By Roel Nieuwenkamp, Chair of the OECD Working Party on Responsible Business Conduct
“I don’t care if it’s legal, it’s wrong.” This quote from US President Obama about tax avoidance illustrates the shift in thinking about tax from issues from a strictly legal perspective to the domain of corporate responsibility.
Global tax avoidance has been attracting increasing attention and ire over the past few years. In the UK public outrage over tax avoidance has been very visible, several years back company executives of the world’s largest MNE were publically scrutinized over tax avoidance issues. In the midst of the financial crisis EU countries like Greece and Portugal were furious to learn that their multinational enterprises paid almost no taxes because of fiscal arrangements involving the same jurisdictions that had put pressure on them to implement severe austerity packages. In developing countries tax base erosion and profit shifting (BEPs) has likewise been the cause of outrage and is increasingly viewed as an impediment to development. According to the OECD ‘’Revenue losses from BEPS are conservatively estimated at USD 100-240 billion annually, or anywhere from 4-10% of global corporate income tax (CIT) revenues. Given developing countries’ greater reliance on CIT revenues as a percentage of tax revenue, the impact of BEPS on these countries is particularly significant.’’ The Luxleaks and SwissLeaks exposed instances of tax avoidance that shocked the general public. Now the Panama Papers have again demonstrated that corporate tax responsibility is not just as a legal issue but also an ethical one.
While the Panama Papers uncovered some clearly illegal conduct they also evidenced widespread practices that while not necessarily illegal are morally questionable. ‘Ethical’ tax issues are often linked to aggressive tax planning. According to the European Commission (EC), a key characteristic of aggressive tax planning practices is that they reduce tax liability through strictly legal arrangements which contradict the intent of the law. The EC Action Plan to strengthen the fight against tax fraud and tax evasion further provides that “aggressive tax planning consists in taking advantage of the technicalities of a tax system or of mismatches between two or more tax systems for the purpose of reducing tax liability and can take a multitude of forms. Its consequences include double deductions (e.g. the same loss is deducted both in the state of source and residence) and double non-taxation (e.g. income which is not taxed in the source state is exempt in the state of residence).”
Several approaches are used in aggressive tax planning including the transfer pricing and the use of brass plate trust companies based in tax havens. Another example of an aggressive tax planning strategy could concern the use of hybrid entities or hybrid financial instruments.
According to the OECD a number of indicators show that the tax practices of some multinational companies have become more aggressive over time. Though companies are usually acting legally, this development is raising serious compliance and fairness issues. In response countries and international institutions have been active in developing creative solutions to curb these practices. For example, the OECD has elaborated a comprehensive action plan on Base Erosion and Profit Shifting (BEPS) which has been endorsed by the G20. At the EU level an Action Plan to strengthen the fight against tax fraud and tax evasion was developed in 2012. Among other recommendations the Action Plan stresses that “[a]ggressive tax planning could thus be considered contrary to the principles of Corporate Social Responsibility”.
Responsible tax planning as an expectation of corporate social responsibility is not a new concept. Indeed the OECD Guidelines for Multinational Enterprises (OECD Guidelines), the most comprehensive standard on corporate ethics, celebrate their 40th anniversary this year and have long included a chapter on Taxation.
Under the OECD Guidelines enterprises are encouraged to design their tax governance and tax compliance in a responsible manner. Furthermore, enterprises are called on to comply with both the letter and spirit of the tax laws and regulations of the countries in which they operate. (See Annex: Relevant language on taxation under the OECD Guidelines for Multinational Enterprises).
46 countries, including the 34 OECD member governments have adhered to the OECD Guidelines and have made a legally binding commitment to set up a National Contact Point (NCP) to promote the recommendations of the OECD Guidelines – including promoting corporate tax responsibility! – in addition to handling complaints arising with regard to the non-compliance with these recommendations.
As of yet one tax related complaint has been brought to the NCP system. In 2012 the Swiss NCP considered a submission based on a leaked report from an auditing firm that suggested that commodities giant Glencore was resorting to various techniques to avoid paying taxes in Zambia with regards to its subsidiary, Mopani Copper Mines Plc. The Swiss NCP undertook mediation with the parties which resulted in constructive engagement and ultimate agreement between the parties.
Did Mossack Fonseca, the law firm at the center of the Panama Papers scandal, act within the spirit of the tax law when advising its clients? Did the clients of that firm act responsibly? Are the practices of establishing shell companies in tax havens, use of transfer pricing, or hybrid mismatch agreements aimed at tax avoidance in line with the OECD Guidelines? As strictly legal arrangements which contradict the intent of a tax law do not pass muster under the framework of the OECD Guidelines, the answer would likely be ‘no’.
As clearly stated by President Obama, international tax planning is no longer simply a legal compliance matter, but also an ethical one. This ethical expectation is already embedded in the OECD Guidelines, which governments have committed to promoting. Additionally it is only a matter of time that more tax related complaints will be filed in the NCP system, thus governments should be active in promoting responsible tax planning as a corporate ethics issue.
The OECD/G20 BEPS project already has already been a game changer in regards to transparency of fiscal policies. Leaks will continue to expose companies’ fiscal conduct in practice. In times of ‘radical transparency’ companies have to take a very critical look at their tax policies and verify whether their policies are not only legally compliant but also ethically sound.
Annex: Relevant language on taxation under the OECD Guidelines for Multinational Enterprises
Chapter XI of the OECD Guidelines provides principles and standards of good practice consistent with corporate citizenship in the area of taxation, it reads:
It is important that enterprises contribute to the public finances of host countries by making timely payment of their tax liabilities. In particular, enterprises should comply with both the letter and spirit of the tax laws and regulations of the countries in which they operate. Complying with the spirit of the law means discerning and following the intention of the legislature. It does not require an enterprise to make payment in excess of the amount legally required pursuant to such an interpretation. Tax compliance includes such measures as providing to the relevant authorities timely information that is relevant or required by law for purposes of the correct determination of taxes to be assessed in connection with their operations and conforming transfer pricing practices to the arm’s length principle.
Enterprises should treat tax governance and tax compliance as important elements of their oversight and broader risk management systems. In particular, corporate boards should adopt tax risk management strategies to ensure that the financial, regulatory and reputational risks associated with taxation are fully identified and evaluated.
The commentary of Chapter XI offers the following reference in order to assess whether certain transactions could be contradictory with the spirit of the tax law:
“An enterprise complies with the spirit of the tax laws and regulations if it takes reasonable steps to determine the intention of the legislature and interprets those tax rules consistent with that intention in light of the statutory language and relevant, contemporaneous legislative history. Transactions should not be structured in a way that will have tax results that are inconsistent with the underlying economic consequences of the transaction unless there exists specific legislation designed to give that result. In this case, the enterprise should reasonably believe that the transaction is structured in a way that gives a tax result for the enterprise which is not contrary to the intentions of the legislature.”