Does corporate tax planning have a future?

FOCUS: Significant changes to the international tax system planned for the next five years, coupled with a major shift in attitudes towards tax avoidance, has all but killed off the traditional tax scheme. So what does the future hold for businesses seeking to engage in tax planning?

To celebrate Out-Law’s 15th birthday we are looking ahead to the big changes facing businesses in the next five years. Read more and follow our celebrations on Out-Law and on Twitter.

The approach of companies and the media to tax structuring, as well as the legal landscape, were very different when Out-Law was born 15 years ago. The situation is very different now compared to 2000, with very few companies prepared to use a tax ‘scheme’. HM Revenue and Customs (HMRC) has a new arsenal of legal powers that can be deployed against scheme users, while a shift in public opinion has effectively blurred the line between legal tax avoidance and illegal tax evasion in the eyes of campaigners and the media.

The next five years are likely to result in many changes to the international tax system as a result of the work of the Organisation for Economic Cooperation and Development (OECD) on base erosion and profit shifting (BEPS). We are likely to see restrictions on the tax benefits that multinational groups can obtain by shifting profits to low tax jurisdictions, as well as an increased focus on tax transparency.

Tax planning at its purest, by legally structuring transactions in such a way as to minimise tax liability, is certainly not dead. There will frequently be more than one way in which a commercial transaction can be structured, and there are no proposals for suggesting that you should be taxed as if you had carried out a transaction in the least tax efficient manner. What is largely dead, however, is the kind of structuring which relies on using tax rules in a way that was not intended, or using artificial structures to create tax profits or losses where there is no economic profit or loss.

Looking back: the legislative changes

Perhaps the biggest legislative ‘game changer’ in the UK over the past 15 years was the introduction of the Disclosure of Tax Avoidance Schemes (DOTAS) regime in 2004. This required those promoting tax schemes to notify HM Revenue and Customs (HMRC) within a short timescale, and to provide details of the scheme. Scheme users also had to disclose on their tax returns the fact that they had used a scheme.

Before DOTAS, accountancy firms were able to routinely market tax schemes to tax directors and corporate groups. The economics of the scheme usually relied on its being effective for two or three years before any legislative change could be enacted. For HMRC, before DOTAS it was often a struggle to keep up with the schemes that were being devised. HMRC tended to be one of the last to hear about a scheme, usually only when a company had to disclose something on a tax return. By that point, the scheme would probably have already been used by many companies. HMRC’s only options were to challenge the scheme in the courts, and to introduce legislation to block any loopholes to prevent future use – by which time the damage had already been done.

More recently, the government has introduced measures that have reduced the appetite for tax planning even further. In 2013, it introduced a general anti-abuse rule (GAAR) which was designed to prevent taxpayers from receiving tax advantages as a result of tax arrangements that are ‘abusive’; perhaps because they involve contrived or abnormal steps, were designed to exploit shortcomings in the legislation or were not consistent with the policy objectives behind the tax provisions. The regime allows HMRC to issue a GAAR counteraction notice in such cases – although it is not believed to have done so to date.

The accelerated payment notice (APN) regime, which was introduced a year later, also made tax schemes less attractive by requiring the tax in dispute as the result of a scheme to be paid up front to HMRC before a tribunal or court had established whether or not the scheme worked. In addition, HMRC has also been successful at challenging the effectiveness of many schemes in the courts.

Shift in public opinion

Over the years, the types of scheme that have to be disclosed to HMRC under DOTAS have been expanded. However, the number of schemes disclosed has also fallen significantly. In the first year of the new regime, to 31 March 2005, over 500 disclosures were made. This had fallen to less than 10 for the six months to 30 September 2014.

Although this is partly a sign of the effectiveness of the new regime and the other measures outlined above, one of the major reasons for this significant shift in behaviour – by large companies in particular – has been the shift in public opinion. Tax campaigners, charities, journalists and MPs have been vocal in the criticisms of companies, and multinationals in particular, who are perceived to have avoided tax – not just in the UK but in many other jurisdictions as well. The line between tax avoidance and tax evasion has been blurred in the public perception.

BEPS and forthcoming changes to international tax

Over the past few years, the OECD has been drawing up a package of measures to target the shifting of profits by multinational groups to low tax jurisdictions and the exploitation of mismatches between different tax systems so that little or no tax is paid. It published its 15-point ‘action plan’ on base erosion and profit shifting (BEPS) in July 2013, and has been developing its proposals since then. The final reports were published in October 2015, although significant work will be needed to turn the recommendations into legislation.

Once OECD member countries begin to implement its recommendations, we are likely to see restrictions on the tax relief that companies can obtain for interest payments. Currently, multinational groups can legally use significant intra-group interest deductions to reduce their taxable profits in companies located in high-tax jurisdictions, even in cases where the group as a whole has little or no external debt. There will also be a clampdown on the use of debt to create tax ‘mismatches’ where a deduction for interest expenses can be claimed in one company while the related income is brought into tax in another company, which is usually in another jurisdiction, later or not at all.

The rules governing when the activities of a company in another state constitute a ‘permanent establishment’, so giving rise to a tax liability in that other state, will also be tightened up. At the same time there will be an increased focus on transparency, with large companies being required to disclose to tax authorities a breakdown of financial information for all countries in which they make profits and pay taxes around the world.

In the UK: the diverted profits tax

The UK has already implemented a new diverted profits tax, designed to ensure that it gets what it perceives to be an appropriate share of tax on the profits of multinationals operating in the UK. It is also proposing measures to force large companies to publish their tax strategy, and to enable them to sign up to a voluntary code of practice in relation to their tax affairs, to come into force over the next few years. There are also proposals for a ‘special measures’ regime to penalise large companies which do not cooperate with HMRC, and to clamp down on advisers that continue to promote avoidance schemes that fail.

However, in pushing forward many of these measures, the UK government has itself failed to appreciate that the climate has changed and that very few companies now have the appetite to enter into marketed avoidance schemes. For any customer-facing business, the downsides of being criticised in the media for having avoided tax are simply too great. We have seen demonstrations outside stores and calls for boycotts of some companies’ products or services.

Tax has moved from being a backroom function to being something that the board takes a real interest in and few boards of major companies would now be prepared to sanction the use of an artificial tax avoidance scheme. At the same time, the thought of being tied up for years in litigation with HMRC over the efficacy of the scheme – having already paid the disputed tax – is not an attractive proposition for most.

So far, the debate over tax avoidance has largely focused on developed countries chasing their share of tax revenues. Over the next five to 10 years we can expect to see more of a focus on developing countries making their tax systems more sophisticated and putting up more of a fight to get their share of the tax cake.