Aussie Openness

As I noted last week, Australia has recently hoisted itself into the spotlight with several aggressive tax initiatives, which have garnered both praise and harsh backlash from international tax organizations. It’s not an unfamiliar place for the Land Down Under, which has always been willing to chart its own course when it comes to tax enforcement and compliance. As a resource-rich country with a thriving marketplace, its government has always been wary of foreign companies it sees as exploiting the jurisdiction without contributing enough to its well-being.

But if its proposal for public country-by-country reporting is finalized, this could be Australia’s strongest move yet, with repercussions sure to be felt around the globe. Public country-by-country reporting has long been the goal of tax transparency advocates, and there have been several efforts both in the U.S. and the European Union to see it enacted as a requirement. So far, none of them have been completely successful, but Australia’s looks to be closer to the finish line than any of the past attempts.

Even if it is watered down or repealed outright, this proposal indicates the seemingly unstoppable move towards greater global tax transparency. It also is another step in the direction of tax enforcement that is ostensibly based on traditional arm’s-length pricing, but will be influenced by a variety of factors that include destination-based and formulary apportionment principles, as well as unpredictable public perceptions and opinions. It’s what I’ve called the “rough justice, soft application” approach–that could ultimately transform the global tax system.

Originally the brainchild of anti-avoidance activists such as Richard Murphy, country-by-country reporting was ultimately adopted by the Organization for Economic Cooperation and Development as part of its 2015 Action Plan on Base Erosion and Profit Shifting project. (A precursor to its more wide-ranging “Two-Pillar Approach,” including the 15% global minimum tax, that it is pursuing today.) But while folding the idea into its BEPS recommendations, the OECD moderated by making it a confidential report to governments, not to be made available to the general public.

The new reporting rule requires companies to submit a blueprint of their global operations, broken down by jurisdiction, including factors such as workforce, taxes paid, and income. In theory, this would give tax administrations a better idea of where to put resources–if a company shows large profits in a jurisdiction but low taxes and a small workforce, it may be a sign that income is being shifted and that tax is being avoided. Profits disproportionate to real substance is always a red flag. Tax examiners will know which transactions need to be put under the microscope.

That was the theory, at least. It was always clear that to view the country-by-country reports as strictly about “risk assessment” for authorities was to miss some of the bigger picture. More likely, the effect of these reports would be to influence corporate behavior–for the taxpayers themselves to change these tax structures. Participating jurisdictions probably already know, more often than not, where the havens are. But for the company to draw up a report showing just how big the disparities are, and the amount of income that is potentially being lost, is akin to waving a red flag at a bull. And if the reports get out–which is always a possibility–it’s even more dangerous to a company’s reputation and audit risk.

Each taxpayer has to make the decision about whether or not the current structure is worth it, if it creates those results. (And keep in mind, this is happening amid many other campaigns, at the national and international levels, to better capture lightly taxed profit without substance.)

Even though the reporting rules have been in place for several years, there’s not much evidence yet about whether or not the rules are “working,” based on any metric. With so much of the data not public and so many potential factors, it will likely take a while for a clear picture to emerge. But one way or another, it’s likely that companies have responded to the rules in their planning.

Impatient lawmakers and tax authorities don’t want to wait before taking the next step, however. Public disclosure would create even more pressure on taxpayers to reconsider related-party transactions and structures. The European Union has instituted a directive which will require country-by-country reporting for EU member states, as well as non-EU countries that have been designated as potential havens. (The EU’s controversial “blacklist.”) That takes effect in 2025.

And then there’s Australia’s proposed initiative, which will take effect for the 2023-2024 tax year. Their template goes beyond the OECD’s, including intangible assets, related-party transactions, and requires companies to explain when effective tax rates are significantly different from statutory rates. The goal is to “enhance transparency, as well as improve comparability and accessibility” and to build “on global trends to help inform the public debate on the tax affairs of large multinationals,” according to the Australian proposal released in a public consultation that ended on April 28.

Of course, if Australia enacts this then the rest of the world will have the benefit of these reports, as if they had enacted them as well. Although only for those companies that choose to do business in Australia--which some may reconsider.

Supporters of public reporting state that the goal isn’t just stronger tax enforcement, but to help the general public to better understand global taxes and to ultimately change the attitude of corporate taxpayers.

Kim Clausing, a professor of economics at UCLA who recently served in the Department of Treasury in tax analysis, wrote in her 2019 book, “Open: The Progressive Case for Free Trade, Immigration, and Global Capital,” that public country-by-country reporting could be “useful in changing social norms regarding taxation among the corporate community.”

“While culture can be difficult to change, a sunshine tax report is a useful step that would encourage companies to value paying tax in their home jurisdictions,” she wrote.

I used “rough justice, soft application” to describe the Pillar One Amount B project, which aims to set margins for routine activities in the hopes of easing compliance burden and enforcement–likely through optional safe harbors. It’s a very different policy but you can see the similar approach in public country-by-country reporting. It would use rule-of-thumb-type measurements to apportion taxable income–but rather than require it outright, it would seek to nudge it through various incentives.

It’s the same basic concept that Australia already uses for its unique “practical compliance guidelines," where companies can place themselves into different “zones” of audit risk by meeting certain profit margin benchmarks. Those benchmarks aren't legal requirements, but companies should think twice before breaking them unless they think their justification is rock-solid.

Given that everyone seemingly agrees that the arm’s-length principle isn’t perfect in our complex, digital economy, there’s definitely an appeal to the “rough justice, soft application” philosophy. But it has drawbacks and risks as well. There are reasons we don’t use these factors in income apportionment outright.

In an open letter to the Australian Treasury, the National Foreign Trade Council warned that “selective reading and sensational reporting” would “inevitably confuse and misinform the public as they would likely fail to inform the reader of the intricacies of international taxation.”

M.I.T. Professor Michelle Hanlon, in a 2018 paper, listed several potential ways that country-by-country reports could be misinterpreted, including double-counting of income, income that is deemed “stateless” but is not involved in tax avoidance, and changes due to evolving accounting standards.

Especially in a world where a few talented engineers or scientists can create assets worth billions of dollars, workforce headcount and income alone can be crude and faulty metrics to track tax avoidance. And in a time when employees can receive compensation in everything from dollars to cryptocurrencies--including equity arrangements that can potentially count as company revenue--it gets even more confusing.

For the taxpayers themselves, to be taxed based on traditional transfer pricing and country-by-country metrics could seem like redundant and potentially contradictory efforts.

“It is as if they are in some type of mezzanine state, in limbo, or in some type of halfway house,” Hanlon wrote. “This puts the [multinational enterprise] in a vulnerable position that will likely be quite costly in terms of future tax controversy – for MNEs and their home countries.”

But whether it makes sense or not, absent a major change in dynamics, it's likely only a matter of time before this becomes a reality for all global companies.

DISCLAIMER: These views are the author's own, and do not reflect those of his current employer or any of its clients. Alex Parker is not an attorney or accountant, and none of this should be construed as tax advice.

LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

• The Senate Finance Committee is holding a hearing Thursday (today) on alleged tax avoidance in the pharmaceutical industry, a field that has long been under the microscope due to its profitability and reliance on intangible assets. No one directly representing any the pharmaceutical firms themselves will be testifying, so don’t expect a ton of fireworks. The Joint Committee on Taxation released a 100-page analysis on these issues, including background on how the Tax Cuts and Jobs Act and OECD initiatives have affected pharmaceutical tax liabilities. Sen. Ron Wyden, D-Ore., chairman of the committee, has long blamed the TCJA for facilitating what he claims is a flight of tax dollars from the U.S., and Republicans are sure to defend what they view as one of their top legislative accomplishments of the past decade. Whether this hearing will produce heat or light on these questions remains to be seen.
• The OECD, working with the The Intergovernmental Forum on Mining, Minerals, Metals and Sustainable Development, released on Wednesday two “toolkits” to assist developing countries on the taxation of minerals. This has long been an important issue for countries rich in natural resources yet poor in revenue, who struggle to capture income from mining and other extractive industries. You might think that commodities like these would be relatively easy to price, but it’s often quite complex–from figuring out the right price for rare minerals to factoring in “management services” and other related-party charges that companies often tack on. These toolkits (one of which focuses on bauxite, a key source of aluminum) run down many of these challenges–for many mining countries it’s likely not new information, but this could be the beginning of a dialogue between the OECD and countries who’ve long claimed their concerns haven’t been taken into account in global tax debates. The organization requested comments on the two documents, which should be interesting.
• Tax treaties are supposed to be a technical and administrative tool for reducing double taxation, but they’ve often been wrapped up in global politics. (Note how the U.S. moved to cancel its treaty with Hungary amid negotiations on EU implementation of the OECD Pillar Two.) And treaties themselves can be used as a tool to recognize, or not, the existence of a country. Case in point: the top Republicans and Democrats on the Senate and House tax-writing committees released a joint statement Wednesday calling on Congress to take action to alleviate tax burdens between the U.S. and Taiwan. Noting that Taiwan’s “unique status precludes it from the typical process of remedying double taxation through a treaty,” the four said that they were “exploring all avenues to provide significant treaty-like benefits through the tax code that will strengthen the economic partnership between the United States and Taiwan in an expedited way.” With tensions between the U.S. and China seemingly at an all-time high, this could be an interesting side issue to keep an eye on.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

Atoma, appearing for the first and only time in Joe Palooka Comics #15 in 1947. A historian from 25th century, in a dystopian world ruled by the "Mighty Chief," she teams up with an accidental time traveler from the 1940s to stop a "robot riot." (She knew he was coming, obviously.) She has mechanical wings which can help her fly, which I'm sure come in handy during her history studies.

Contact the author at amparkerdc@gmail.com.