The Real Cost Of Global Tax Reform: An Unsustainable Increase In Accounting And Legal Fees

Leaders from the Group of 20 largest economies (G20) met in Turkey last month to put their final stamp of approval on a major overhaul of the international rules governing corporate taxes. The vote was the icing on a cake that the Organization for Economic Cooperation and Development (OECD) has been baking for many years with the goal of clamping down on tax avoidance among multinational corporations.

The formal name for the OECD plan is the Base Erosion and Profit Shifting project, but it has been conveniently reduced to a four-letter word by most tax professionals who simply refer to it as BEPS. And it’s about to become their biggest headache.

The full BEPS plan calls for a far-reaching list of recommended changes to tax policy and taxpayer reporting requirements. Chief among these is a country-by-country reporting requirement, which requires companies to declare the amount of revenue, profit and tax paid in each country in which they do business, along with details on total employment, capital and assets used in each location. According to the OECD, this detailed reporting process would provide tax authorities with complete transparency into profit generated in each tax regime, and would eliminate any vagaries around where exactly the profits on goods sold can be claimed.

But that’s not how many big companies see it. In fact, according to Mary Van Veen, vice president of tax at DuPont, the country-by-country reporting requirement spelled-out in BEPS provides just enough detail to be dangerous, but not enough to be useful. She explained:

“BEPS will embolden tax authorities to audit multinational companies based on superficial data that is included in the country-by-country reporting mandate without any real understanding of the underlying business.”

She explained the types of common tax scenarios that multinational corporations encounter that will stymie an effort like BEPS:

“For example, let’s say you are a U.S. based corporation with operations in 80 countries. Under the BEPS country-by-country reporting scenario tax authorities will be provided with baseline data about your total revenues generated in each country, number of employees in that country and overall size of your operation in that country.

“It’s extremely likely that tax authorities in higher tax countries will audit your company if they see that you have more employees there than in Switzerland, a lower tax country, yet you report higher revenue in Switzerland. This will happen with very little understanding of the make-up of those employees, what types of jobs they have and the level of responsibility they hold. The employees in Switzerland may have strategic and tactical responsibility for the entire EMEA region, and may hold all of the intellectual property employed in the region, but that level of detail is not reported under BEPS.

“It’s over-simplified to allow tax authorities to pull out what they like and make a case on it, without having a conversation with the company about what’s really happening in each country.”

Van Veen is right. Her thesis has been proven repeatedly throughout the history of corporate taxation and efforts to simplify it. The fact is: corporate tax is hugely complicated. Complete transparency into the tax strategy of a giant corporation with operations around the globe would require a level of detailed scrutiny that no tax authority could ever hope to implement. So, instead, they look for a few basic red flags – such as larger number of employees generating a smaller chunk of revenue than a comparable amount of employees in another country – and then start auditing.

How will that impact corporations? For one, it will get expensive. The multinationals I’ve been talking with are all expecting a flood of governmental scrutiny from tax authorities around the globe that could crush their existing tax departments with increased tax audits and conflict resolution.

Van Veen estimates that her team at DuPont will likely double the amount of time they currently spend on controversy resolution as a result of BEPS. But that’s just part of the cost. There will also be a huge administrative cost involved with integrating systems and getting all of the information required for country-by-country reporting ready for dissemination.

Longer-term, the costs could be even more significant. The grim reality is that all of this is happening at a time when tax compliance budgets at multinational corporations are shrinking. The macroeconomic situation is not terribly good right now, particularly in China and Europe, where companies are pulling out all of the stops to generate quarterly earnings growth despite a global economic slowdown. Pair this tepid economic outlook with a potentially huge drain on personnel and economic resources resulting from increased tax conflict and it becomes clear that something’s got to give.

Could this eventually rear its head in corporate profits? It may. In fact, it’s an area we plan to explore further very soon. The issue will also likely rear its head in mergers and acquisition activity with tax-driven inversion deals likely to become more and more common.

U.S. lawmakers have already begun to raise red flags about the possible negative implications of BEPS. In a Congressional hearing this week, House Ways and Means Tax Policy Subcommittee chairman Charles Boustany, (R-La) said:

“This is a highly subjective standard set by the OECD that seems to unnecessarily target American companies, while also disregarding the detrimental impact these recommendations will have on U.S. companies that currently operate under the worldwide system of taxation observed in the U.S.”

Van Veen pointed out that with so much scrutiny being placed on companies to show evidence to support their tax structures in low tax regimes such as Switzerland and Ireland, many may end up moving additional substance to those locations beyond what is technically required. This will have the opposite of the effect intended by the OECD in that much-needed jobs may move from higher tax countries to lower tax regimes to counter the impact of BEPS.

“As a public company, we have the obligation to maximize return to shareholders. Multinationals are obligated to structure their companies in ways that maximize their return, which includes legally minimizing taxes. There may be companies that have taken that too far, but not every multinational deserves black-eye for legally fulfilling their fiduciary responsibility to shareholders. U.S.-based multinationals are already operating at a disadvantage relative to our foreign competitors due to our outdated and archaic tax code. These companies will now spend significant additional resources to defend their non-abusive tax structures.”