Taxing times

The taxation reform debate continues to escalate as federal and state governments search for new revenue-raising measures and a more efficient taxation system. Domini Stuart reports.

A local manufacturer pays Google to promote its product within Australia. It claims a tax deduction for a legitimate business expense. Google says it has no permanent home here and all of the work that generates its business takes place overseas – for tax purposes, Google’s search business customers are billed from Singapore. Is that legal? Illegal? Legal, but morally reprehensible?

“Even a simple example like this points to the complexity of today’s boardroom challenges,” says Craig Cooper, director at accounting firm RSM Bird Cameron. “Digital business models that enable income to be generated remotely have emerged so quickly that they’re not captured by our current tax rules.”

However, while large multinationals have had first-move advantage in terms of communication technology, revenue authorities are catching up fast.

Precision targeting

The Australian Taxation Office (ATO) is one of the most advanced in terms of technology and, as employees continue to be shed, computerised systems are playing an increasingly significant role.

“Reduced manpower doesn’t mean a lower level of scrutiny across the board,” says Tony Katsigarakis, commercial director at Wolters Kluwer Corporate Reporting Solutions. “The ATO wants to automate scrutiny of companies with a low risk-profile so it can focus its resources on those that are more questionable.”

For a while, the ATO has been working hard to present a more approachable face to taxpayers and encourage higher levels of engagement. Now it is moving into a phase of chasing and prosecuting companies that are not paying their fair share of tax.

“One of the key responsibilities of the board is to set the risk profile and ensure that a consistent message permeates the entire organisation,” Katsigarakis continues. “Some companies describe themselves as good corporate citizens willing to pay their fair share of tax, others say they pay tax in accordance with the law. That means they’re interpreting the law as they’re entitled to do, but there’s also a suggestion that they might be prepared to push boundaries. This is likely to send up a red flag to the ATO.”

International transparency

Companies that operate internationally are facing an even higher level of scrutiny from the tax authorities. “For some years, the Organisation for Economic Co-operation and Development (OECD) has been working to maintain the fairness and integrity of international tax systems,” says Mark Molesworth, a tax partner with BDO in Brisbane. “Its base erosion and profit shifting (BEPS) project aims to create consistency, at least between major developed economies, in terms of the taxation of international transactions between related parties. The BEPS project will also increase transparency with measures such as country-by-country reporting. As the OECD finalises its recommendations I would expect Australia and other developed nations to implement changes to their domestic law, with the aim of leaving tax avoiders with nowhere to hide.”

If a current exposure draft gets through parliament, every global group in Australia with more than $1 billion turnover will soon be required to provide the tax office with details of its international-related party transactions on a country-by-country basis.

 “Where one Australian company has one foreign subsidiary that may not be too complicated,” Molesworth continues. “But, where there’s a web of different companies in different jurisdictions, it will be a very large undertaking to identify, pull apart and report to the tax authorities on all of the transactions that occur between those companies.”

A social contract

The concept of fairness is also gaining traction within the community. “There’s a growing perception of business as a social contract: ‘we allow you to operate in our economy on the basis that your interactions with the tax system are transparent’,” says Molesworth. “Not so long ago, getting caught out by the tax office was just a matter of having to pay more money. Now reputational risk is becoming far more apparent to boards. The community wants to know that, while companies have a duty to build shareholder value, this is within the context of operating as a good, tax-paying citizen.”

As the push for transparency continues, directors should give careful thought to how their company would appear to an outsider if its tax information was suddenly made public. “No board wants to find itself in the media spotlight and smelling less than sweet,” says Katsigarakis. “Your organisation might have good reasons for posting very high revenue and paying very little tax but, if anything looks amiss or is potentially open to misinterpretation, you must be ready to explain that. We’re seeing a lot of naming and shaming at the moment and ordinary taxpayers are growing increasingly resentful of companies that appear to be avoiding paying their fair share of tax in Australia.”

Some boards seem concerned that resentment could have an impact on their bottom line. “Amazon recently moved its procurement and shipping operations out of Luxembourg and back into the UK,” says Cooper. “This will reintroduce value into the UK and the extra profit will be taxed there. The Amazon board obviously thought about this very carefully and decided that the increased cost is more than offset by the positive impact on its reputation.”

Ongoing reform

Large corporations are continuing their push for a lower rate of company tax. “The economic argument is that a more competitive tax rate would create more high-value jobs by attracting foreign investment,” says Cooper. “However, some people suggest it would do little more than increase profits for foreign investors as lower-skilled jobs disappear.”

Scaling back the full dividend imputation system has been proposed as a way of funding a rate reduction. “This sounds logical but it’s important to remember that the shareholders who would be affected are, by and large, individuals, including all of those who are part of a superannuation fund,” says Cooper. “Scaling back dividend imputation would change the direct tax mix so that companies would pay less but individuals would pay more.”

There is also a push for Australia to change its approach to the tax breaks that support research and development (R&D). “Australia’s tax incentive program is quite unusual in that it helps companies to initiate and fund eligible R&D activities,” says Cooper. “In other countries such as the UK, tax authorities have adopted a so-called ‘patent box’ approach which links the tax incentives to income generated from the intellectual property (IP) the R&D has created. As this encourages companies to commercialise their R&D on home soil it could be a positive move for Australia. We’re said to punch above our weight in terms of the number of patents registered and the amount of IP we generate. We’re appallingly bad at commercialising the results locally.” 

Good tax governance

Managing tax risk is an integral part of the governance process and the ATO is looking for evidence of good governance.

“It expects the board and management to be sufficiently engaged with the taxation affairs of the company to understand its tax profile and to feel confident that the tax risks are being well managed,” says Molesworth. “It is also seeking early engagement with companies involved in significant transactions. Rather than waiting for a company to lodge its annual tax return then taking six months to analyse the data, the tax office wants to talk about the taxation treatment that will apply while the transaction is in process.”

Companies seen to be doing the right thing are categorised as low risk on the ATO’s risk-differentiation framework and can expect minimal scrutiny as long as no red flags appear in the system. The board needs to be sure that there are robust systems and processes in place to support the company’s position if a red flag did appear.

“That could make the difference between a quick visit from the tax office or a regulator and having them camp out in your reception area while you scramble around trying to pull together information,” says Katsigarakis.

That doesn’t mean every director needs to be a tax expert, or that the board should spend an inordinate amount of time discussing tax.

“In terms of everyday accounting, it should just be a matter of making sure the finance people understand the risk profile and know that you don’t expect any surprises,” says Cooper. “The board should also make sure that the finance team has the resources it needs in terms of effective systems and processes and also to call in advice whenever it’s needed.”

However, major transactions such as buying a new business, entering into a significant finance arrangement, going offshore or trading internationally demand more of the board’s attention.

“Directors must have a view on whether appropriate protective measures have been taken and feel comfortable with the amount of risk associated with a particular transaction,” says Cooper. “For example, if you decide to take an aggressive position on a very big transaction and the tax office takes you on, the primary tax could be significant but penalties and interest could easily double the amount of cash you end up having to pay.”

When major transactions are being discussed, Molesworth recommends that the board talks to the advisors in person.

“This can give directors an insight into the quality of the tax advice management is receiving and it also provides a good test of the advisor,” says Molesworth. “A good one will be able to boil down complex tax law in order to explain the outcomes in concise commercial terms.”