Concern about tax avoidance issues is at an all time high amongst investors. Kepler Cheuvreux recently gathered a number of key speakers together in Paris from the European Commission (EC), NGOs, academia and the legal community to clarify the key risks. This article recaps the key points of that discussion.
The context was set with a discussion on ‘austerity budgets’: there is clear agreement amongst most countries that the tax base needs to be extended. However many states have taken the path of least resistance in taxing the least mobile part of their tax base. A key negative social effect of this shift can be felt in the levels of disposable incomes among the poorest sections of populations being most affected (particularly through VAT increases which disproportionally reduce the disposable income of the least wealthy), but also increasingly the middle classes. Looking forward there are limitations as to how far such fiscal policies can be extended, especially if governments want to be reelected! Therefore the focus now is increasingly on corporates that have borne a lesser relative share of the burden.
Fundamentally, regulatory efforts have been largely defensive in the sense that initiatives such as the OECD Base Erosion and Profit Sharing programme (BEPS), and various EU measures attempt to close loopholes rather than push for the systematic international changes needed. Laws have been introduced in a piecemeal way. Country-by country reporting, which should be central to any SRI investor’s transparency wish list, is one example. So far in Europe it’s been entered into different directives such as CRD IV for banks and the Accounting Directive for extractives sectors, with mentions in other proposals. We will have to wait and see if standardized country reporting for all sectors across the EU can be introduced.Another phenomena of this piecemeal approach has been in what we think is the most critical short to medium term impact on companies: EU fiscal state aid investigations. We were not the only broker that believed investors should watch for more of these. These investigations use competition law (not tax law because there is no adequate harmonized framework) to pursue companies and countries for so called “tax rulings” or agreements around liabilities made behind closed doors. These agreements between corporates and a national tax authority are never publically revealed (unless leaked). Though rulings are used for legitimate non tax purposes such as increasing the ability to plan for cash flows within a global group or establishing investment fund structures, they have been misused for extremely low (down to zero) tax liabilities well outside established tax base norms.
A current EU proposal to ensure all tax rulings can be seen by EU member states is gaining traction. However there is suspicion that such confidential documents will ever reach the stage of regulation forcing public disclosure. It’s not just investors that don’t know the ins and outs of business tax behaviors; it might be a good start if the country tax departments themselves got the data they need!
One of the key takeaways of the event was that the EU is considering a Common Consolidated Corporate Tax Base (CCCTB). This would mean a harmonized standard for corporate tax payment across the EU, potentially with one single EU tax return which would for the first time allow for allocation of tax liabilities across member states. A central aim is to achieve a taxation of EU revenues, at least once, and at least with a double-digit rate. Panelists agreed that such efforts at integration would be a significant step forward for all stakeholders.
On a lighter note, a panellist recounted how he had seen sweeping changes in
the “criminal” nature of the way tax avoidance is treated both by the media and regulators, observing that the kind of dawn raids by authorities against businesses by a multitude of regulators was until recently reserved for the likes of the most serious criminal offenses of gangsters and traffickers. Global companies should be on guard for business ethics related regulatory risks across the world. We were reminded that 60% of global trade is intra-group, meaning that it takes place within a company but that investors have little visibility over how it is accounted for. The speaker partly blamed accounting standards such as the IFRS as “not fit for purpose”, saying the financial crisis could not have taken place if it was. Financial statements, the speaker said, could, in certain areas such as deferred taxes, intangibles and other liabilities, be works of fiction. The Booker Prize, the speaker said, could be a more appropriate reward for such creativity. Such statements might seem sweeping, but a fellow speaker said the financial crisis had in a very short space of time created a sphere of extremism based on the social impacts of fiscal policyfrom the Occupy movement to the Tea Party.
Tax governance was also held to be key to reducing risks by increasing accountability. Numerous conflicts may occur if tax (and even occasionally secrecy as we know from the CEO of a major British bank) are a major consideration in variable pay for a board and senior managers. At board level, the conference was told, a named member should be accountable for tax affairs, with a yearly risk assessment. Special consideration needs to be paid to the “substance” of transactions based around real third party sales (as opposed to intragroup) as the more that artificial (ie pure accounting transactions) tax structures are used, the higher the risk.
Overall, the event heard, greater tax transparency is of benefit to both investors and society if it allows for more efficient markets. Where it does, the cost of capital should decrease for the most transparent markets that reduce risks in capital allocation, and, in the best cases, simultaneously maximise social benefits.
Sudip Hazra is an ESG Research Analyst at Kepler Cheuvreux