Tax executives have ranked the UK, US and Australia as having surpassed emerging markets, putting the countries among the top five tax risk countries as geopolitical events and uncertainty surrounding tax rules create insecurities. China and India also ranked highly for posing a high tax risk.
The first instalment of EY’s 2017 tax risk and controversy survey, Tax steps into the light, found that 59% of the 901 tax and finance executives questioned across 69 jurisdictions see globalisation as a cause for greater risk and uncertainty around tax rules, while 55% cite an increase in government disclosure and transparency requirements.
"Until recently, emerging markets have been far more unpredictable for global businesses from a tax perspective, with the introduction of new tax rules in regions such as Africa and Latin America," said Rob Hanson, EY global tax controversy leader. "Now, with seismic geopolitical change taking shape across the US, the UK and beyond, we are seeing a significant increase in tax risk and uncertainty and a move toward more imminent controversy in developed markets. This may be heightened by anticipation around a prospective US tax reform, augmented by the effect of authorities having access to more information and developing more effective tools to collect revenue."
Concerns have also been intensified by the OECD’s BEPS project, which is being implemented worldwide, and the additional measures being taken by governments to widen their tax nets and boost revenues. Of those surveyed, 55% said they have experienced an increase in tax disclosure and transparency measures, and 41% have seen an increase in the volume and/or intensity of tax audits.
Developed nations spread fear
The US took the top position for presenting the most significant tax-related risks in the next two years in EY’s survey, mainly for the anticipated tax reform.
President Donald Trump and his administration are trying to push through a long-awaited tax reform package, but the process is not simple. It could take years to agree on final measures that can pass both houses of Congress. Tax rates and how the reform will remain revenue neutral are just some of the headline issues being discussed.
"Concerns about the US could be driven by high level of uncertainty around how – and whether – the US Congress will enact comprehensive tax reform," said Heather Maloy, EY tax controversy leader for the US.
The UK was in second place for its tax risk ranking as the country negotiates its exit from the EU.
Besides Brexit, the UK’s and Australia’s tougher tax enforcement measures have been a key reason why companies are once again fearing developed nations. Both countries have introduced legislation for a diverted profits tax (DPT), while Australia has also implemented the Multinational Anti-Avoidance Law (MAAL). To date, Diageo is the first multinational to have announced that it has fallen victim to the DPT in the UK, while some reports suggest McDonald’s could be at risk of a DPT assessment in Australia when its law enters into force on July 1 2017.
"Looking ahead, developed nations are likely to pose the highest tax risk for taxpayers, be they individuals or corporations, because of two interconnected factors: namely demographics and slower growth," said Steven Sieker, tax partner at Baker McKenzie in Hong Kong. "It is no coincidence that public scrutiny of taxpayers and tax affairs has increased significantly since the Great Recession began and governments began to struggle with reduced revenue as a result of reduced profits and income."
"In both cases (rich and poor countries) there has been a decline in revenue collection, primarily as a result of the overall global economic decline. But for multinationals trading with developed nations, the tax risk is higher," said Osman Mollagee, international tax partner at PwC South Africa. "There are two main factors: Firstly The greater 'need’ for funds, meaning that the richer nations have a much greater indebtedness in relation to expenditure in general but also, more specifically, in relation to social services spending (think of, for example, the massive pensions and healthcare obligations in the context of a generally ageing population, whereas the poorer countries have comparatively younger populations). And secondly, the question of capacity and resources, i.e. the tax authorities in the richer nations have far greater resources, more sophisticated systems, depth of experience in dealing with global tax avoidance, and so forth."
Sieker agreed that the contrast between the aging populations in developed nations and younger individuals in emerging markets is posing a challenge for countries such as the US and UK. "We have begun to see across the developed world the impact of aging populations with the working age populations peaking or even beginning to decline in some countries such as Japan," Sieker said. "By contrast, developing countries with relatively young populations and high rates of growth can take a less aggressive stance towards taxation, relying instead on favourable demographics and investment patterns to satisfy the demands of public spending. These demographic changes and the challenges of low growth are unlikely to be fixed quickly."
Nevertheless, Mollagee believes the risks posed by developed nations in likely to be temporary, potentially only having an impact in the medium-term. "As to the actual period, the critical factor will be the timing of the global economic recovery. To be clear, the need for funds by developed nation governments will not reduce (and will get worse) and the risk of multinationals engaging in base erosion and profit shifting (BEPS) practices will reduce only slightly, but the big point is that the pressure on governments will ease gradually as the cash starts rolling in as a natural consequence of the economic upturn. I guess the jury is still out on the timing of the economic recovery, but we see 'popular’ commentators pointing to around five years."
For corporations this means that scrutiny of the tax authorities and of the public in developed nations is likely to intensify, according to Sieker. "As a result, tax is likely to remain a matter of importance to senior leadership in companies both large and small. This is further reflected in the increased resources and headcount devoted by corporates to compliance of all types, including taxation."
Andrew Wellsted, head of tax for Norton Rose Fulbright in South Africa, said that despite the risks taxpayers face in developed nations, emerging markets are not "upping resources" to ensure that they can monitor tax compliance, suggesting that compliance in these markets is unlikely to be simple.
Transfer pricing, indirect taxes and PEs among high-risk areas
The activities or issues that tax executives consider to be the highest risks for their companies include the transfer pricing of goods and services, followed by indirect taxes, permanent establishments (PEs), limitation of deductibility of financing expenses and withholding taxes.
The 2008 economic crisis and the implementation of the BEPS measures have increased the risk of tax authorities auditing transfer pricing activities.
"Out of the three main anti-BEPS 'themes’, the primary one that multinationals can most actively respond to is the one of 'substance’," said Mollagee. "So our main advice to clients is to focus on ensuring that reported profitability (and thus tax paid) is aligned with management and operational substance. In other words, if there are more employees and valuable activities in certain countries (and less in others), then the expectation is that more taxable profits will be reported in those countries where the greater substance is. A second piece of advice is also to generally stay away from 'aggressive’ tax positions."
Separately, as countries including India and the Gulf Cooperation Council’s (GCC) member states implement an indirect sales tax on goods and services, the operational and reporting challenges are growing for businesses. This is further compounded for multinationals with the implementation of BEPS Action 1 that addresses the challenges posed by the digital economy.
"Indirect tax continues to be a high-risk area for corporates and in general most of the focus is on developed nations," said Justin Whitehouse, Middle East indirect tax leader at Deloitte. "However, the developing and emerging markets remain high priority for tax, due to extremely significant structural changes on VAT that are occurring there – India is going through major reforms with its new GST system and the GCC nations are, in particular, an area of focus because the VAT system there will be entirely new and there is generally a lack of resources in the market to address the reforms. For these reasons, we see all clients with operations in the GCC taking the implementation of VAT as a serious area of focus and concern."
"The world is witnessing a trend of reverse polarisation, the developed countries are guarding their tax base and the developing nations are opening up to free trade," said Jiger Saiya, direct tax partner at BDO India. "While there has been consistent divergence on the income tax policies of nations, they are opening up to a more harmonised indirect tax system."
Businesses acting on the risks
As these tax risks become more widely realised, businesses are making sure they stay ahead.
As BEPS becomes part of the global tax landscape, 53% of tax executives in EY’s survey said they have implemented the necessary reporting systems to comply with BEPS, compared with 71% stating in 2015 that they needed additional resources to meet the new information requirements.
Moreover, the tax risk has become part of the boardroom agenda as CEOs and the board have increased their oversight of tax risk and controversy over the past two years. Many respondents (73%) now provide periodic briefings to the CEO or CFO on tax risk and/or controversy.
"In a landscape characterised by uncertainty and change, it is critical to have a clear and structured line-of-sight of flashpoints for controversy around the whole organisation," EY’s Hanson said. "Now more than ever, the C-suite is beginning to understand that tax policy and risk is much more than just an issue for the tax function. Tax teams must take responsibility for helping the wider business understand and respond to all of the implications."
While global disclosure, reporting and transparency requirements increase, more than half (56%) of the executives questioned are concerned, however, that governments will require public disclosure of tax information.
Hanson said tax authorities are making strategic use of data analytics to facilitate compliance and audit determinations, and are increasingly sharing this data with tax authorities in other jurisdictions. "This exposes businesses to more risk if their people, processes and systems are outdated or misaligned with government requirements and expectations," he said.
Nevertheless, the biggest BEPS challenge for many is the availability and quality of data for reporting, with 57% of executives from large businesses saying it is costing them more to make the necessary changes and ensure long-term compliance.
"In short, the task of managing tax risk and controversies is more difficult than ever," Hanson concluded.