a fast-moving world, with companies forever devising innovative tax schemes in a bid to minimise their liabilities. Australia, for example, now operates a system of “Taxpayer Alerts” which set out any concerns the Australian Tax Office might have with new schemes. More generally, governments recognise that achieving better tax compliance will require corporate boards to take more responsibility for their own tax strategies and to be more aware of the financial and reputation risks attached to any strategy. To tackle such issues, heads of tax administrations from 35 countries met in Seoul this September under the auspices of the OECD’s Forum on Tax Administration. This rather unique forum, set up in 2002, promotes co-operation between revenue bodies and senior government administrators to develop good tax administration practices.
There was broad agreement in Seoul that international non-compliance is a significant and growing problem which requires a response by both national governments and at the level of the OECD. National responses include employing effective risk management techniques at the organisational and operational levels, and strengthening enforcement with stiffer penalties, and so on. The need for dedicated organisational units to deal with offshore non-compliance should also be considered, while the role of accounting and legal firms, investment banks and other institutions in promoting the use of tax shelters to avoid compliance with the tax rules should be addressed. Top management and audit committees of large enterprises (e.g. CEOs and boards of directors) should be encouraged to assume greater direct responsibility for their tax planning strategies.
However, to be effective, comissioners at Seoul agreed that national initiatives need to be reinforced by international actions. These would include sharing information on the identification of tax schemes and on any mitigating strategies being used by different countries. The exchange of information provisions found in bilateral tax treaties and developing tax information exchange agreements with offshore financial centres would also be reinforced. Also, the OECD Transfer Pricing Guidelines should be kept up to date and its consistent application promoted. Moreover, practical co-operation between revenue bodies and other law enforcement agencies should be improved.
Governments have to earn their right to raise tax money too, of course. Commissioners in Seoul recognised that public attitudes towards paying tax are influenced by a range of factors, such as perceptions about the quality of public goods and services, and the level of trust between citizens and their governments in general. It is up to tax administrations and governments to work together to influence these attitudes and secure that trust.
Over the next two years, the Seoul conference agreed that action at the OECD level should focus on four areas:
(i) Further developing the OECD’s directory of aggressive tax planning schemes so as to identify trends and measures to counter such schemes.
(ii) By the end of 2007, completing a study on the role of law and accounting firms, other tax advisors and financial institutions, in relation to non-compliance and the promotion of unacceptable tax minimization arrangements.
(iii) Examining how the 2004 OECD Principles of Corporate Governance can be applied in the tax area.
(iv) Improving the training of tax officials on international tax issues. Progress on these initiatives will be reviewed at the next meeting of the Forum, which will be hosted by South Africa in January 2008.
OECD work on tax administration and the text of the Seoul Declaration can be found at: www.oecd.org/ctp/ta
OECD work on transfer pricing: www.oecd.org/ctp/tp
The OECD Principles of Corporate Governance: www.oecd.org/daf/corporate-affairs/companylaw
©OECD Observer No. 257, October 2006
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