Tax Morality in Corporate Tax
10 October 2013
Posted by: Author: Bernard Sacks
Author: Bernard Sacks (Mazars)
Corporate tax practitioners have traditionally focused on minimising companies’ tax burdens through whatever legal means are available. This practice has come into question, and notions of ‘fairness’ and ‘morality’ are quickly becoming a part of the global debate on taxes. This does not, however, simply signal a shift towards a more altruistic outlook. Since the global financial crisis, governments around the world are facing increasing fiscal deficits while, at the same time, having to respond to growing pressure from political and social stakeholders to increase spending as the economic downturn impacts on more and more individuals. The growth of multinational corporations brought with it a growth in tax planning expertise, with a focus on mitigating corporate tax through a variety of legal means, such as taking advantage of offshore tax havens, and maximising profits in subsidiaries located in countries with lower tax rates.
Indeed, countries vied with one another to offer attractive tax incentives in order to boost investment by multi-nationals into their economies. But all this is changing, and today governments everywhere are increasingly less sympathetic towards companies who engage in ‘planning’ to mitigate their tax liability. Civil society, the media and consumer groups have also taken up cudgels against such companies.
Recent high-profile cases demonstrate that corporate tax is in the spotlight. International brands such as Starbucks, Google, Apple and Amazon have all been criticised for tax planning practices that have resulted in low tax bills in both developed and emerging market countries. Closer to home, SAB Miller has been accused of dodging taxes in Africa and is the subject of intense scrutiny by civil rights group ActionAid, a Johannesburg- based international organisation that aims to ‘alleviate poverty and social injustice across the planet’.
Their report on the multinational brewing giant, Calling Time: Why SAB Miller should stop dodging taxes in developing countries caught the attention of tax officials across Africa, resulting in a meeting of a number of tax authorities from African countries, facilitated by the African Tax Administration Forum (ATAF), where transfer pricing in developing countries was a key topic of discussion. ActionAid contends that tax breaks on big companies’ profits cost developing countries over US$138 billion in tax every year globally – money which, they say, could be used to improve public services such as health and education.
Some African countries are waking up to the lost revenue that practices such as transfer pricing can engender, and are tightening up on transfer pricing regulations. In South Africa, the revision of Section 31 of the Income Tax Act 58 of 1962 to align SA’s legislation with the OECD Model Tax Convention was one of the major steps taken to address this issue. The revised legislation makes arm’s length transactions compulsory for all international dealings between connected persons.
At the same time, countries’ local tax authorities are starting to impose withholding taxes on payments to companies in other countries. Namibia, for example, in certain circumstances imposes a withholding tax of 25% on the gross fees payable to a non-resident for services rendered by a company resident in another country.
Aligned with transfer pricing, is the issue of thin capitalisation. A new draft interpretation note from SARS on Section 31 of the Income Tax Act released in March this year will force companies to justify the loans they receive from foreign shareholders. The note covers the application of thin capitalisation rules. Historically a company would have been considered to have been thinly capitalised if its debt from foreign shareholders or connected persons is excessive in relation to its equity.
Previously, companies followed what was known as the ‘safe harbour’ provision which said that as long as their debt to equity ratio did not exceed 3:1, companies would not be considered thinly capitalised. Companies will now have to apply an arm’s length test to determine the acceptable amount of debt. The process to be able to demonstrate an arm’s length basis is now far more rigorous. The current proposals provide for safe harbour provisions in terms whereof interest not exceeding a prescribed rate and not exceeding a prescribed percentage of taxable income will be regarded as not being excessive. Regrettably, such measurement criteria do not adequately make provision for situations such as start-up enterprises or temporary adverse trading conditions.
SARS is trying to prevent the profits of South African companies being stripped out and paid to foreign shareholders as interest. Currently foreign shareholders may qualify for exemption from South African income tax on such interest. When SARS introduces withholding tax on interest (expected to come into effect 1 January 2015), qualifying foreign shareholders will (subject to tax treaty relief) pay 15%.
Is Corporate Tax a Moral Issue?
Not everyone is on the side of those calling for a moral underpinning to corporate tax. Global business icon Bill Gates, for example, recently said on Australian television programme Q&A that corporate tax is not a moral issue, and by following local laws companies are doing the right thing. He said that if someone wants those companies to pay more tax they should change the rules. Google chief Eric Schmidt is also quoted as saying if countries didn’t like Google’s tiny tax bills, they should change the laws. And in its testimony before the US Senate Committee, Apple noted that companies consider themselves obligated to their shareholders to carefully manage their post-tax income through appropriate structures.
What the OECD Says
On 19 July this year, at the request of the G20 finance ministers, the Organisation for Economic Development and Cooperation published an Action Plan on Base Erosion and Profit Shifting to address the perceived deficiencies in existing international tax and transfer pricing rules. It proposes 15 action points subdivided into transparency and disclosure actions, treaty-related actions, and permanent establishment and transfer pricing actions. The target completion date for the Plan is 31 December 2015 or earlier. Although much of the popular attention on this issue has focused on businesses operating in the digital economy such as Amazon and Google, most of the proposed initiatives will also affect companies operating in the conventional economy. They include a strengthening of the CFC rules and initiatives to limit the erosion of the tax base by use of interest deductions and other financial payments, to counter harmful tax practices more effectively, taking into account transparency and substance, and to prevent treaty abuse.
This article was first published in TaxTalk magazine (Spetember/October Edition 2013)