—–For general audience—-–
Banks need to assess if clients pay their fair share of taxes. And how Pillar Two of the OECD/G20 Base Erosion and Profit Shifting Project can help.
Back in 2016, I wrote on the media spotlight for Transfer Pricing (and the likelihood it would remain there for some time). In the article(1) I discussed that the most important risk that MNCs might face was not just the risk of additional tax, penalties and interest, but the real damage to their company’s overall reputation.
In the article, links to videos (3) show how the “immoral” or “unethical” approach towards Tax led to reputational damage for companies like Google, Amazon and Starbucks. As you can imagine, due to this development, banks also started to worry about their own reputation when it comes to serving clients that get publicly shamed.
Visit the blog-page for this and more articles (click here).
Media coverage created several reputational risk challenges for MNCs looking to reconcile legally compliant tax positions with the public perceptions about them.
In another article(2) I reported on the OECD BEPS project, which delivered 15 recommendations (the worldwide implementation thereof scheduled to occur between 2016 and 2024) and the leading role the EU was taking in implementing (13 of the 15 recommendations coded in – so-called – hard law). Like anti-money laundering (AML) and countering the funding of terrorism (CFT), this led banks to face increasing pressure when it comes to compliance aimed at Client Tax Integrity (CTI). In this article a report on how the above topics merge, and how this keeps bankers awake at night.
So, what worries banks? Integrity and reputational risks!
You might expect that banks are concerned about the illegal (criminal) behaviour of clients. And yes, of course, they do. But there is a consensus that illegal behaviour is wrong (and has consequences once discovered). Therefore, there is something that worries banks even more. Banks fear the (legal) behaviour of clients that can be deemed immoral. Legal but immoral. Facilitating these activities could be seen as banks condoning the client’s immoral behaviour. This opens the door to integrity and reputational risks for the bank as well. This is called Client Integrity risk.
Can tax be deemed unethical?
There are plenty of individuals who see tax as just another of those annoying costs of doing business, such that they would do all that’s necessary to shrink their tax bills. They would take the view that if they’re not breaking the law in reducing the tax they pay on their income, then they’re doing nothing wrong. But if you get too enthusiastic in doing so, your behaviour might be frowned upon, and deemed unethical. Consequently, banks will need to assess their clients on this. Making use of deductible items etcetera is fine, but one paying less, or no tax becomes a goal on its own, it is very likely deemed immoral. Client Tax Integrity is a subset of Client Integrity.
Tax Evasion (non-payment or underpayment of taxes) and fraud is illegal. But Tax Avoidance isn’t. Tax Avoidance comes in different forms. Aggressive Tax Avoidance (in practice also referred to as aggressive tax planning) and Acceptable Tax Planning. However, what is acceptable or not, is neither clear-cut nor static.
Tax evasion is the illegal non-payment or underpayment of taxes. For example, intentionally established offshore constructions with the goal to disguise ownership and/or control, leading to non-adherence to applicable laws regarding tax liability. Aggressive Tax Avoidance is the arrangement of a taxpayer’s affairs that intends to reduce his tax liability and that, although the arrangement could be legal, is usually in contradiction with the intent of the law it purports to follow.
The bank’s risk appetite.
Politicians, society and regulators expect banks (and for that matter, also other financial institutions and ‘gatekeepers’) to prevent their services from being misused for Tax Evasion and/or Aggressive Tax Avoidance. On a case-by-case basis, banks will have to analyse and decide if either the client or transaction (or both) is within the bank’s risk appetite.
Banks are expected to develop an appropriate risk model and take reasonable measures to mitigate the risk of being used by clients for tax evasion and/or aggressive tax avoidance (4). This includes mitigating the risk of willingly facilitating such client activities. The need for financial institutions to better explain and sharpen their approach to prevent being involved in such client behaviour has increased in recent years.
What to expect.
The minimum that banks will research (for example during the account opening process) is why a certain company is established. In particular, if this happens to be in a tax haven(6). Expect questions to ascertain if the main purpose is the reduction of the tax burden (i.e., tax optimization or tax avoidance). Even though these questions might come across as intrusive, it is important to take the questions seriously and to take time to respond. Be prepared for follow-up questions. Keep in mind that the bank isn’t nosy and prying, but simply trying to fulfil its legal obligations. This mostly consists of maintaining detailed records as proof of the research done.
Best practices to establish if companies pay their fair share of tax.
International banks with a lot of experience in dealing with multinationals (and their many subsidiaries) will likely perform a more comprehensive review (desk study) to ensure that their client pays its fair share of tax. This entails researching:
- the clients’ approach to arm’s length principles.
- concerns or points of attention regarding the tax position of the client that appeared in the news, on internet or in social media.
- if transparency is provided through publicly available information. For example, information shared through a website or other means (like a tax contribution report or tax paragraph in the annual report) on the approach towards taxation. This could be taxes in general, or specific to certain aspects. The annual report and corporate website are the most likely document/place where banks will try to find this type of information. Transparency is increased.
- if the effective tax rate is published. Ideally, this needs to be relatively high.
- if a tax reconciliation is published whereby the effective tax rate is compared to the nominal tax rate. The nominal tax rate is calculated as a weighted average of all the countries where the multinational operates its businesses (not the nominal rate in the country of the parent). This is usually explained in the notes to the reconciliation including an overview of the items that account for the difference between the rates.
- if Country-by-country reporting (CbCR) (5) is publicly available. The reporting shows the aggregate data on the global allocation of income, profit, taxes paid and economic activity among tax jurisdictions in which it operates. CbCR is a requirement detailed in Action 13 of the OECD’s BEPS guidelines. CbCR primarily provide tax authorities information to help them assess transfer pricing risks and make determinations on how they allocate tax audit resources.
Recent developments
Recent statements by the OECD inclusive framework and G20 (July 2021), outlined the agreement to focus on implementing a Robust Global Minimum Tax rate. In the latest publication (8 October 2021), 136 countries and jurisdictions (more than 90% of Global GDP) have joined the OECD Base Erosion and Profit Shifting Project – Two-Pillar-Solution. This aims at reforming international taxation rules and ensuring that multinational enterprises pay a fair share of tax wherever they operate. I wrote in more detail on this in an earlier article (7).
Pillar One: “Pay tax where you make your money” (Support local)
Pillar Two “If you don’t pay enough tax, you will be charged” (Immoral behaviour not accepted)
Pillar One: “Pay tax where you make your money” (Support local). Also referred to as the allocation of taxing rights. This will ensure a fairer distribution of profits and taxing rights among countries with respect to the largest Multinational Companies MNCs, including digital companies.
Especially relevant to the topic of this article is Pillar Two (so-called global anti-base erosion mechanism) “If you don’t pay enough tax, you will be charged” (Immoral behaviour not accepted). It seeks to put a floor on competition over corporate income tax, through the introduction of a global minimum corporate tax rate that countries can use to protect their tax bases.
The global minimum corporate income tax under Pillar Two – with a minimum rate of 15% – is estimated to generate around USD 150 billion additional global tax revenues annually. Additional benefits will also arise from the stabilisation of the international tax system and the increased tax certainty for taxpayers and tax administrations.
The approach would leave jurisdictions free to determine their own corporate tax rates (including whether they have a corporate income tax) but allow other jurisdictions to tax income that would otherwise be subject to low levels of effective taxation thereby ensuring that all internationally operating businesses pay a minimum level of tax.
Link to write-up on relevant sections of the OECD Two-Pillar-Solution (click here)
The work on this approach is based on the premise that, in the absence of multilateral action, there is a risk of uncoordinated, unilateral action, both to attract more tax base and to protect the existing tax base. This will have adverse consequences for all countries. The approach, therefore, seeks to advance a multilateral framework to achieve a balanced outcome, that limits the distortive impact of direct taxes on investment and business location decisions and provides a backstop for situations where the relevant profit is booked in a tax rate environment below a minimum rate.
Conclusion
Sure, banks worry about the illegal behaviour of clients. But they fear legal behaviour, that could potentially be deemed immoral and unethical, even more. Serving clients that get publicly shamed opens the door to integrity and reputational risks for the bank. Facilitating aggressive tax planning is equal to condoning immoral behaviour. Politicians, society and regulators expect banks to prevent their services from being misused. Therefore, banks are expected to develop an appropriate risk model and take reasonable measures. These models will need to be fed with data. Publicly available data (for example through annual reports), but also proprietary data (to be provided by the client). The latter means responding to questionnaires that might come across as intrusive, but are intended to find an answer to a very important question “Does the client pay a fair share of taxes”
Answering this question may have recently gotten a lot easier. By focusing on implementing a Robust Global Minimum Tax rate, the OECD and G20 take steps to make it impossible to pay less than a fair share. Though jurisdictions are free to determine their own corporate tax rate(s), but allow other jurisdictions to tax income that would otherwise be subject to low levels of effective taxation thereby ensuring that all internationally operating businesses pay a minimum level of tax of 15%.
Will this mean the end of long Tax Integrity Assessments with loads of “intrusive” questions? That remains to be seen.
Visit the blog-page for this and more articles (click here).
Footnotes:
(1) A Holistic view on Transfer Pricing (click here)
(2) BEPS 2.0 – Background for those not too familiar with the topic
(3)
Margaret Hodge grills Google Boss on UK tax dodging (click here)
Amazon, Starbucks and Google grilled by MPs over tax (click here)
(4)
Amongst others, the following developments are relevant in this context:
- The Base Erosion and Profit Shifting (BEPS) initiative from the OECD and the Anti-Tax Avoidance Directives
- Increased focus on the area of tax compliance by society in general,
- The EU’s 4th Anti Money Laundering Directive
- Approved EU-proposal enforcing financial intermediaries to report aggressive tax planning by clients (DAC6)
- Proposal for mandatory disclosure of CRS Avoidance Arrangements and Opaque Offshore Structures
(5)
CbCR applies to multinational companies (MNCs) with combined revenue of euros 750 million or more. Country-by-Country Reporting (CbCR) is part of the OECD’s Base Erosion and Profit Shifting (BEPS) Action Plan 13. In essence, large multinationals must provide an annual return, the CbC report, that breaks down key elements of the financial statements by jurisdiction. A CbC report provides local tax authorities visibility to revenue, income, tax paid and accrued, employment, capital, retained earnings, tangible assets and activities.
Implementation depends on when countries implement CbCR into their own legal system, but the intention is that reports will be are required for the fiscal years starting on or after the 1st of January 2016 (FY16) and should be filed within 12 months of the relevant year-end.
CbC reports will need to be filed 12 months after the fiscal year has ended, starting with the first financial year starting after 1 January 2016. CbC reports are primarily to be filed where the parent company is headquartered (HQ). If the HQ country has not implemented CbCR, MNCs should file in the country with CbC reporting where their most significant activities occur.
(7) How far are we from a Robust Minimum Global Tax Rate? (click here)
Featured image: Sunset before a typhoon at Quarry Bay Park in Eastern District (Hong Kong). The larger the typhoon the more beautiful the sunset. A completely pink sky announces a super typhoon (Photo: Chenwei Yang).
TREASURY INSIGHTS & CURRENT TOPICS 