Limits on Tax Planning in the Current Climate

The limitations placed on tax planning have become the most important area of our professional activity, both for in-house tax advisors and for external practitioners. In fact, in recent years, this issue has become ‘the name of the game’. This article examines the new role of tax directors, finance directors and their tax advisers in this ever-changing world, as discussed during a panel at the Taxand 2010 Global Conference for multinational companies held in Berlin in April 2010.

In all jurisdictions, tax authorities are pushing for a reduction in the scope of activities and planning developed by tax advisors. More than ever, approaches taken by different tax authorities are converging to a degree never seen before. The tax authorities of each jurisdiction are monitoring and learning from the experiences and proposals of other tax authorities, all of which are being enhanced by the Organisation for Economic Co-operation and Development’s (OECD) work and forums on this subject. It is therefore important to highlight the trends and shed some light on recent administrative policies and developments that are changing the tax landscape.

Before going into any country-specific anti-abuse measures, it will be useful to identify the global trends in anti-abuse measures. Times have changed drastically in the tax arena since the onset of the global financial crisis. France is an example of a centralised country that has traditionally called for more regulation in a number of areas. But clearly, before 2008 and the economic crisis, although some players often demanded some kind of regulation in the tax arena, not all countries agreed with this approach. Self-regulation through the free market was more or less the major driving factor.

The US has often been viewed as the leader in this respect, alongside the UK and some other countries that have built their models on tax competition. There was no common EU approach on tax regulation, and the major emerging countries, such as China and India, were also keen on keeping their independence and not entering into a centralised process (obviously, tax havens are a question apart, as they clearly chose their model based on a combination of low taxes and banking secrecy). In other words, the open economy and the maximisation of the exchange of goods were considered central to general growth and regulation. Tax regulation was increasingly seen as an area on which each country was taking its own stance with the aim of remaining attractive to business.

Of course, international studies on harmful tax competition, tax evasion and tax havens existed, but the foundation for a global international approach to these developments was not outlined by the OECD until 2000, through a global forum in which OECD and non-OECD countries worked together to draw up common principles of transparency and exchange of information for tax purposes. These were, however, more of a description of what would be good to achieve and were, at that time, far from being internationally accepted standards. It was a working group of 32 countries.

The financial crisis radically changed priorities, leading politicians in the G8 and the G20 to endorse the subject and make it a high priority, citing the intention to clean up the economy and, more generally, install the ‘Global Plan for Recovery and Reform’. Nowadays, taking a stand against it would not be politically correct and all economies are expected to adopt and adapt. The global public’s expectations are high and its tolerance of non-compliance is zero.

In this regard, the OECD Global Forum on Transparency and Exchange of Information brings together 90 jurisdictions. It has proposed:

  • Article 26 of the OECD Model Convention.
  • A bilateral and a multilateral model agreement on exchange of information on tax matters.
  • Annual progress reports.
  • Assessment by the Global Forum.

The so-called ‘black’ and ‘grey’ lists originate from here and are adapted and adopted on a yearly basis.

Recently more than 150 bilateral agreements on the exchange of information have been signed, although not all of them are in force today due to incompatibility with internal law or the absence of ratification. In a number of jurisdictions, there is no one even able to respond to information requests. There is also a need for clarification on what the conditions are for a valid information request. Plus, new issues are likely to arise in the implementation phase.

The EU has also been working, over the past few years (perhaps more slowly than desirable), on a Code of Conduct and has issued proposed measures for ‘good tax governance’. The trend is there, the efforts will be co-ordinated and the pressure will increase over time, with the effectiveness of the exchanges of information, country by country.

Anti-Avoidance Rules

Looking at the anti-abuse measures in the different domestic legislations, Spain is an example of a civil law country with highly implemented anti-avoidance rules – General Anti-Avoidance Rules (GAAR) – in multiple forms. The trend examined above is clearly reflected in the law. Moreover, case law is upholding very restrictive interpretations of domestic tax benefits and tax treaties if they lead to abusive tax positions.

In France, new tools have been added to this ‘traditional toolbox’ of anti-abuse measures:

  • The abuse-of-law procedure has been extended to all taxes.
  • New transfer pricing documentation requirements have been implemented for large companies.
  • The concept of ‘unco-operative state or territory’ has been introduced in the French tax code. This is the ‘black list’, with very serious consequences arising for jurisdictions on the list (e.g. severely increased withholding taxes).

Regarding the US, the recently codified economic substance doctrine is noteworthy, particularly in light of the strict liability provisions for transactions that fail the economic substance doctrine. Other relevant doctrines to be highlighted in this respect are substance over form, sham transaction and the step transaction doctrines.

In India, on the contrary, we might see GAARs in very limited cases, although a GAAR has been proposed in the draft Direct Tax Code (DTC). Additionally, there are numerous court cases regarding treaty shopping and transfer pricing.

As we can see, anti-abuse measures have generally converged and become more profuse in recent times among the different jurisdictions.

Furthermore, if we take as an example the treatment of different structures by the tax authorities and courts of several countries, we can see that in a number of cases the same structures are challenged by them on the basis of very similar arguments. In a case concerning a change in business model, for example, more or less the same issues are raised by the authorities: the existence of a permanent establishment (PE), transfer pricing issues, disposal of intangible assets, etc.

Another very tangible example of what the current hot topics might be in inspections and court cases is the economic substance requirement versus business purpose arguments.

In Spain, we have seen a very restrictive evaluation of the requirement for valid economic reasons in restructuring transactions. The business purpose test is fast becoming a new threshold for tax-driven transactions. Economic substance is no longer deemed sufficient by the Spanish tax authorities and courts, which are now requiring there to be a commercial purpose for the restructuring transaction in order for it to be deemed valid.

Although France has not reached the extreme of requiring a business purpose for every holding structure, in the US this approach is very deep-seated and the economic substance doctrine is an Internal Revenue Service (IRS) ‘weapon of choice’.

For that reason, we can generally say that we are facing a common reality: the same strong limitations on tax planning are being established in different jurisdictions, and what might be a new development in one jurisdiction will become the norm in another part of the world a few months, or years, down the road. An example of this is the new transaction disclosure obligation in the US – in time we shall see how it affects the rest of the world. In view of this situation, what can we do? Is tax planning a thing of the past?

We sincerely do not think so, but the scenario has changed and so must our procedures and decisions in the tax arena.

On the one hand, we must be very careful to ensure that there is the utmost transparency in tax-related decisions (otherwise we should be aware that, sooner or later, such transparency is going to be required for reasons of disclosure of transactions). On the other hand, the company’s senior management will increasingly take those tax-related decisions.

We have to bear in mind the recent work undertaken by the OECD on tax governance. Since the Seoul Declaration, this area has generated an impressive amount of documents and initiatives in many countries. The main drivers of this cultural change brought on by the OECD are as follows:

  1. Transparency may lead to a real-time conversation about the interpretation of the statutes and, as a consequence of these discussions, the world will be a safer place for both taxpayers and the tax authorities.
  2. Giving the board of directors full responsibility for handling the company’s tax affairs will increase the board’s focus on this area of management and on controlling the associated risks.

In a way, the reaction by the tax authorities reflects the belief that ‘taxes are too serious an issue as to be left in the hands of tax advisors’.

Several years ago, the Australian Tax Authorities developed a guide for directors to explain to them what their duties are in terms of understanding and controlling the tax affairs of the company that they serve. This guide is being used by other jurisdictions as an example of how directors should behave and so it is worth reviewing it.

Consequently, we would suggest that these issues should already be on the agenda of the boards and tax directors of all companies doing business in OECD territories.

Aside from transparency and tax governance, we need to also come to terms with the fact that the era of structures without economic substance, and sometimes without even a business purpose, is over. Now, more than ever, we should avoid blacklisted countries. We must apply a two-level test – economic substance plus business purpose – although different approaches still exist, depending on the jurisdiction.

Allow us to make a final recommendation: tax mitigation is still a duty, planning is complex, and you must think long term.

The authors thank Vicente Bootello and Mukesh Butani at Taxand for being co-authors of this article.


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